Theory of Absolute Advantage

Absolute advantage refers to how a company, country, or region produces a greater quantity of a
product while maintaining the amount of time it takes to produce the product.

When there is absolute advantage, the same quantity of goods are produced using a lesser quantity of
inputs than another company. This increases competition between companies, and can be advantageous
for trade.

It is important to note that absolute advantage looks into the efficiency of production for a single
product.

Define Absolute Advantage in Economics

If a company has a lower absolute advantage, it can produce products and services at a lower absolute
cost per unit, which uses a small number of inputs, or possibly a more efficient process than another
company that produces the same good or service.

The unit cost is a crucial measure to determine operational analysis of a company. Analyzing unit cost is
an effective way to determine if the company is producing content efficiently.

The absolute advantage matters because it determines if a producer can provide goods or services in
greater quantity for the same or lower cost than competing producers.

Additionally, absolute advantage is an effective basis for gains from trade between companies who
produce different goods with different absolute advantages.

Specialization, division of labor, and trade with producers who have different absolute advantages leads
to more gains than production in isolation. It is also related to comparative advantage, which opens up
more widespread opportunities for gains from trade, as well as division of labor.

What Is the Origin of Absolute Advantage?

Adam Smith first developed the idea of absolute advantage in his book, "The Wealth of the Nations." He
used this idea to demonstrate how countries that specialize in producing and exporting certain goods
gain from trade with other countries.

In "Wealth of the Nations," Smith uses labor as the only input. Absolute advantage is determined by
comparison of labor productiveness, so it is possible for a party to have no absolute advantage.

There are several good examples of this in the Chinese economy and the Canadian Economy. The
Chinese economy exports low-cost manufactured goods, and takes advantage of their low unit labor
costs.

The Canadian economy is rich in low cost land, and has an absolute advantage in agricultural production.

Absolute Advantage Example

Comparative advantage looks at the reduction of opportunity cost, which is the potential benefit gained
by choosing to produce more of one product instead of producing the maximum amount of both
products a country has absolute advantage in.
In the chart below, we see the United States has the absolute advantage in both refrigerators and shoes.

Absolute advantage examines the productivity of workers in each country, answering the question "how
many inputs are needed to produce shoes in Mexico?"

Comparative advantage asks the question in a different way, instead focusing on the output it takes to
produce goods in a country.

It identifies the good where the absolute advantage is relatively larger, or where the productivity
disadvantage is smaller.

Comparative Advantages help countries consider possibilities for trade, and how to maximize production
for profit.

In this situation, the United States has a higher comparative advantage of shoes over refrigerators (1
worker in the US versus 4 in Mexico), and Mexico has a higher comparative advantage of shoes (5
workers in Mexico versus 4 in the US).

If both countries were to continue with their production rates, using 40 workers per good, the United
States would produce 10,000 shoes and 40,000 refrigerators.

Mexico would produce 8,000 shoes, and 10,000 refrigerators, shown in the chart below.
If point A on each graph which is where countries start producing and consuming before trade. At this
point, the United States produces 20,000 refrigerators and 5,000 pairs of shoes.

Mexico produces 4,000 pairs of shoes and 5,000 refrigerators, for a total of 9,000 shoes produced, and
25,000 refrigerators produced.

If each country were to transfer workers toward their area of comparative advantage, this would shift
slightly.

If the US transferred six workers away from shoes to work on refrigerators, the shoe production
decreases by 1,500 units (6/4 x 1,000), and refrigerator production increases by 6,000 (6/1 x 1,000).

If Mexico moves toward their area of comparative advantage, and transfers 10 workers to work on
production of shoes, the production of refrigerators decreases by 2,500 (10/4 x 1,000), and production
of shoes increases by 2,000 pairs (10/5 x 1,000).

This leads to a greater production of goods overall, as shown in the chart below.
This example shows that even though the United States has an absolute advantage in both goods, both
countries can benefit from increased production in their area of comparative advantage. The United
States will then export refrigerators, and import shoes.

Theory of Absolute Advantage

Saddique Ansari • May 11, 2023 • 9 min read

Theory of Absolute Advantage

Statement
A country has an absolute advantage in the production of that good, which it
can produce in greater quantity with the same quantity of resources than
another country.

Origin
The Theory of Absolute Advantage is one of the earliest economic theories
that explains the benefits of specialisation and international trade between
countries. It was proposed by Adam Smith, the father of modern economics,
in 1776 in his seminal work, "The Wealth of Nations." The theory of absolute
advantage is based on the idea that countries can benefit from trade if they
specialise in producing goods or services in which they have an absolute
advantage over other countries.

The Purpose of the Theory of Absolute Advantage

The purpose of the theory of absolute advantage is to demonstrate the
benefits of specialisation and international trade between countries. By
specialising in the production of goods and services in which they have an
absolute advantage, countries can increase their output through better
resource allocation. This, in turn, can lead to economic growth and higher
living standards.

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Assumptions
The theory of absolute advantage is based on some assumptions, which are
given below.

 There are only two countries in the world (Countries A and B).
 Both countries can only produce two goods. (Chairs and tables).
 The same resources are used to produce both goods.
 Both countries have different factor endowment in terms of the quality
of their resources.
 Resources are homogeneous within a country. For example, all the
workers in a country have the same skills, qualifications, productivity,
and motivation.
 The factors of production or inputs (such as labor and capital) are not
mobile between countries.
  There is constant opportunity cost. (We assume a straight-line
production possibility frontier.)
 There is no transportation cost.
 There is free trade between trading countries. It means that there are no
trade barriers for international trade.
 There is barter trade.

Data Example
Let’s use a data example to better understand the concept of absolute
advantage.

Consider the following maximum output table.

A table showing maximum output of two countries.

According to the above table, by using all the resources,

Country A can produce 40 chairs or 20 tables and country B can produce 20

chairs or 40 tables.

Suppose that each of the countries A and B has 10 workers. Then, In country
A, 10 workers can produce 40 chairs or 20 tables and each worker can produce
4 chairs or 2 tables. While in country B, 10 workers can produce 20 chairs or 40
tables and each worker can produce 2 chairs or 4 tables.

Now let's consider different cases of resource allocation.

Case 1: Self-Sufficiency Output

Suppose that both countries are self-sufficient. Both countries produce chairs
and tables according to their own needs. Suppose that both countries use half
of their workers for the production of chairs and half for the production of
tables. In country A, 5 workers will produce 20 chairs, and 5 workers will
produce 10 tables. While in country B, 5 workers will produce 10 chairs, and 5
workers will produce 20 tables.

Following table shows self-sufficiency output in this scenario.

TWO is the total world output produced by both countries. For example, the
total world output of chairs is 30 which is the sum of the outputs of country A
(20) and country B (10).

Case 2: Output after Specialisation before International

Trade
The specialisation decision will be made on the basis of absolute advantage.
The specialisation decision will be made by using the maximum output table.
A table showing absolute advantage.

Country A can produce more quantity of chairs; hence, country A has an

absolute advantage in the production of chairs.

Country B can produce more quantity of tables; hence, country B has an

absolute advantage in the production of tables.

Country A has an absolute advantage in the production of chairs. So, country

A should specialise in the production of chairs.

Country B has an absolute advantage in the production of tables. So, country

B should specialise in the production of tables.

The following table shows output after specialisation.

A table showing output of countries after specialisation.

It can be noted from above two cases, that the total world output (TWO) is
increased due to specialisation. But the problem is that country A does not
have tables and country B does not have chairs. This problem can be solved
through international trade.

Case 3: Output after Specialisation and International

Trade
In order to do international trade, countries have to deciode the barter
exchange rate.

The barter exchange rate is the rate at which one country’s goods can be
exchanged with another country’s goods. It is also called the barter terms of
trade. The following points are important.

 The opportunity cost table is used to decide the barter exchange rate.
 The barter exchange rate must lie between opportunity cost ratios.

Here is the opportunity cost table.

A table showing oppotunity costs.

For country A, the opportunity cost of making 1 chair = 0.5 tables

For country B, the opportunity cost of making 1 chair = 2 tables

Let us take the barter exchange rate as 1 chair = 1 table

Suppose that country A has exported 15 chairs and imported 15 tables

The barter exchange rate is 1 chair = 1 table. So, 15 chairs = 15 tables

For country A, Exports =15 chairs and Imports =15 tables

For country B, Exports =15 tables and Imports =15 chairs

The output after international trade is shown in the table below.

A table showing the output of countries after the international trade.

Gains from Specialisation and International Trade

 Country A’s output is increased by 5 chairs and 5 tables.
 Country B’s output is increased by 5 chairs and 5 tables.
 Total world output is increased by 10 chairs and 10 tables.

Diagrams of the Theory of Absolute Advantage

Diagram for Country A
The following diagram shows all above cases of resource allocation in country
A.

A diagram illustrating gains for country A from the theory of absolute

advantage.
Case 1: Self-Sufficiency Output
Point P (20, 10) shows self-sufficiency output.
1

Case 2: Output after Specialisation before International

Trade
Point P (40, 0) shows output after specialisation before international trade.
2

Case 3: Output after Specialisation and International

Trade
Barter exchange rate is 1 chair = 1 table. So, 40 chairs = 40 tables (This is used
to draw the trade possibility line, TPL). And 15 chairs = 15 tables.

Point P (25, 15) shows output after international trade.

3

For Country A , Exports = 15 Chairs Imports = 15 Tables

Country A's Gains from Specialisation and International

Trade
 Country A’s output is increased by 5 chairs and 5 tables
 Country A’s output is above PPF, which shows a decrease in scarcity, an
increase in output and economic growth.

Diagram for Country B

The following diagram shows all above cases of resource allocation in country
B.
A diagram illustrating gains for country B from the theory of absolute
advantage.

Case 1: Self-Sufficiency Output

Point P (10, 20) shows self-sufficiency output.
1
Case 2: Output after Specialisation before International
Trade
Point P (0, 40) shows output after specialisation before international trade
2

Case 3: Output after Specialisation and International

Trade
Barter exchange rate is 1 chair = 1 table. So, 40 chairs = 40 tables (This is used
to draw the trade possibility line, TPL). And 15 chairs = 15 tables.

Point P (15, 25) shows output after international trade.

3

For Country B, Imports = 15 Chairs Exports = 15 Tables

Country B's Gains from Specialisation and International

Trade
 Country B’s output is increased by 5 chairs and 5 tables.
 Country B’s output is above PPF, which shows a decrease in scarcity.

Problem with the Theory of Absolute Advantage

It does not explain the possibility of specialisation and international trade if
one country has an absolute advantage in both goods.

Limitations of the Theory of Absolute

Advantage
While the theory of absolute advantage provides a useful framework for
understanding the benefits of specialisation and international trade, it has
several limitations, including:
The theory assumes that there are only two countries and two goods
produced, and that all resources are homogeneous within a country, which is
an unrealistic oversimplification of the real world.

The theory assumes that all factors of production are fixed and cannot be
increased or decreased. In reality, factors of production are not fixed and can
be increased or decreased through investment and innovation.

The theory does not account for the impact of government policies, such as
subsidies and taxation, on trade.

The theory does not account for the impact of technological change on trade.

The theory assumes free trade without trade restrictions. In reality, there may
be tariffs, quotas, and other trade restrictions between countries.

The theory assumes a constant opportunity cost, but in reality, the opportunity
cost may not be constant, especially if resources are not homogeneous or if
the production process becomes more complex.

The theory assumes barter trade, but in reality, most international trade is
conducted through monetary exchange.

The theory assumes no transportation costs, which can have a significant

impact on trade patterns.

Real-world Examples of the Theory of Absolute

Advantage
Here are some real-world examples of the theory of absolute advantage in
action:

Saudi Arabia and Oil Production

Saudi Arabia has an absolute advantage in oil production due to its abundant
oil reserves and low cost of production. As a result, it specialises in oil
production and exports oil to other countries that do not have an absolute
advantage in oil production.

Japan and Electronics Manufacturing

Japan has an absolute advantage in electronics manufacturing due to its
highly skilled workforce and advanced technology. As a result, it specialises in
electronics manufacturing and exports electronic products to other countries.

China and Textile Production

China has an absolute advantage in textile production due to its low labour
costs and large workforce. As a result, it specialises in textile production and
exports textiles to other countries.

New Zealand and Agriculture

New Zealand has an absolute advantage in agriculture due to its favourable
climate and abundant natural resources. As a result, it specialises in agriculture
and exports agricultural products to other countries.

Zambia and Copper Production

Zambia has an absolute advantage in copper production due to its abundant
copper reserves and low cost of production. As a result, it specialises in copper
production and exports copper to other countries. In fact, copper is Zambia's
main export, accounting for over 70% of the country's total export earnings.

These examples illustrate how countries can benefit from specialising in the
production of goods in which they have an absolute advantage, and then
trading with other countries to obtain goods in which they do not have an
absolute advantage.

Theory of Absolute Advantage vs. Theory of

Comparative Advantage
The theory of comparative advantage, developed by David Ricardo in the early
18th century, is another important economic theory that explains the benefits
of international trade. The key differences between the theory of absolute
advantage and the theory of comparative advantage are that the idea of
absolute advantage focuses on productivity and efficiency, while the theory of
comparative advantage focuses on opportunity costs. The theory of
comparative advantage suggests that countries should specialise in producing
goods and services for which they have a lower opportunity cost of
production than other countries. This means that a country should produce
the goods and services in which it is relatively more efficient, even if it is not
absolutely efficient in producing them. Despite these differences, both Smith's
theory of absolute advantage and Ricardo's theory of comparative advantage
justify the benefits of specialisation and international trade.

Conclusion
In conclusion, the theory of absolute advantage provides a useful framework
for understanding the benefits of international trade between countries. By
specialising in the production of goods and services in which they have an
absolute advantage, countries can increase their productivity and efficiency
and reduce their production costs. However, the theory has several limitations
and assumptions that must be considered, and it should be compared with
other economic theories, such as the theory of comparative advantage, for a
more complete understanding of the benefits of international trade.