China and other Asian economies export low-cost manufactured goods, which take advantage of their much lower unit labor costs. China and Consumer Electronics : Many consumer electronics are manufactured in China. China can produce such goods more efficiently, which gives it an absolute advantage relative to many countries. Imagine that Economy A can produce 5 widgets per hour with 3 workers. Economy B can produce 10 widgets per hour with 3 workers.
Assuming that the workers of both economies are paid equally, Economy B has an absolute advantage over Economy A in producing widgets per hour.
This is because Economy B can produce twice as many widgets as Economy B with the same number of workers. Absolute Advantage : Party B has an absolute advantage in producing widgets.
It can produce more widgets with the same amount of resources than Party A. If there is no trade, then each country will consume what it produces. Adam Smith said that countries should specialize in the goods and services in which they have an absolute advantage. When countries specialize and trade, they can move beyond their production possibilities frontiers, and are thus able to consume more goods as a result.
A country has a comparative advantage over another when it can produce a good or service at a lower opportunity cost. In economics, comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another.
Even if one country is more efficient in the production of all goods has an absolute advantage in all goods than another, both countries will still gain by trading with each other.
More specifically, countries should import goods if the opportunity cost of importing is lower than the cost of producing them locally. Specialization according to comparative advantage results in a more efficient allocation of world resources. Larger outputs of both products become available to both nations. Imagine that there are two nations, Chiplandia and Entertainia, that currently produce their own computer chips and CD players.
Chiplandia uses less time to produce both products, while Entertainia uses more time to produce both products. Chiplandia enjoys and absolute advantage, an ability to produce an item with fewer resources. However, the accompanying table shows that Chiplandia has a comparative advantage in computer chip production, while Entertainia has a comparative advantage in the production of CD players. The nations can benefit from specialization and trade, which would make the allocation of resources more efficient across both countries.
Comparative Advantage : Chiplandia has a comparative advantage in producing computer chips, while Entertainia has a comparative advantage in producing CD players. Both nations can benefit from trade. It is important to distinguish between comparative advantage and competitive advantage. Though they sound similar, they are different concepts. Unlike comparative advantage, competitive advantage refers to a distinguishing attribute of a company or a product.
It may or may not have anything to do with opportunity cost or efficiency. For example, having good brand recognition or relationships with suppliers is a competitive advantage, but not a comparative advantage. In the context of international trade, we more often discuss comparative advantage. Absolute advantage refers to differences in productivity of nations, while comparative advantage refers to differences in opportunity costs. Absolute advantage compares the productivity of different producers or economies.
The producer that requires a smaller quantity inputs to produce a good is said to have an absolute advantage in producing that good.
The accompanying figure shows the amount of output Country A and Country B can produce in a given period of time. You may also have a look at the following articles —. Your email address will not be published. Save my name, email, and website in this browser for the next time I comment. Free Investment Banking Course. Login details for this Free course will be emailed to you. Forgot Password? Article by Madhuri Thakur. Differences Between Absolute and Comparative Advantage Absolute Advantage is the ability with which an increased number of goods and services can be produced and that too at a better quality as compared to competitors whereas Comparative Advantage signifies the ability to manufacture goods or services at a relatively lower opportunity cost.
Absolute Advantage Absolute advantage is when a country can produce particular goods at a lower cost than another country.
Both Absolute Advantages vs Comparative Advantage are popular choices in the market; let us discuss some of the major Difference. Basic Concept It deals with the lower marginal cost of production of a specific good in comparison to competitor Country.
It deals with lower marginal and opportunity cost of production of a specific good compared to competitor Country. Trade Benefits The concept of absolute advantage may not always be mutually beneficial for both the countries involved in the trade transaction.
Both the Countries in transactions are mutually benefitted because of the comparative advantage of each other. Cost of Production Absolute advantage refers to lowering the production cost of a specific good in comparison to competitors. Comparative advantage specifically refers to the lower opportunity cost of production of specific goods in comparison to competitors. Production of Goods Countries having an absolute advantage of producing a good produces a higher volume of that good with the same available resources.
Countries with comparative advantage take into account the production of multiple goods in a country while deciding the production of a specific good and resource allocation for the same. Comparative advantage considers the opportunity cost of production; it is more effective in decisions for resource allocation, domestic production, and import of specific goods. Consider a hypothetical world with two countries, Saudi Arabia and the United States, and two products, oil and corn.
Further assume that consumers in both countries desire both these goods. There is only one resource available in both countries, labor hours. Saudi Arabia can produce oil with fewer resources, while the United States can produce corn with fewer resources. Table 1 illustrates the advantages of the two countries, expressed in terms of how many hours it takes to produce one unit of each good.
In Table 1 , Saudi Arabia has an absolute advantage in the production of oil because it only takes an hour to produce a barrel of oil compared to two hours in the United States. The United States has an absolute advantage in the production of corn. We illustrate what each country is capable of producing on its own using a production possibility frontier PPF graph, shown in Figure 1.
Recall from Choice in a World of Scarcity that the production possibilities frontier shows the maximum amount that each country can produce given its limited resources, in this case workers, and its level of technology. Arguably Saudi and U. Thus, before trade, the Saudi Arabian economy will devote 60 worker hours to produce oil, as shown in Table 3. With the remaining 40 worker hours, since it needs four hours to produce a bushel of corn, it can produce only 10 bushels.
The slope of the production possibility frontier illustrates the opportunity cost of producing oil in terms of corn. Using all its resources, the United States can produce 50 barrels of oil or bushels of corn. Thus, in the U. Saudi Arabia can produce barrels of oil or 25 bushels of corn. In terms of corn, notice that Saudi Arabia gives up the least to produce a barrel of oil. These calculations are summarized in Table 4.
Again recall that comparative advantage was defined as the opportunity cost of producing goods. The United States gives up the least to produce a bushel of corn, so it has a comparative advantage in corn production. In this example, there is symmetry between absolute and comparative advantage. Saudi Arabia needs fewer worker hours to produce oil absolute advantage, see Table 1 , and also gives up the least in terms of other goods to produce oil comparative advantage, see Table 4.
Such symmetry is not always the case, as we will show after we have discussed gains from trade fully. But first, read the following Clear It Up feature to make sure you understand why the PPF line in the graphs is straight. When you first met the production possibility frontier PPF in the chapter on Choice in a World of Scarcity it was drawn with an outward-bending shape.
This shape illustrated that as inputs were transferred from producing one good to another—like from education to health services—there were increasing opportunity costs.
In the examples in this chapter, the PPFs are drawn as straight lines, which means that opportunity costs are constant. When a marginal unit of labor is transferred away from growing corn and toward producing oil, the decline in the quantity of corn and the increase in the quantity of oil is always the same. In reality this is possible only if the contribution of additional workers to output did not change as the scale of production changed.
The linear production possibilities frontier is a less realistic model, but a straight line simplifies calculations. It also illustrates economic themes like absolute and comparative advantage just as clearly.
Consider the trading positions of the United States and Saudi Arabia after they have specialized and traded. Given their current production levels, if the United States can trade an amount of corn fewer than 60 bushels and receives in exchange an amount of oil greater than 20 barrels, it will gain from trade.
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