Comparative Advantage Vs. Absolute Advantage
In international trade, companies can have absolute and comparative advantage in producing goods and services over other countries.
A country has absolute advantage in producing goods if it is able to produce goods at a lower cost in terms of resources compared to other countries.
On the other hand, the country that can produce a product at the lowest opportunity cost, compared to producing other products, has a comparative advantage in that specific product.
As long as different countries have different opportunity costs of producing different goods, there are gains to be made in international trade.
Let’s take an example to understand the concept of comparative advantage and absolute advantage and how two parties can get better outcomes by specializing in their comparative advantage and trading.
The following table shows the labour cost of producing per unit of cloth and wine in England and Portugal.
From the table, you can see that Portugal has absolute advantage in producing both wine and cloth as it is able to produce both the goods at a lower cost compared to England.
Portugal has a comparative advantage in producing wine. We find this out by calculating which country has lesser opportunity cost for producing one unit of wine. For Portugal, the opportunity cost of producing one unit of wine = 80/90 = 0.89 units of cloth. For England, the opportunity cost of producing one unit of wine = 110/100 = 1.1 units of cloth. Since Portugal has less opportunity cost for producing one unit of wine, it has comparative advantage over England to produce wine.
England has comparative advantage in producing cloth. For Portugal, the opportunity cost of producing one unit of cloth = 90/80 = 1.125. For England, the opportunity cost of producing one unit of cloth = 100/110 = 0.91. Therefore, England has comparative advantage in producing cloth.
In this case, Portugal should focus on producing wine, and England should focus on producing cloth and trade with each other. England would produce cloth and trade it with Portugal for wine. This way it will get wine for 100 instead of 110. Similarly, Portugal can get cloth for 80 instead of 90.
The following two videos from Khan Academy explain the concept of comparative advantage and absolute advantage with the help of examples.
The first video explains how two parties can get better outcomes by specializing in their comparative advantage and trading.
The second video explains that a party benefits from trade as long as there is a comparative advantage and not necessarily an absolute advantage.
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- Gross Domestic Product and Gross National Product
- Benefits and Costs of International Trade
- Comparative Advantage Vs. Absolute Advantage
- Ricardian and Heckscher-Ohlin Models of International Trade
- Trade and Capital Restrictions
- Balance of Payments Accounts
- Factors Affecting Balance of Payments
- Trading Blocs, Common Markets, and Economic Unions
- Role of International Organizations (IMF, World Bank, and WTO)