Absolute Advantage Vs Comparative Advantage

By Sean Stevenson – Latest Revision January 22nd, 2021

What Is An Absolute Advantage Vs A Comparative Advantage?

Absolute advantage and comparative advantage are two separate approaches that deal in microeconomics and macroeconomics. 

Specifically, how businesses and entire countries might choose to enact policies for the allocation of resources.  When dealing with productive valuations and manufacturing processes, this allows for the most efficient choices to be made.

Absolute advantage refers to the inherent capacity of a manufacturing process to produce a specific good more efficiently and effectively than their competition, while also maintaining dominance in terms of lower marginal costs. 

In essence, this means that a company (or even a country) can outproduce its competition while spending less on its manufacturing process overall.

Example of an Absolute Advantage

Absolute Advantage Vs Comparative Advantage

In the chart above, we can easily see a demonstrable example of an absolute advantage

Note that business 1 creates fewer microchips per hour than business 2.  Moreover, it takes more employees to accomplish this same task of manufacturing a similar product in comparison.

Conversely, business 2 creates more microchips per hour than business 1.  It also uses a smaller number of employees to do so.  This means that it is not only outproducing its competition, but it is also using less resources to fulfill its production process. 

In essence:

  • Business 2 is essentially seizing a greater portion of the available market share from would-be competitors by producing more of the same product (which they then sell to their customers).
  • Business 2 is employing less employees than business 1 to fulfill the same process.  This ensures their production costs are lower than the immediate competition.

Since business 2 is both outproducing its competition and keeping marginal costs comparatively lower, it can be said that it has gained an absolute advantage.  This means that any competition will have a hard time challenging its current dominance in the economical sector in which it thrives.

Comparative Advantage

A comparative advantage deals in relative costs of production.  This metric is also known as the opportunity cost of production

In essence, it is a method by which a producer may analyze its operational costs and decide upon the ideal means of product diversification based on its existing resources.

Example of a Comparative Advantage

Absolute Advantage Vs Comparative Advantage

In the chart above, we can easily deduce that business 1 is producing less microchip units and less graphical processors than business 2.  This represents the businesses’ peak efficiencies when their manufacturing processes are in full swing.

Clearly, business 2 can outproduce business 1 in either category.  However, business 2 decides it wishes to analyze the opportunity cost for both of their products.  This will give it a better idea of how to best allocate its efforts and resources.  

In terms of its business model, it will know which product it stands to benefit the most from.

Opportunity Cost

Opportunity cost is the relative amount of profits being made from a productive framework or process.  Using this indicator, a business can better understand the gains it will make from one product or system when compared to another. 

Essentially, the higher the indicator per unit being produced, the more revenue a company will expect by producing that specific product or service.

Example of Opportunity cost

Absolute Advantage Vs Comparative Advantage

Putting it all together:

Business 1 can produce more microchips or graphical processors than business 2.  However, upon closer inspection using the opportunity cost method, we can see the situation is more complicated.

The opportunity cost of producing a single microchip unit is higher for business 2 when compared to business 1.

However, the opportunity cost of producing a single graphical processor is higher for business 1 than it is for business 2.

Thus, from these findings (using the comparative advantage principle): 

  • Business 2 realizes that it should ultimately produce microchips.
  • Conversely, business 1 comes to realize that its real strength is in graphical processor units.
  • Even although business 2 outproduces business 1 in terms of total units manufactured, it cannot come close to matching the opportunity costs (potential revenues) that business 1 enjoys in its production of graphical processor units.
  • On the surface business 2 appears a much larger enterprise in its raw productive capabilities than business 1.  Clearly however, business 1 is nonetheless far more capable of profiting in the production of graphical processors.

As a corollary, using the comparative advantage and opportunity cost, any company can discover where its productive strengths are.  From this information, it can then leverage its efforts to maximize profits.  

Image Conceptualization

For your reference, below are the primary differences between absolute advantage vs comparative advantage.  

Absolute Advantage Vs Comparative Advantage

In both absolute advantage and comparative advantage, the idea is to get the fundamentals down to one low number.  This gives insight as to which fundamental advantage is most prevalent.  The higher the “lowered” (or calculated) number, the better it will be for the business model in practice. 

An Important Concept:  While absolute advantage can define the superiority of one production process over another, a comparative advantage will illustrate the details of actual opportunity cost.

Used in tandem, absolute advantage and comparative advantage can offer key insights into a business model. 

From the information gathered, a more focused approach can be realized.  This allows any enterprise to funnel its resources into making more profit.  It can also optimize its product diversification in the process to match existing market trends.

Understanding Absolute Advantage Vs. Comparative Advantage

The use of absolute advantage and comparative advantage are both related to productive output.  Using these methods, a business or a country can be compared to its competitors.  This creates a heightened analysis in terms of raw production capability and the realized gains being made from customers (revenue). 

Using this analysis, production can be refined and efforts leveraged for maximum effect.  In short, planning for the future becomes intuitive when the details are made clear.

Key differences between absolute advantage vs comparative advantage are listed below:

  • The absolute advantage is the rate at which a good can be produced, and the marginal costs associated with its production process.  This allows an organization to see how much it produces at peak-efficiency when compared to others companies.
  • On the other hand, the comparative advantage is a method of understanding marginal and opportunity costs in greater detail.  This allows an organization to see where it is making the most profit (often represented “per unit”).
  • Both absolute advantage vs comparative advantage are integral to the globalized economy.  International trade relations are founded upon the mutual understanding that profits must ultimately be realized by both parties involved.  The negotiations that exist today reflect both absolute advantage and comparative advantage.  Used in tandem, they allow for countries or businesses to make better decisions on what to produce, export, import, etc.
  • Some countries enjoy an absolute advantage in certain sectors.  A good example of a shift in global economics and trade has been the relatively recent rise of Chinese manufacturing.  In certain segments of the market, China has an absolute advantage, allowing it to produce more of the same products while also enjoying lower marginal costs.  If you see Chinese goods at the stores you frequent, you will have discovered evidence of their relatively recent economic prowess.
  • The comparative advantage method delves into more meticulous detail.  A country or a business can make far better decisions by better understanding how to optimize their existing production, resource allocation, and trade agreements. 
  • Absolute advantage tends to deal in broader terms, which can be useful for discovering already existent trends within the market.
  • Some international trade agreements are not effective for both parties.  In such circumstances, it is often an absolute advantage that dominates.  This results in secondary trade agreements -or even sanctions- being conferred as an economical counter toward the offending party.  In practice, this helps to ensure that no single economy gains too great an advantage over the others.

History of Absolute Advantage Vs Comparative Advantage

Adam Smith was a well-known Scottish economist and philosopher of his time.  He contributed to what became known as the Scottish Enlightenment (which peaked during the 18th and early 19th century).  This era was defined by an effluence of scientific and intellectual accomplishments.  Some argue this created a “ripple” effect throughout Europe and indeed the world.

Often, Smith himself is referred to as “The Father of Economics,” in part for his book and magnum opus, “An Inquiry into the Nature and Causes of The Wealth of Nations” (also known simply as “The Wealth of Nations”) which was first published in 1776 (1).   

Adam Smith’s theories and philosophy created numerous economical concepts.  These led to the creation of absolute advantage and comparative advantage as we know them today. 

His arguments on international trade, the division of labor, and the specialization of production, led to far more efficient policies being enacted throughout history. 

Most countries in existence today, have heeded Smith’s advice.  Specialized economics are now common-practice.  Any absence of goods or services can be easily compensated for by actively trading with others nations.

In point of fact, our heavily globalized economy now operates more like a singular organism, rather than the nationalistic economies of the past.  According to Statista.com the global trade value of goods was estimated to be over 19 trillion U.S dollars in 2019 (nearly tripling since 2000).

This staggering growth -rooted in Smith’s economic revelations- has proven the methodology of absolute advantage vs comparative advantage to be a sound foundation for modern economical theorem. 

Today, any country that fails to diversify its goods and services without considering absolute advantage vs comparative advantage, will render themselves deficient in an increasingly hyper-efficient globalized economy.

The World Trade Organization

Founded in 1995, the World Trade Organization (or WTO) remains the only international organization that deals directly with the policies and rules of globalized trade.  The role of the WTO remains one of ensuring that free trade flows uninterrupted.

Ostensibly, the World Trade Organization works to assist in negotiations between compliant member governments.  This allows for stable and normalized trade relations to thrive.  Often, the metrics of absolute advantage vs. comparative advantage are used to realize optimal outcomes.

Absolute Advantage Vs Comparative Advantage

Under regulated globalized trade, these shipping containers are first brought up for inspection by port authorities.  Once approved, they will be brought to market for local consumers and businesses alike.

For both exporters and manufacturers, the knowledge that foreign markets are readily available creates an economic incentive to market attractive products around the globe. 

Ensuring international accountability and prosperity can only happen through mutual gain.  Moreover, these gains must remain rooted in accountable economics from one nation to the other.

International trade laws and regulations must be upheld.

As an organization, the WTO resolves trade disputes by mediating a settlement process.  In essence, the World Trade Organization provides oversight that can be used to ensure all trading partners are following international law.  This works to facilitate free and fair-trade practices globally, with concerns being dealt with based on standardized practices.

Through resolving disputes amiably, the WTO has been effective in breaking down barriers.  Entire economies and peoples have benefitted immensely from its efforts over the years.

The primary system by which the World Trade Organization operates, is the WTO agreements.  These were negotiated, signed, and legislatively ratified by the majority of trading economies in existence today.

Key Takeaways

  • The world trade organization was founded in 1995, and remains the only international organization that ensures globalized free trade flows uninterrupted.
  • Absolute advantage vs absolute comparative advantage are principles that have a real effect in today’s world economy.  As methodologies, they represent a means of ensuring best trade practices not only between businesses, but between entire nations.

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