Absolute advantage is the ability of an individual, company, region, or country to produce a greater quantity of a good or service with the same quantity of inputs per unit of time, or to produce the same quantity of a good or service per unit of time. time using a smaller amount of inputs than another entity that produces the same good or service.
An entity with an absolute advantage can produce a product or service at a lower absolute cost per unit using fewer inputs or a more efficient process than another entity that produces the same good or service.
Ideas Clave
Absolute advantage is when a producer can produce a good or service in greater quantity for the same cost, or the same quantity at a lower cost, than other producers.
Absolute advantage can be the basis of large profits from trade between producers of different goods with different absolute advantages.
Through specialization, division of labor and trade, producers with different absolute advantages can always win over isolated production.
Absolute advantage is related to comparative advantage, which can open up even more widespread opportunities for the division of labor and profits in trade.
Understand the absolute advantage
The concept of absolute advantage was developed by Adam Smith in his book The Wealth of Nations to show how countries can benefit from trade by specializing in producing and exporting goods that they can produce more efficiently than other countries. Countries with an absolute advantage may decide to specialize in the production and sale of a specific good or service and use the funds that good or service generates to purchase goods and services from other countries.
According to Smith’s argument, specializing in products in which each has an absolute advantage and then marketing products can improve the situation of all countries, as long as each has at least one product for which it has an advantage. absolute over other nations.
Assumptions underlying the theory of absolute advantage
The idea of absolute advantage is based on a series of assumptions on the part of Adam Smith. Although influential and insightful, absolute advantage theory is not always entirely accurate because many of these fundamental assumptions are not true in practice. Here are the most important of these assumptions:
Lack of mobility for production factors
Adam Smith assumes that factors of production cannot move between countries. This assumption also implies that each country’s production possibilities frontier will not change after trade.
Trade barriers
There are no barriers to international trade for the exchange of goods. Governments implement trade barriers to restrict or discourage the import or export of a particular good. Since there are no trade barriers, in theory nations would be in similar conditions to exchange their goods and would be able to see in which segments they are really more competitive. However, there are many reasons why the advantages could vary such as taxes, exchange rate, cost of inputs, among others.
Balance of trade
Smith assumes that exports must equal imports. This assumption means that we cannot have trade imbalances, trade deficits, or surpluses. A trade imbalance occurs when exports are higher than imports or vice versa.
Constant returns to scale
Adam Smith assumes that we will earn constant returns as production scales, meaning there are no economies of scale. For example, if it takes 2 hours to make one loaf of bread in country A, then it should take 4 hours to produce two loaves of bread. Consequently, it would take 8 hours to produce four loaves of bread.
However, if there were economies of scale, it would be cheaper for countries to continue producing the same good as the quantities are higher.
General Example of Absolute Advantage
Consider the two hypothetical countries, Atlantica and Krasnovia, with equivalent populations and resource endowments, producing two products, guns and bacon. Each year, Atlantica can produce 12 guns or 6 rashers of bacon, while Krasnovia can produce 6 guns or 12 rashers of bacon. Each country needs a minimum of 4 guns and 4 rashers of bacon to survive. In a state of autarky, producing only for its own needs, Atlantica can spend a third of the year making weapons and two-thirds of the year making bacon for a total of 4 guns and two rashers of bacon, Krasnovia can spend a third of the year making bacon and two thirds of the year making weapons to produce the same, 4 guns and 4 rashers of bacon. This leaves each country on the brink of survival, with barely enough guns and bacon to go around. However, it is not that Atlantica has an absolute advantage in the production of pistols, and Krasnovia has an absolute advantage in the production of bacon.
Absolute advantage also explains why it makes sense for people, companies, and countries to trade. Since each has advantages in the production of certain goods and services, both entities can benefit from trade.
If each country specialized in its absolute advantage, Atlantica could make 12 weapons and zero bacon, while Krasnovia makes no weapons and makes 12 rashers of bacon. By specializing, the two countries divide their work tasks between them. If they then exchange 6 guns for 6 rashers of bacon, each country would have 6 of each. Both countries would now be better off than before, because each would have 6 guns and 6 rashers of bacon, instead of 4 of each good they could produce on their own.
This mutual gain from trade forms the basis of Adam Smith’s argument that specialization, division of labor, and subsequent trade lead to a general increase in wealth from which everyone can benefit. Smith believed this was the root cause of the nations’ eponymous wealth.
Absolute advantage and comparative advantage
Absolute advantage can be contrasted with comparative advantage, which is when one producer has a lower opportunity cost to produce a good or service than another producer. Absolute advantage leads to unambiguous gains from specialization and trade only in cases where each producer has an absolute advantage in the production of some good. If a producer lacks an absolute advantage, then Adam Smith’s argument would not necessarily apply. However, the producer and his trading partners could still gain from trade if they can specialize based on their respective comparative advantages.
