The Relationship Between Absolute Advantage and Comparative Advantage

The Relationship Between Absolute Advantage and Comparative Advantage

Absolute advantage is fairly simple in theory but it can be difficult to tease out in practice. Even with the existence of absolute advantage, the influence of comparative advantage and other factors affecting trade make absolute comparisons between countries difficult.

Key Takeaways

  • Absolute advantage is when a producer can produce a good or service in greater quantity for the same cost, or the same quantity at a lower cost, than other producers.
  • Comparative advantage, on the other hand, takes into account the opportunity cost in order to achieve absolute advantage. It shows things are not always as simple as absolute advantage.
  • Companies and countries use advantage in order to boost profits or mitigate losses. Advantage plays are always occurring.

How Absolute Advantage is Achieved

Absolute advantage refers to the ability of a nation to produce a product or service more cheaply than another nation. This might be a result of inputs, such as natural resources, or because of the cost or productivity levels of labor. Absolute advantage may also arise from the level of available capital, such as factories or infrastructure. For example, India has an absolute advantage in operating call centers compared to the Philippines because of its low cost of labor and abundant labor force.

Absolute Advantage vs. Comparative Advantage

However, when it comes to trade, absolute advantage is not as important as comparative advantage. Comparative advantage takes into account the opportunity cost of specializing in one activity over another. It might be cheaper for India to operate call centers compared to the Philippines, but the potential gains from another activity, such as information technology services, might be far greater.

Indeed, India has seen immense growth in its IT services industry, with revenue doubling since 2010. It has a comparative advantage in specializing in IT relative to other nations. This may be why India’s contribution to the call center business has been declining over time. On the other hand, the Philippines has seen its call center industry boom because it has a comparative advantage in relating to American customers.

Of course, in the real world, specialization and trade is not quite this simplistic. Other factors that influence trade decisions include barriers such as tariffs and quotas, the cost and economies of scale in production, and the mix of goods and services demanded by the local population. While a country may enjoy an absolute and even comparative advantage in a particular good or service, it often still produces those items for which it doesn’t necessarily have an advantage.

Advantages and Global Trade

So far, the discussion has been strictly regarding trade and industrial advantage. A special consideration when considering advantages, whether absolute or comparative, are the countries involved and their unique abilities to use their advantage to sway global markets in their favor.

Nations, and even large groups like OPEC, may release information or achieve/lose advantage if it will help their overall standing in the global markets. This could be done in any number of creative ways, but is most often seen in the matters of supply-and-demand, and its direct effect on the pricing of commodities and other sectors.

Skip to toolbar