INSIGHTS

Absolute vs Comparative Advantage: Examples & Benefits

Google+ Pinterest LinkedIn Tumblr

If you are an economics student, you would surely have heard about the absolute vs comparative advantage. It is a concept relating to international trade amongst countries. It shows which country is better at producing a certain commodity. Absolute advantage is when a country can make a product in greater quantity than the other country. Comparative advantage is related to the opportunity cost (the cost of next best alternative forgone). A country has a comparative advantage over the other country when it faces a lower opportunity cost in producing a particular product than the other country.

A country also has a comparative advantage over other countries if it can produce the product using fewer resources. It is important for countries to have comparative and absolute advantages. This will prevent them from the need to import goods from other countries which is not economically feasible at all. These advantages help countries increase their export revenue. They can produce goods at a lower cost than other countries, and they are able to sell it to other countries at a profit. A country has these advantages because of the weather conditions of their region, the machinery they have available, the labor skills the country has, the finance available to them and the research expertise available with them.

Absolute vs Comparative advantage examples

The meaning of absolute vs comparative advantage must be clear by now, so we will discuss a few examples of absolute vs comparative advantage now.

Example 1

An example of absolute vs comparative advantage is of Saudi Arabia and Pakistan. Yes, you guessed it right! Saudi Arabia has an absolute advantage in oil. Saudi Arabia is extracting around 10.5 million barrels of oil each day whereas Pakistan is not extracting too much oil, because it does not have much to extract. The maximum extraction per day that Pakistan has done is 98 thousand barrels per day in 2014.

However, on the other hand, Pakistan has an absolute advantage over Saudi Arabia in producing farm products due to the high availability of arable farmland unlike Saudi Arabia. Saudi Arabia does not produce much wheat in the country. Whereas, Pakistan is producing around 26 million tonnes of wheat. As you can see, each country has an absolute advantage over one product which helps them gain export revenue from other countries.

Example 2

Another absolute vs comparative advantage example is a hypothetical example of two countries. Country A and country B. Country A can produce either 300 cars or 60 houses while country B can produce either 350 cars or 210 houses. As it can be seen, country B has an absolute advantage over country A in both the products, however, country B has a comparative advantage over country A in producing houses.

On the other hand, country A has a comparative advantage over country B in producing cars. With this example, we can see that if both the countries produce both the goods with evenly distributed resources, the world output will be lower than if both the countries specialize in their respective fields. They just need to produce the product in which they have a comparative advantage. An assumption here is that the world has just two countries: country A and country B. This shows that specializing and trade is beneficial for the entire world, however, that is another field and we will not be going further into it.

Absolute vs Comparative Advantage importance

The absolute and comparative advantages are of utmost importance to countries these days because they define the self-reliance of the countries. A country will not be economically stable if it will have to import every commodity it needs from other countries. It needs to have a specialty in at least some goods so that it can be self-reliant, and can earn export revenues. In today’s world, each country specializes in some goods.

For example :

Afghanistan specializes in animal products


Australia specializes in plastics and rubber

Bangladesh specializes in garments

Canada specializes in base metals

China specializes in electronics spare parts and gadgets

Switzerland specializes in luxury watches

Pakistan specializes in wheat and other agricultural products

Saudi Arabia specializes in oil

Italy specializes in clothing and footwear

France specializes in perfumes and pharmaceuticals

Japan specializes in motor vehicles and electronics.

The term “specializes in” here means that the country either has an absolute advantage or a comparative advantage in that product over other country or countries.

Countries and Specialization

Producing the products in which each country has comparative advantage can improve the entire world’s conditions, and this is what is being done now. The produce of the entire world would increase when countries play be their comparative advantages instead of producing everything. If the countries produce things in which they do not have a comparative advantage, resources would be wasted.  The country can by the sbuye product at lower cost from other countries. The concept of comparative advantage, specialization and trade is quite clear to all the countries by now. Each country allocates their resources in producing those things in which they have a comparative advantage.

It would be clear by now to everyone of us that absolute advantage is not as important as comparative advantage. A country may be capable of producing more units of a particular product than the other country. However, that is not because the country can produce that products using less resources. This is because the country simply has more resources to produce the goods and services.

Comparative advantage brings into consideration the opportunity cost of the products produced. It is a better measure of a country’s specialty. For example, if America can produce a certain product in a higher quantity than Bangladesh, it is because Bangladesh is a much smaller country than America. It has much smaller quantity of labor, equipment, machinery, and finance available. A correct measure would be to see what each country has to give up (the opportunity cost) to produce a single unit of a product. Hence, they will be using the theory of comparative advantage.

Advertisements

Write A Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.