Absolute Advantage (Economics) - Explained
What is Absolute Advantage?
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Table of ContentsWhat is Absolute Advantage?How to Determine Absolute AdvantageExamples of Absolute Advantage Academic Research on Absolute Advantage in Economics
What is Absolute Advantage?
The advantage of being able to produce a good or product with fewer input resources is called Absolute Advantage. The producer of the goods could be any legal entity from a single person, a business, to the economy of a country as a whole. It is a comparative term used in economics when comparing the output capacity of a country, business, or an individual in relation to another similar entity. The entity that produces more with less inputs has the Absolute Advantage.
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How to Determine Absolute Advantage
The metric of Absolute Advantage is the ability of an absolute unit to produce goods with fewer resources compared to another similar entity. Using fewer resources, incurring lower production and operational costs, and getting more returns deems it better at production than others. Access to better technology, cheaper labour, or more efficient operational procedures and production values is a given. Its a good way of drawing comparisons between goods producing ability of individuals, companies, and nations according to expenditure of resources. Since Adam Smith postulated this theory, its used as one of the basic metrics to compare international trade in the economic sphere. Smith posited that countries focus on specializing in producing goods they have an Absolute Advantage over. The theory also suggests that countries export these goods produced at low costs and efforts, and import goods they do not have Absolute Advantage in producing, from countries that do. This also keeps the fuel of international trade burning. But this theory in its basic form is too simplistic to explain international trade. For example, if a country X produces oil for $10 per barrel and coal for $12 per ton, while country Y produces oil for $12 per barrel and coal for $15 per ton, there could be no trade between the two. This is patently false as is evident from the actual trade scenario. Country X would have nothing to gain in trade with country Y according to the theory of Absolute Advantage. Thus it was concluded that international trade is conducted via Comparative Advantage as opposed to a strict adherence to Absolute Advantage. Renowned economist Adam Smith raised the question of why do countries trade goods, in his book The Wealth of Nations. In answering the question, he theorised that certain nations have an advantage in producing certain goods, but not all. Selling their better goods to buy other goods that are better made elsewhere is the first basis of international trade. He chose time - or the number of working hours required to produce a good - as the basic premise of measuring Absolute Advantage. Mercantilists believe that countries should strive to have as big a favourable trade balance as possible by maximizing the difference between their imports and exports. A country that produces the maximum number of goods to export, while its imports are few, has a favourable trade balance, as the difference in price is paid in Gold standard. Conversely, countries incapable of producing worthwhile goods need to import them from other countries, incurring a negative trade balance. Smith criticised this view and believed that the welfare of a country depended on meeting the needs of its populace and hence spending in acquiring goods while fuelling international trade was the way to go. He argues that production and consumption are the key factors to acquiring wealth and declares that needs of people, and the cost of social welfare must be prioritised. Thus he arrives at the theory of Absolute Advantage and how it is beneficial to all countries involved in international trade.
Examples of Absolute Advantage
Lets take the fictional example of Brazil vs China in the production of coffee and garments. Brazil requires 30 hours to produce a bag of coffee while China requires 60 hours to do the same. China requires 10 hours to produce a bolt of clothing while Brazil requires 40 hours to do the same. Considering the number of working hours required by each country to produce these goods as a homogenous source, Brazil has the Absolute Advantage in producing coffee while China has the Absolute Advantage in producing garments. Smiths theory falters when a certain country has the Absolute Advantage in producing the maximum number of goods. In this case the country would be almost self sufficient and has no need to participate in international trade. To counter this fallacy, economist David Ricardo suggested the theory of Comparative Advantage which also takes into account the opportunity cost of producing goods in addition to the number of working hours. Thus, countries rely on relative advantage of goods production to participate in international trade.
Academic Research on Absolute Advantage in Economics
- Absolute and comparative advantage, reconsidered: the pattern of international trade with optimal saving, Brecher, R. A., Chen, Z., & Choudhri, E. U. (2002). Review of International Economics, 10(4), 645-656. This review studies different economic models to reassess the theories of Absolute Advantage and Comparative Advantage in light of the recent technological advances and their impact on international trade.
- Agricultural productivity, comparative advantage, and economic growth, Matsuyama, K. (1992). Journal of economic theory, 58(2), 317-334. This journal focuses on economic growth relative to agricultural productivity of a country through the lens of the Comparative Advantage theory.
- Adam Smith's theory of absolute advantage and the use of doxography in the history of economics, Schumacher, R. (2012). Erasmus Journal for Philosophy and Economics, 5(2), 54-80. This article sheds light on Adam Smiths theory of Absolute Advantage by reconstructing historical doxographic models on economic theories. The author also critically examines Smiths perception in the economic sphere and his legacy.
- On Super Absolute Advantage of International Trade [J], Chong, L. I. (2005). International Trade Journal, 3, 002. This journal discusses the phenomenon of Super Absolute Advantage that results from the exchange of commodities between countries. The impact of this phenomenon on international trade is also examined.
- Linking Absolute and Comparative Advantage to IntraIndustry Trade Theory, Weder, R. (1995). Review of International Economics, 3(3), 342-354. This journal demonstrates the prevalence of relative advantage in international trade and the absolute differences in demand.
- National competitiveness and absolute advantage in a global economy, Parrinello, S. (2006). This essay takes a look at the different parameters that fuel international trade, competitive advantages at the national as well as global levels.
- A simple model of firm heterogeneity, international trade, and wages, Yeaple, S. R. (2005). Journal of international Economics, 65(1), 1-20. This paper sheds light on the difference in opportunity cost and production time thats made by heterogenous skill levels and wages, of homogenous factors like workforces, on international trade.
- A theoretical evaluation of alternative trade intensity measures of revealed comparative advantage, Vollrath, T. L. (1991). Weltwirtschaftliches Archiv, 127(2), 265-280. The author evaluates the indices of comparative advantages and the intensity of measures in global and bilateral trade.
- Firms' competitive and national comparative advantages as joint determinants of trade composition, Abd-el-Rahman, K. (1991). Review of World Economics, 127(1), 83-97. This review highlights the effect of national competitiveness in addition to comparative advantage that decide the trading goods composition of a country.
- A survey of the theory of international trade: Part 1, The classical theory, Chipman, J. S. (1965). Econometrica: Journal of the Econometric Society, 477-51z. This article surveys the classical international trade theory and discusses it in detail.
- Trade and the environment: from a 'Southern' perspective, Muradian, R., & Martinez-Alier, J. (2001). Ecological Economics, 36(2), 281-297. This article takes a look at the environmental cost of international trade and examines whether ecological cost impact the outcome of the trading economy. It considers and differentiates between the Northern and Southern perspective on the issue.
- Technology, geography, and trade, Eaton, J., & Kortum, S. (2002). Econometrica, 70(5), 1741-1779. This paper examines the different parameters in play related to Absolute Advantage in comparison with geographic limitations and comparative advantage, by developing Ricardian trade models.
- Comparative advantage and the normative economics of international trade policy, Sykes, A. O. (1998). J. Int'l Econ. L., 1, 49. This journal takes a look at international trade in light of normative economies and the Absolute Advantage enjoyed by a few.