What is Absolute Advantage? – With Examples

What is Absolute Advantage? - With Examples

Absolute advantage means the ability to produce a higher portion of goods and services using the same amount of output. As an example of absolute advantage, USA can produce computers (ex: 5 within an hour) more efficiently than Canada (ex: 2 within an hour) .

What is absolute advantage?

Absolute advantage means the ability to produce a higher portion of goods and services using the same amount of input or using less amount of inputs to produce the same quantity of goods and services by an individual, company, region or country than its rivals.

Theory of absolute advantage

The theory of absolute advantage says that there are only two countries and these countries trade with each other when they have an absolute advantage in producing products. As an example, when country X has an absolute advantage in producing wheat and country X exports its wheat to country Y by importing cloth from country Y that country Y has an absolute advantage in producing cloth. 

Who is the founder of the absolute advantage theory?

The famous economist “Adam Smith” has developed the theory of absolute advantage in his book “The Wealth of Nations” which was published in the 18th century. In this book, he explains how countries can gain from international trade by specializing in producing and exporting goods.

Smith stated that as long as each country has at least one good in which it has a clear advantage over other countries, specializing in the products in which they each have an absolute advantage and then selling the goods can benefit all countries.

According to Smith, based on specialization, subsequent trade and division of labour, countries can gain mutual benefits from trade. This, Smith believed, was the root source of the eponymous “Wealth of Nations.”

Absolute advantage examples

1. Absolute advantage examples in international trade

Absolute advantage examples

 International trade enables nations to buy goods at lower prices from other countries rather than producing them at high domestic rates. To engage in international trade, a country should apply the basic theory of “absolute advantage”.  

As a result of the unable of every country to produce all the goods and services, international trade has occurred. Further, some countries are more efficient to produce some goods than other countries. These countries can make goods and services at a lower absolute cost than other countries.

According to the absolute advantage theory, each country should specialize in producing certain goods at a lower absolute cost. Then they can produce these goods more than the domestic demand and export the extra amount. A country can import the goods and services that they are inefficient to produce when compared to other countries.

The final result of this process is countries are encouraged to export and import goods by engaging in international trade.

The benefit of the theory of absolute advantage is that it can help countries maximize their productivity and efficiency. As a result of the absolute advantage, countries can enjoy an output level beyond the production capacity.

Within the last few decades, many countries in the world have shown rapid economic growth. For example of absolute advantage, we can say, the USA, China, Japan, and South Korea have engaged in international trade regularly. One of the major reasons for these countries’ fast economic growth is engaging in international trade. 

Examples of absolute advantage – how to calculate absolute advantage

1.1 Example of absolute advantage – output approach

The output approach considers about the number of outputs that can be produced using a unit of inputs. That means when engaging in international trade, a country should produce more and export the commodity that it can get a higher number of outputs than another country using a unit of input. This country should produce less and import the commodity that they can get a lower number of outputs than another country using a unit of input.

Absolute advantage example – output approach

According to the above example, the USA can produce 3 mobile phones within a labour hour while Canada can produce 5 mobile phones within a labour hour. So, Canada can produce more mobile phones than the USA within a labour hour. In other words, Canada is more specialized to produce mobile phones than the USA. That means Canada has the absolute advantage of producing mobile phones.

The USA can produce 4 computers within a labour hour while Canada produces 2 computers within a labour hour. So, the USA can produce more computers than Canada within a labour hour. In other words, the USA is more specialized to produce computers than Canada. That means the USA has the absolute advantage of producing computers.

1.2 Example of absolute advantage – Input approach

The input approach considers the less number of inputs when producing a particular commodity. That means when engaging in international trade, a country should produce more and export more of the commodity that they can produce with less number of inputs than another country. This country should produce less and import more of the commodity that they produce with the higher number of inputs than another country.

Let’s consider the above mobile phone – computer example using the input approach.

Absolute advantage example – Input approach

The USA needs 1/3 of labour hours to produce a mobile phone while Canada needs 1/5 of labour hours to produce a mobile phone. So, Canada can produce mobile phones more than the USA using lower labour. In other words, Canada take lower cost to produce mobile phones than the USA. That means Canada has the absolute advantage of producing mobile phones

The USA needs 1/4 of labour hours to produce a computer while Canada needs 1/2 of labour hours to produce a computer. So, the USA can produce computers more than Canada using lower labour. In other words, the USA take lower cost to produce computers than Canada. That means the USA has the absolute advantage of producing computers.

We can draw Production Possibility Frontiers (PPF) of USA and Canada as follows. USA can produce more computers. That is why PPF of USA is aligned with vertical axis. Canada can produce more mobile phones. That is why PPF of Canada is aligned with horizontal axis.

Absolute advantage graph

absolute advantage graph

2. Example of absolute advantage in real life

The skills of people may differ from one person to another person. A chef can cook better than an accountant. An account can make accounts better than a musician. A musician can sing songs and play musical instruments better than a construction worker.

So, when producing goods and services, we can specialize people according to their skills. It will advantageous for not only one person but also for the entire society. This is how we can simply apply absolute advantage to maximize the individual output level. In other words, example of absolute advantage in real life. When we use the most skilled person for the relevant position, it will save the resources of society and give the maximum output level with excellent quality.

What are the sources of absolute advantage?

Low cost of production drives to achieve the absolute advantage. If it is related to the factors of production, not only labour, we can identify several ways that absolute advantage comes from.

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What are the four factors of production?

We can identify several ways that absolute advantage comes from as follows

1. Cheap factors of production (Ex: cheap labour, cheap capital)

2. Natural resources abundance (Ex: some countries are abundant with precious metals such as gold, and platinum)

3. Public infrastructure (Ex: a great public infrastructure can reduce the transport costs)

4. Higher level of productivity and efficiency. These are occurred through the division of labour, labour specialization, and technological advancements.

5 assumptions of the theory of absolute advantage

Adam Smith has developed the theory of absolute advantage based on the number of assumptions. Here are the most significant of these assumptions:

1. Factors of production are difficult to mobile

According to Adam Smith, factors of production cannot move between countries. He made this assumption to keep constant the production possibility frontier of nations after the trade

2. There are no trade barriers

Adam smith has assumed that there are no trade barriers to exchanging the goods such as government trade barriers including import and export taxes.

3. There are no trade imbalances.

Trade imbalances mean trade surpluses and deficits. Trade surpluses occur when exports are higher than imports. Trade deficits occur when imports are higher than exports. Adam Smith mentioned that exports must be equal to imports in international trade. So, there are no any trade imbalances.

4. There are only two countries and these two countries produce only two goods.

5. There are no economies of scale

If there are any economies of scale, when production is increased, the unit cost per the same good should be decreased. But Adam Smith assumes that there are constant returns not economies of scale. That means he assumed that, if we take one labour hour to produce one wheat kilogram, we need two hours to produce two wheat kilograms. But this is not practical. Because when country produce two kilograms of wheat, it may take less than two labour hours.

The theory of absolute advantage is not 100 percent correct. Because it is based on the above-mentioned assumptions and these assumptions are not true or practical.

What happens when a country has an absolute advantage in all goods?

High income countries can produce all the goods at a lower cost than low-income countries. Because high income countries abundant with the skilled employees, new technologies, advanced equipment, up-to-data production process.
So, is there any opportunity to still gains from international trade? Yes.
David Ricardo stated that still countries can get mutual benefits, although one country has an absolute advantage in all goods. For that each country should have comparative advantage to produce one good.

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