Absolute advantage is the most basic yardstick of economic performance – it means that one economy can produce something for lower costs than another; fewer resources are required to produce the same number of goods. Panama, a tropical country, can produce bananas much more cheaply than Canada, which would need expensive greenhouses. Panama has an absolute advantage over Canada as far as banana production is concerned.
If one economy, company or person can produce more of a good with the same amount of effort and resources than others, they have an absolute advantage over them. The term was coined over 250 years ago by the Scottish economist and philosopher Adam Smith.
For many complicated products, absolute advantage is difficult to measure, because several factor inputs are involved.
The Economist says the following regarding absolute advantage:
“This is the simplest yardstick of economic performance. If one person, firm or country can produce more of something with the same amount of effort and resources, they have an absolute advantage over other producers.”
“Being the best at something does not mean that doing that thing is the best way to use your scarce economic resources. The question of what to specialize in–and how to maximize the benefits from international trade–is best decided according to comparative advantage.”
Comparative vs. absolute advantage
If an economy has an absolute advantage, it does not necessarily mean that it should be producing that good. An economy with a comparative advantage, however, should be producing it.
While absolute advantage refers to the difference in productivity of nations, companies or individuals, comparative advantage refers to higher or lower opportunity costs.
Comparative advantage is the ability of, for example, one economy to produce a particular product or service at a lower marginal and opportunity cost over another.
Opportunity cost refers to the benefit that an economy could have received, but gave up, to take a different course of action. In other words, opportunity cost is the difference in the cost between what an economy, company or individual chooses to do and what they could have done. When a person is looking at opportunity cost, he or she will think: “If I do this, what will I have to give up?”
Absolute and comparative advantage do not remain the same or change in parallel – they may evolve differently over time.
A country’s advantage may be absolute in producing several different goods, however, it is not advisable to try to produce all of them. Ideally, it should focus on goods where it has a relative advantage.
Examples of absolute advantage
The Canadian economy, where low-cost land is abundant, has an absolute advantage in agricultural goods relative to most other countries in the world.
China, Thailand and Vietnam, on the other hand, produce and export low-cost manufactured goods – they have an absolute advantage because of their considerably lower unit labor costs.
While the United States produces 700 million gallons of wine annually, Italy produces more than 4 billion gallons. Italy has an absolute advantage because it produces each bottle of wine using fewer resources than the US does. Italy’s output is considerably greater than the US’ over the same amount of time.
Imagine carpenter John can make a table in 10 hours, while carpenter Bill can make an identical table in 8 hours. Bill has an absolute advantage over John because it takes him fewer hours to produce one table.
However, this does not necessarily mean Bill should be making tables. Bill should then look at his comparative advantage in producing tables, i.e. against other activities. If he finds that he makes more money making chairs, he should focus on being a chair-maker.
Absolute advantage – Adam Smith
Adam Smith (1723-1790), a Scottish moral philosopher and pioneer of political economy, known by economists today as the ‘father of modern economics’, said that nations should specialize in making goods and providing services in which they have an absolute advantage.
Mr. Smith first described the principles of absolute advantage in his 1776 publication An Inquiry into the Nature and Causes of the Wealth of Nations. He described it in an international trade context.
When economies specialize and trade, they are able to move beyond their domestic markets and can consume a greater quantity of goods as a result.
According to Mr. Smith, it is not possible for all economies to become rich simultaneously by following mercantilism, because what one country exports another imports.
Instead, all countries would gain simultaneously if they traded freely and specialized in accordance with their absolute advantage.
“What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. The general industry of the country, being always in proportion to the capital which employs it, will not thereby be diminished….. but only left to find out the way in which it can be employed with the greatest advantage.”
(Adam Smith, The Wealth of Nations, Book IV:2, Modern Library edition)
Comparative and absolute advantage quotes
In a paper published in the University of Washington website, Prof. Harrington explains Adam Smith’s absolute advantage theory:
“Political and economic liberalism found their expression in Smith’s argument that the wealth of nations depends upon the goods and services available to their citizens, rather than the gold reserves held by the sovereign.”
“Maximizing this availability depends, first, on putting all resources to use, and then, on the ability to obtain goods and services from where they are produced most cheaply (because of ‘natural’ or ‘acquired’ advantages), and to pay for them by production of the goods and services produced most cheaply in the country, with costs measured in terms of direct and “embedded” labor inputs.”
American Nobel laureate Paul Samuelson (1915-2009) was once challenged by American-Polish mathematician Stanislaw Ulam (1909-1984) to “name me one proposition in all of the social sciences which is both true and non-trivial.”
According to the World Trade Organization, it took several years before Samuelson came back with a response, which he suggested was comparative advantage. Regarding comparative advantage, Samuelson said:
“That it is logically true need not be argued before a mathematician; that is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them.”
The term should not be confused with competitive advantage, which simply refers to the features that give a firm an edge over its competitors regarding a specific good or service. Examples include price, quality, longer-lasting guarantees, credit terms, access to raw materials, and faster delivery times.