Absolute advantage and

Comparative advantage
• Absolute advantage and comparative advantage are two important
concepts in economics and international trade
• They influence how and why nations and businesses devote resources
to the production of particular goods
Difference
• Absolute advantage • Comparative advantage
refers to uncontested introduces opportunity
superiority of a country cost as a factor for analysis
or business to produce a in choosing between
particular good better different options for
production diversification
Absolute advantage
• 1776 Adam Smith (Father of economics) questioned the concept of
mercantilism saying that trade is not a zero sum games
• Arguments by Adam Smith
• Different countries can have advantages in different resources which makes
countries have different advantages in production
• Given different advantages, it was proposed that countries should
concentrate on producing where they have absolute advantage and import
products that the country is less advantageous in production
• Adam Smith’s other contentions
• Wealth of nation is reflected of productive capacity not in holding of species
• The Concept of “invisible hand
• An unseen force or mechanism that guides individuals to unwittingly benefit society
through the pursuit of private interests
• The natural force that guides free market capitalism through competition for scarce
resources
• The differentiation between varying abilities of companies and
nations to produce goods efficiently is the basis for the concept of
absolute advantage
• This analysis helps countries void the production of products that
would yield little or no demand, leading to losses
• A country’s absolute advantage, or disadvantage, in a particular
industry, can play an important role in the types of goods it chooses
to produce
Comparative advantage
• Using the concept of Adam Smith, David Ricardo wrote a book
entitled “Principles of Economy” which proposes the concept of
comparative advantage
• There is a possibility that a specific country can have advantage on
both products produced by two countries
• Countries should focus production where they are more efficient and
import products where they are less efficient
• Trade is a positive-sum game – all countries that participate in trade
realize economic gains
• Assumptions on comparative advantage
• Two countries and two goods
• Zero transportation costs
• Similar prices and values
• Resources are mobile between goods within countries, but not across
countries
• Constant return to scale
• Fixed stock resources
• No effects of income distribution within countries
• “The Paul Samuelson critique”
• The ability to offshore services jobs that were traditionally not internationally
mobile may have the effect of mass inward migration, where wages would
then fall
• Comparative advantage takes a more holistic view, with the
perspective that a country or business has the resources to produce a
variety of goods
• The opportunity cost of a given option is equal to the forfeited
benefits that could have been achieved by choosing an available
alternative in comparison
• In general, when the profit from two products is identified, analysts
would calculate the opportunity cost of choosing one option over the
other
• https://www.youtube.com/watch?v=Vvfzaq72wd0