Absolute advantage

Absolute advantage

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In economics, principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources. Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

 first described the principle of absolute advantage in the context of international trade
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...

, using labor as the only input.

Since absolute advantage is determined by a simple comparison of labor productivities
Labor productivity
Workforce productivity is the amount of goods and services that a worker produces in a given amount of time. It is one of several types of productivity that economists measure. Workforce productivity can be measured for a firm, a process, an industry, or a country...

, it is possible for a party to have no absolute advantage in anything; in that case, according to the theory of absolute advantage, no trade will occur with the other party. It can be contrasted with the concept of comparative advantage
Comparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...

 which refers to the ability to produce a particular good at a lower opportunity cost
Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the best alternative that is not chosen . It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices. The opportunity cost is also the...

.

Origin of the theory


The main concept of absolute advantage is generally attributed to Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

 for his 1776 publication An Inquiry into the Nature and Causes of the Wealth of Nations in which he countered mercantilist ideas. Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism
Mercantilism
Mercantilism is the economic doctrine in which government control of foreign trade is of paramount importance for ensuring the prosperity and security of the state. In particular, it demands a positive balance of trade. Mercantilism dominated Western European economic policy and discourse from...

 because the export of one nation is another nation’s import and instead stated that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage. Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves. While there are possible gains from trade with absolute advantage, the gains may not be mutually beneficial. Comparative advantage focuses on the range of possible mutually beneficial exchanges.

Example 1


  • Party A can produce 5 widgets per hour with 3 employees.
  • Party B can produce 10 widgets per hour with 3 employees.


Assuming that the employees of both parties are paid equally, Party B has an absolute advantage over Party A in producing widgets per hour. This is because Party B can produce twice as many widgets as Party A can with the same number of employees.

Example 2


  • Country A can produce 1000 parts per hour with 200 workers.
  • Country B can produce 2500 parts per hour with 200 workers.
  • Country C can produce 10000 parts per hour with 200 workers.


Considering that labor and material costs are all equivalent, Country C has the absolute advantage over both Country B and Country A because it can produce the most parts per hour at the same cost as other nations. Country B has an absolute advantage over Country A because it can produce more parts per hour with the same number of employees. Country A has no absolute advantage because it can't produce more goods than either Country B or Country C given the same input.

Example 3


You and your friends decided to help with fundraising for a local charity group by printing t-shirts and making birdhouses.
  • Scenario 1: One of your friends, Gina, can print 5 t-shirts or build 3 birdhouses an hour. Your other friend, Mike, can print 3 t-shirts an hour or build 2 birdhouses an hour. Because your friend Gina is more productive at printing t-shirts and building birdhouses compared to Mike, she has an absolute advantage in both printing t-shirts and building birdhouses.

  • Scenario 2: Suppose Gina wasn't as agile with the hammer and could only make 1 birdhouse an hour, but she took a sewing
    Sewing
    Sewing is the craft of fastening or attaching objects using stitches made with a needle and thread. Sewing is one of the oldest of the textile arts, arising in the Paleolithic era...

     class and could print 10 t-shirts an hour. Mike on the other hand takes woodworking and so he can build 5 birdhouses an hour, but he doesn't know the first thing about making t-shirts so he can only print 2 t-shirts an hour. While Gina would have the absolute advantage in printing shirts, Mike would have an absolute advantage in building birdhouses.

Further reading

  • Irwin, Douglas A. 1996. Against the Tide: An Intellectual History of Free Trade.Princeton: Princeton University Press.
  • Smith, Adam. 1776. An Inquiry into the Nature and Causes of the Wealth of Nations, The Glasgow edition of the works and correspondence of Adam Smith, edited by R.H. Campbell and A.S. Skinner, 1981, Liberty Press.
  • Schumpeter, Joseph A. 1954. History of economic analysis. Twelfth printing, 1981, George Allen & Unwin.
  • Trefler, Daniel. 1995. "The Case of the Missing Trade and Other Mysteries." American Economic Review 85: 1029-1046.

See also


  • Comparative advantage
    Comparative advantage
    In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...

  • Economies of scale
    Economies of scale
    Economies of scale, in microeconomics, refers to the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. "Economies of scale" is a long run concept and refers to reductions in unit...

  • Gains from trade
    Gains from trade
    Gains from trade in economics refers to net benefits to agents from allowing an increase in voluntary trading with each other. In technical terms, it is the increase of consumer surplus plus producer surplus from lower tariffs or otherwise liberalizing trade...

  • Global labor arbitrage
    Global labor arbitrage
    Global labor arbitrage is an economic phenomenon where, as a result of the removal of or disintegration of barriers to international trade, jobs move to nations where labor and the cost of doing business is inexpensive and/or impoverished labor moves to nations with higher paying jobs...

  • Heckscher-Ohlin model
    Heckscher-Ohlin model
    The Heckscher–Ohlin model is a general equilibrium mathematical model of international trade, developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. It builds on David Ricardo's theory of comparative advantage by predicting patterns of commerce and production based...

  • Intra-industry trade
    Intra-industry trade
    Intra-industry trade refers to the exchange of products belonging to the same industry. The term is usually applied to international trade, where the same kinds of goods or services are both imported and exported.-Examples:...

  • New trade theory
    New Trade Theory
    New Trade Theory is a collection of economic models in international trade which focuses on the role of increasing returns to scale and network effects, which were developed in the late 1970s and early 1980s....

  • On the Principles of Political Economy and Taxation
    On the Principles of Political Economy and Taxation
    On the Principles of Political Economy and Taxation is a book by David Ricardo on economics. The book concludes that land rent grows as population increases...

  • Real wage
    Real wage
    The term real wages refers to wages that have been adjusted for inflation. This term is used in contrast to nominal wages or unadjusted wages. Real wages provide a clearer representation of an individual's wages....

  • Relative price
    Relative price
    A relative price is the price of a commodity such as a good or service in terms of another; i.e., the ratio of two prices. A relative price may be expressed in terms of a ratio between any two prices or the ratio between the price of one particular good and a weighted average of all other goods...

  • Revealed comparative advantage
    Revealed comparative advantage
    The revealed comparative advantage is an index used in international economics for calculating the relative advantage or disadvantage of a certain country in a certain class of goods or services as evidenced by trade flows...

  • Ricardian model
  • Supply and demand
    Supply and demand
    Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...

  • Trade
    Trade
    Trade is the transfer of ownership of goods and services from one person or entity to another. Trade is sometimes loosely called commerce or financial transaction or barter. A network that allows trade is called a market. The original form of trade was barter, the direct exchange of goods and...


External links



  • Absolute Advantage, University of Washington
  • http://www.investopedia.com/terms/a/absoluteadvantage.asp
  • http://www.investopedia.com/university/economics/economics2.asp
  • http://www.economypedia.com/wiki/index.php?title=Absolute_advantage