Absolute advantage and comparative advantage are two very important terms used in economics. Both terms usually come into use when talking about International Trade. Both these are simple terms to define the capacity of a business or a country as a whole to produce or manufacture a good absolutely on their own or choose to allocate resources to the activity that is of maximum benefit to the economy. Though people often use both terms to convey the same meaning, they are very different from each other. Thus, to understand the real meaning and use of both these terms, we need to know the differences between Absolute Advantage vs Comparative Advantage.
Meaning of Absolute & Comparative Advantage
Before we detail the differences, let us see what both terms mean:
Absolute advantage is a scenario in which a business or a country is wholly sufficient to continuously produce a higher quality product at better rates than others. A country might have an absolute advantage in producing some goods due to its natural resources, climate conditions, etc. For example, extracting oil in Saudi Arabia is easier due to its abundance.
On the other hand, comparative advantage means a business or the economy considers the opportunity cost while allocating limited resources to the production. Countries mostly consider comparative advantage to better allocate resources to the activities they can perform within the country more efficiently and at a lower cost. It is basically the ability of a company or country to make better goods in all respect than others.
For example, assume the US could produce 30 units of mobiles or 10 units of laptops with a given amount of resources. On the other hand, China could produce 15 units of mobiles or 30 units of laptops with its resources. Now, let’s see what the opportunity cost has to say. For the mobiles, the opportunity cost is 3 units for the US (30/10), while for China, it is 0.5 units (15/30). For the laptops, the opportunity cost is 0.33 (10/30) for the US and 2 (30/15) for China. This means that the US has a comparative advantage in producing mobiles, while China enjoys a comparative advantage in the production of laptops.
We can say that absolute advantage talks about the productivity of a nation and its absolute strength and command over the production of something. On the other hand, comparative advantage is all about defining the opportunity cost and enabling an economy to make better decisions.
Absolute Advantage vs Comparative Advantage: Differences
Following are the differences between absolute advantage and comparative advantage:
A country or company has an absolute advantage if it is impeccably more efficient at making or producing any product. On the other hand, a country or economy has a comparative advantage when it is comparatively more efficient at producing any product than any other company or country.
David Ricardo was the first economist to develop the theory of comparative advantage. The theory focuses on the differences in relative opportunity costs between different countries regarding the production of commodities. Adam Smith, the father of modern economics, came up with the theory of absolute advantage in his 1776 publication – The Wealth of Nations.
As with all the theories, both comparative and absolute advantage is also based on certain assumptions. Some of the main assumptions of both theories are:
For absolute advantage:
- Slow or no mobility of factors of production.
- Trade balance wherein exports must be equal to imports.
- No trade barriers for the exchange of goods.
- Persistent return to scale.
For comparative advantage:
- There are only two countries, and each produces only one commodity.
- Labor is the single factor of production and remains unchanged.
- The cost of labor is detrimental to the price of the commodity.
- Constant cost of returns.
- Mobility of factors of production.
- The exchange ratio between the two countries is the same.
- Factors of production are utilized to full capacity.
Benefit to Country
Absolute advantage assumes that the country having supremacy in producing the goodwill has the benefit. Trade under absolute advantage is not mutually beneficial; instead benefits the country with absolute advantage. Under comparative advantage, trade is mutually beneficial to both countries.
Cost as a Factor
In comparative advantage, opportunity cost comes into play because economies need to decide the best way to utilize their resources. Out of various alternatives, the country chooses the one that is in line with the resources and also the cost. For instance, assume Japan is better at producing electric cars than racing cars. Now, the country would focus on the former and import racing cars. Cost is the primary factor in absolute advantage (not the opportunity cost).
Allocation of Resources
Absolute advantage does not consider the opportunity cost, and therefore, resource allocation is not relevant. On the other hand, comparative advantage considers resource allocation as it takes the opportunity cost into account.
What does it Tell?
Absolute advantage helps to understand the allocation of resources and international trade patterns. On the other hand, comparative advantage helps in understanding the direction of international trade.
Mutual and Reciprocal
Under absolute advantage, the trade is not mutual and reciprocal. On the other hand, the comparative advantage theory is mutual and reciprocal.
Absolute Advantage vs Comparative Advantage: Which is Better?
There is often a doubt that it is possible for a country to have a comparative advantage without having an absolute advantage. The fact is that the whole concept of comparative advantage is the real reason why countries do trade. Even if a country does not have the resources to have an absolute advantage in producing or manufacturing something, it can still engage in international trade and benefit from it via the concept of comparative advantage.
Having an absolute advantage, however, does not always mean that a company will have a comparative advantage. In fact, it depends on the opportunity costs. While the comparative advantage is what an economy achieves or takes up by giving up a small opportunity, absolute advantage is what an economy is unmatched at.
While the absolute advantage is almost non-existent in the real-world, comparative advantage ensures that countries can always engage in trades and play on their strength.
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