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Absolute Advantage

Updated on April 9, 2024
Article byKosha Mehta
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Absolute Advantage?

Absolute advantage refers to the benefit of manufacturing a thing or product while utilizing a lower quantity of the necessary input resources. The producer of the commodities might be any kind of legal body, ranging from a single individual to a corporation in the economy of an entire nation.

Absolute Advantage

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Absolute advantage is also used to describe the advantages of free markets in global business. A country’s absolute dominance in a particular commodity would enable it to acquire an economic advantage over other countries. Through this, the promotion of the free market and the concept of work specialization also came into play.

Key Takeaways

  • The absolute advantage belongs to the business, nation, or person who can generate more with fewer resources and has the edge.
  • Adam Smith, the “father of modern economics,” is credited with introducing absolute advantage to international business in 1776.
  • There is no standard formula to compare absolute advantage in numbers. Instead, it’s just a notion that helps determine who stands to gain the most.
  • Absolute advantage is the ability to produce more than a rival. Comparative advantage is the ability to produce at a lower opportunity cost than the competition.

Absolute Advantage Explained

Absolute Advantage definition suggests a comparison phrase employed in economics when analyzing the production capacity of one nation, firm, or person to that of another comparable organization. The absolute advantage is that the organization can create more with fewer resources.

It is a term used in economics to describe a party’s greater capacity for output than its competitors. More specifically, it is the capacity to manufacture a certain commodity or service at a cheaper cost (that is, more efficient) than the other party. A “party” might be a firm, individual, nation, or other entity producing products or services.

Adam Smith, a Scottish philosopher, often known as the “father of modern economics,” is generally credited with establishing the idea of absolute advantage in the context of international commerce in 1776. An Inquiry into the Nature and Causes of the Wealth of Nations was a monumental work written by Adam Smith in which he argued that for nations to become wealthy, they should specialize in the production of the goods and services in which they have an absolute advantage and engage in free trade with other nations to sell their goods. Smith is credited with coining the term “free trade.”

Adam is credited with developing the concept of absolute advantage. He demonstrated how nations might benefit by exclusively specializing in the commodities and services they can provide efficiently. Smith proposed that nations may engage in commerce to produce goods they could not produce cost-effectively.

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solute Advantage vs Comparative Advantage: Video

 

Assumptions Of Absolute Advantage Theory

While giving the theory, Adam did consider certain assumptions. Let us have a look at them.

  1. The Incapability Of The Factors Of Production To Move Around

    Adam Smith operates on the assumption that production elements are immobile across national borders. This hypothesis also suggests that following the transaction, there will be no modification to the Production Potential Frontier in any of the countries involved.

  2. Trade Barriers

    Obstacles to commerce do not hinder the buying and selling of things. Instead, governments erect trade barriers to limit or dampen the import or export of a specific good.

  3. Trade Balance

    dam believes that imports and exports must be the same. Because of this premise, we can’t have a trade imbalance, deficit, or surplus. A trade imbalance is created when the opposite is true, namely when imports exceed exports.

  4. Always Finding Its Way Back To Scale

    It is assumed that one will obtain the same rewards regardless of how much is produced. For instance, if the production of one computer by Sam takes two hours, then the production of two computers should take four hours. As a direct result of this, the production of four computers would require a total of eight hours.

Example

Let us have a look at the absolute advantage example. The term “absolute advantage” refers to the likelihood that one nation may produce a product at a lower price than the other country is able owing to variations in the supply circumstances of each country.

Let’s take the example of rice and the knowledge that Vietnam can produce rice at a lower cost than Japan. Rice is being shipped from Vietnam to Japan due to this circumstance. Despite this, Vietnam shipped more than one million tonnes of rice overseas in 1989.

The 1990s saw a rise in that nation’s yearly rice exports, which eventually exceeded 3 million tonnes. This unrivaled competitive edge led to an increase in rice exports, which, in turn, contributed to a reduction in the poverty level in that nation by driving up work and income.

Criticism

The theory of absolute advantage postulated that the only type of commerce that could take place between countries was bilateral trade and that there could only be two different goods being traded. However, when the volume of commerce and the requirements of individual nations began to rise, this premise was called into serious question. As a result, the concept did not consider the possibility of countries engaging in international commerce.

The assumption of unfettered commerce between states was another important tenet of the Absolute Advantage Theory. However, it didn’t take into consideration the restrictive actions taken by governments throughout the world. The restrictions comprised numeric limits, technical trade obstacles, and trade restrictions that were imposed for the sake of protecting the environment or adhering to public policy.

Adam Smith’s “Vent for Surplus” theory is not satisfying, bringing us to our third point. This philosophy can potentially have significant unfavorable implications on the growth process of underdeveloped countries. These nations cannot profit from selling their surplus output on international markets because they are required to export goods to bring their balance of payments into a neutral position despite food shortages at home.

David Ricardo, an English economist in the 19th century, created the idea of comparative advantage; before that, the absolute advantage concept of commerce was the preeminent model for understanding international trade.

Frequently Asked Questions (FAQs)

How to calculate absolute advantage ?

No set formula can be used to compare absolute advantage in terms of numbers. It is only an idea that allows for identifying the party that stands to gain the most from the situation. Examining the output of the product in issue between the two parties is all that is required to accomplish this goal. The one with a higher total production has a clear edge over the others. For instance, let’s imagine that Sam makes 20 cards per day and Jane makes ten cards per day. Sam has an unbeatable position in making cards and has an absolute advantage.

What is absolute advantage and comparative advantage?

Many people confuse the terms absolute advantage vs comparative advantage. The capacity of an entity to create more of an item or service than a rival is referred to as absolute advantage. The capacity of an actor to create an item or service at a lower opportunity cost than that of a rival is referred to as comparative advantage. A single nation can’t hold a comparative advantage in all the products available to consumers. However, a nation can have an absolute edge in every good.

What does absolute advantage mean?

Suppose a person, a company, or a nation can manufacture an item at a lower cost than another person, a company, or a country. In that case, they have an absolute advantage over that other person, company, or country.

This article is a guide to What is Absolute Advantage & its definition. We explain its theory in detail, along with its assumptions, criticism, and an example. You can also go through our recommended articles on corporate finance –

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