What does it mean if one country has an absolute advantage over another country?

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Definition:

When a person, company, or society has an absolute advantage over another, it can produce more of the same product with the same or fewer inputs.

Takeaway

An absolute advantage is like getting something on sale…

When you go to a store and see a sale, you can buy the same number of products that you usually buy without spending as much money as you typically do. Absolute advantage is similar. If you have an absolute advantage over another producer, you can make more goods or services with fewer raw materials or less cash input into the process.

What is absolute advantage?

Absolute advantage is an economic term that describes when one producer of a good or service can make that product at a lower cost than another. Put another way, given the same number of inputs, the producer with absolute advantage can create more units of a product than the other. It refers to each party’s efficiency in production — The more efficient producer has an absolute advantage.

Economist Adam Smith introduced the concept of absolute advantage in 1776 when he wrote An Inquiry into the Nature and Causes of the Wealth of Nations. In the book, he argued that the path to wealth is for nations to specialize in producing products for which they have an absolute advantage and to allow free international trade so it can export the goods it makes and import the things it needs.

By focusing only on the things for which it has an absolute advantage, a country can make the most of its production capacity and create the most value, using the proceeds from trade to acquire other products more efficiently than producing them domestically

This idea contrasts with the concept of mercantilism, which dominated economic discussion and practice at the time. Under mercantilism, nations heavily restrict trade and work to produce everything they need within their borders. Economists usually use absolute advantage to compare countries, but they can use it to compare any two regions. For example, Nebraska might have an absolute advantage in producing corn when compared to Massachusetts, even though they are both part of the same country.

What are examples of absolute advantage?

One real-world example of absolute advantage is in oil production. Nations in the Middle East have an absolute advantage when it comes to producing oil. In oil-rich nations, businesses can use simple, inexpensive techniques to drill for the resource and get it in large quantities. In other countries, like the United States, producing oil requires more expensive efforts, such as offshore drilling.

Many Central and South American countries have an absolute advantage when producing coffee. The climate of these regions is uniquely suited for growing coffee, making it far easier for coffee seeds to grow into lucrative plants. A nation like Canada, with its rather cold climate, might not be able to produce coffee at all. If it could, it would involve expensive climate-controlled growing environments.

Chile and Zambia both have an absolute advantage over other parts of the world in terms of mining copper. Both countries’ lands happen to include large stores of copper, making it easy for them to build large-scale mining operations that harvest a lot of the metal.

What is the theory of absolute cost advantage?

The theory of absolute cost advantage states that two countries will only trade with each other if each has an absolute advantage over the other when it comes to producing a product. For example, country A will only exchange its coffee for country B’s copper if A has an absolute advantage for providing coffee, and B has an absolute advantage for producing copper.

What are the advantages and disadvantages of absolute advantage?

The benefit of the theory of absolute advantage is that it can help countries maximize their productivity and efficiency. If one country has an absolute advantage over every other when it comes to producing one product, having that nation focus all of its resources on creating that product benefits the whole planet. The producing country receives the most value for its labor by selling that product to other countries and can import any goods that it needs. There are, however, many disadvantages to the theory of absolute advantage.

One is that the theory relies on truly free trade between nations. In reality, this is rare as tariffs, quotas, and other factors add friction to trade between regions. Even if one nation can produce a product at a lower cost than its neighbors, trade restrictions could make it more efficient for those other countries to make the product domestically. They may even intentionally apply tariffs to protect domestic businesses from the other country’s advantage.

Another disadvantage is that focusing all of a country’s production on a single good is unrealistic and potentially dangerous. While a region may have an absolute advantage at manufacturing a product, if that product isn’t in high demand, focusing all of its resources on making it is a bad idea.

For example, uranium is useful for power nuclear power plants, but there are only about 440 reactors in the world. If a country with absolute advantage focused all of its resources on mining uranium, it could quickly outstrip demand, leaving it with a lot of uranium it cannot sell.

The theory of absolute advantage also assumes that trade involves only two parties and two goods. In reality, international exchange is much more complicated, with most countries trading with dozens of others and exchanging hundreds or thousands of different things.

What is the difference between absolute advantage and comparative advantage?

An absolute advantage is when one country can make something at a lower cost than another. Comparative advantage is when a nation can make something at a lower opportunity cost than another.

Consider this example:

With its resources, Country A can produce 100 pounds of coffee, or it can make 50 pounds of tea (it cannot make both). With the same resources, Country B can make 90 pounds of coffee or 48 pounds of tea. Country A has an absolute advantage for both products.

But the opportunity cost of producing each good looks like this:

In this scenario, Country B must sacrifice 1.875 pounds of coffee to make a pound of tea, but Country A has to sacrifice 2 pounds of coffee to make one pound of tea. Because Country B gives up less tea to make the same amount of coffee, it has a comparative advantage over Country A.

How do you calculate an absolute advantage?

To calculate absolute advantage, you must know the cost of the inputs involved in making something, as well as how much that region can make using those inputs. Then, compare the production capacity of one area to the production capacity of another, assuming both use the same inputs.

For example, Harry and Sally both like to knit and sell handmade scarves out of their home. They use the same raw materials and purchase them at the same price from the same store, meaning that the difference in production input is the amount of time it takes to make a scarf.

Harry can make five scarves in 20 hours, and Sally can make four scarves in 20 hours. In this scenario, Harry has an absolute advantage because he can make one more scarf than Sally using the same amount of time. Put another way; he makes one scarf every four hours, and Sally makes one every five hours. Sally is 80% as efficient as Harry when it comes to making scarves.

Does the US have an absolute advantage?

In the real world, it can be challenging to determine whether one country has an absolute advantage. The theory of absolute advantage assumes only two countries and two products are involved in trade, but real-life business involves many more parties and goods.

Some of the advantages that the United States has over other countries include a skilled workforce and many natural resources. This means that the U.S. likely has an absolute advantage when it comes to producing high-tech services and services like computers and software, as well as things that rely on large areas of farmland, such as corn.