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Absolute advantage

In economics, the 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.[1][2][3][4][5][6] Adam Smith first described the principle of absolute advantage in the context of international trade, using labor as the only input.

Since absolute advantage is determined by a simple comparison of labor productivities, it is possible for a party to have no absolute advantage in anything;[7] in that case, according to the theory of absolute advantage, no trade will occur with the other party.[8] It can be contrasted with the concept of comparative advantage which refers to the ability to produce a particular good at a lower opportunity cost.

Contents


Origin of the theory

The main concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication An Inquiry into the Nature and Causes of the Wealth of Nations in which he countered mercantilist ideas.[7][9] Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism 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.[7] Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves.[10] 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.

Examples

Example 1

Party B has the absolute advantage.
Party B has the absolute advantage.

  • 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 C has the absolute advantage.
Country C has the absolute advantage.

  • 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 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
  • Economies of scale
  • Gains from trade
  • Global labor arbitrage
  • Heckscher-Ohlin model
  • Intra-industry trade
  • New trade theory
  • On the Principles of Political Economy and Taxation
  • Real wage
  • Relative price
  • Revealed comparative advantage
  • Ricardian model
  • Supply and demand
  • Trade

References

External links

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