TeachMeFinance.com - explain Absolute Advantage
Absolute Advantage --
Country A can produce product z using one unit of labour.
Country B can produce product z using two units of labour.
Country A has an absolute advantage over Country B in product z.
A country has an absolute advantage economically over another, in a particular good, when it can produce that good at a lower cost. Using the same input of resources a country with an absolute advantage will have greater output. Assuming this one good is the only item in the market, benificial trade is impossible. An absolute advantage is one where trade is not mutually beneficial, as opposed to a comparative advantage where trade is mutually beneficial.
Limitations to the theory may exist if there are single kind of utility. The very fact that people want food and shelter already indicates that multiple utilities are present in human desire. The moment the model expands from one good to multiple goods, the absolute may turn to a comparative advantage. However, pure labor arbitrage, where one country exploits the cheap labor of another, would be a case of absolute advantage that is not mutually beneficial.
The two concepts have applications outside international trade, though this is where they are most commonly used. Suppose that two castaways on a desert island gather both fruit and grain, which they then share equally between them. Suppose that Castaway A can gather more fruit per hour than Castaway B, and therefore has an absolute advantage in this good. Nonetheless, it may well make sense for A to leave some fruit-gathering to B. This is because it is possible that B gathers fruit slightly slower than A, but gathers grain extremely slowly.
One needs to look at comparative advantage rather than absolute advantage, to discover how A and B can each best allocate their effort. If A's initial advantage over B in grain-gathering is greater than his or her advantage in fruit-gathering, then fruit-effort should be transferred from A to B, to the point where A's comparative advantages in the two goods are equal. Thus it may be rational for fruit to flow from B to A, despite A's absolute advantage.
About the author
Author: Mark McCracken is a corporate trainer and author living in Higashi Osaka, Japan. He is the author of thousands of online articles as well as the Business English textbook, "25 Business Skills in English".
Copyright © 2005 by Mark McCracken, All Rights Reserved.
TeachMeFinance.com is an informational website, and should not be used as a
substitute for professional financial or legal advice. TeachMeFinance.com and its owner recommend consultation with a professional financial advisor prior to any
investment or financial decision.
Please read our disclaimer.