Absolute Advantage and Comparative Advantage are two distinct terms related to International Trade and Economics. They are some major determinants of the reasons and ways in which businesses and countries allocate resources to the production of certain goods.
Absolute Advantage vs Comparative Advantage
The main difference between Absolute Advantage and Comparative Advantage is that the former compares businesses or countries in terms of their capability to produce more with a lesser quantity of inputs. While the latter compares countries or enterprises in terms of their ability to manufacture a particular commodity at a lesser marginal and opportunity cost.
Absolute advantage refers to a situation in which a business or a country can produce a commodity at a faster rate, higher quality and a profit that is higher than another contesting business or country.
Comparative Advantage, on the other hand, describes a situation in which a country or business can manufacture commodities and services at a lower opportunity cost than another contesting country or business.
Comparison Table Between Absolute Advantage and Comparative Advantage (in Tabular Form)
| Parameter of Comparison | Absolute Advantage | Comparative Advantage |
|---|---|---|
| Definition | An enterprise or a nation that can produce higher quality goods or services with lesser inputs and lower cost is said to hold an absolute advantage over the production of that goods or services over other contenders. | An enterprise or a nation that can produce higher quality goods or services at a lower opportunity cost than other contenders is said to have a comparative advantage over other contenders. |
| Significance | It acts as the foundation for earning greater profits from exchanges between different entities having an absolute advantage over different goods and services. | It encourages producers to specialise in the production of certain commodities and services. |
| Compares | Productivity of the countries. | Potential gain lost in the production. |
| Developed by | Adam Smith | David Ricardo |
| Limitation | Cannot work even if one of the producers does not have an absolute advantage over any of the commodities or services. | Interference of domestic politics acts as an impediment in the actualisation of the Comparative Advantage Model. |
What is Absolute Advantage?
It refers to the ability of an entity or a country to produce a commodity or service at a cost that is lower than any other contender. To have an Absolute Advantage in the production of a commodity or service, the entity or the country needs to produce that commodity or service with lesser inputs or within lesser time than the other country or entity producing the same commodity or service.
The theory of Absolute Advantage was advanced by Adam Smith in his famous work, Wealth of Nations. Through this concept, he tried to explain how nations can benefit from trade by specialising in the production of certain commodities or services and exporting them to gain an upper hand over other nations producing the same commodity or services.
Nations having an absolute advantage in the production of certain goods or services can use the profits earned from the sale of those goods or services to buy commodities and services from other nations in which they are lacking.
If all the nations follow the same process and exchange goods and services in which they have an absolute advantage, then all the nations can gain from such a relationship. However, it is important to note that such a relationship is practicable only when each of those nations have at least one commodity or service in which they hold an absolute advantage over others.
For example: Country A produces both wine and corn. But Country B produces better quality wines with a lesser quantity of inputs and sells for a greater profit. Thus, Country B is said to hold an absolute advantage in the production of wine. Therefore, in this scenario, Country A should concentrate on the production of corn in which it may hold an absolute advantage rather than contesting Country B’ s efficiency in wine production.
What is Comparative Advantage?
It refers to the ability of an entity or a country to produce a commodity or service at a lower foregone opportunity cost than that of other trading entities or countries. It doesn’t mean that a particular enterprise or country is more efficient in producing a particular commodity or service. Rather it implies that the enterprise of the country has to sacrifice less to produce that commodity or service.
The concept was developed by David Ricardo in his famous book On the Principles of Political Economy published in 1817. In this book, he tried to explain how England and Portugal would mutually benefit if they tried to specialise in the production of goods in which they have comparative advantage rather than producing goods that would demand higher cost and inputs. Accordingly, he suggested that Portugal should concentrate on the production of wine and England should focus on the manufacturing of clothes.
Central to this concept is the idea of opportunity cost that is defined as the potential gain lost due to the selection of a particular alternative over another. A company or a country that produces a commodity at a lower rate of potential gain lost is said to have a comparative advantage over its contenders in the production of that commodity.
Comparative Advantage can also be thought of as the best alternative between two alternatives having both advantages and disadvantages or a trade-off.
It is based on the idea that voluntary trade and cooperation can mutually benefit all enterprises or nations at all times. It encourages nations or businesses to increase efficiency in the production of goods or services having lower opportunity cost so that they can mutually benefit each other.
For example: Suppose both Country C and Country D produce wine and corn. In Country C, the opportunity cost for the production of 1 unit of wine is equal to 2 units of corn. While in Country D, it is equal to 0.25 units of corn. Therefore, in this scenario Country D is said to have a comparative advantage over Country C in wine production.
Consequently, even if Country C holds an absolute advantage on the production of both wine and corn, it will try to focus on the production of corn and Country D will concentrate on the production of wine. After that, they will trade with each other and benefit mutually.
The theory of Comparative Advantage is regarded as the basic tenet of the theory of international trade.
Main Differences Between Absolute Advantage and Comparative Advantage
- Both Absolute and Comparative Advantage are important for the workability of the international trade. While the latter enables countries to decide the goods and services they would like to develop. The former ensures efficiency in the production of those goods and services.
- With the concept of opportunity cost, Comparative Advantage helps in determining which goods or services should be produced domestically and which of them should be imported from other countries. While Absolute Advantage focuses only on improving production and increasing exports. It does not help in making such decisions.
- Absolute Advantage distinguishes between countries or enterprises in terms of their productivity. While Comparative Advantage distinguishes between countries or entities in terms of their foregone opportunity cost.
- Absolute Advantage concentrates on making the production of a specific product more efficient. Conversely, Comparative Advantage is more comprehensive and aims to ensure that enterprises or countries have the required resources to produce diverse commodities and services.
- The concept of Absolute Advantage may not be practicable even if one of the producers involved in the trade are lacking in any absolute advantage in the production of some commodity or service. While domestic politics like government interference for ensuring full-employment, national self-sufficiency, protection of the agricultural sector etc. act as an impediment in the actualisation of Comparative Advantage.
Conclusion
Both are distinct economic terms used to make comparison between companies or countries involved in domestic or international trade. They also justify why business entities or countries should trade with each other.
If two businesses or countries having Absolute Advantage in certain commodities or services trade with each other, then they can mutually benefit from such an exchange. And even if a producer does not have an Absolute Advantage in production of certain commodities or services, the businesses or countries can still benefit from such a relationship by specialising in goods or services based on their respective Comparative Advantages.
References
- https://www.nber.org/papers/w10668.pdf
- https://cloudfront.escholarship.org/dist/prd/content/qt07g7g8h8/qt07g7g8h8.pdf