What it means for a country to have an absolute advantage versus a country having comparative advantage?

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By Indeed Editorial Team

Updated February 7, 2022 | Published June 29, 2021

Updated February 7, 2022

Published June 29, 2021

Absolute advantage and comparative advantage are concepts often linked to international trade and economics that can help determine how well countries, companies or businesses can manufacture products when considering a variety of variables. These advantages influence decisions made by entities—usually countries—to commit natural resources and produce specific goods. In this article, we define absolute advantage and comparative advantage and discuss the differences between the two analytical concepts.

Key takeaways

• Absolute and comparative advantages are concepts used in economics and international trade to evaluate product values.

• Absolute advantage evaluates how efficiently a single product can be produced for quality, quantity and profit.

• Comparative advantage helps an entity select between several products to determine which has the greater return. 

 

Absolute advantage is when an entity can manufacture a better product at a faster rate and with greater profit than one produced by a competing country or business. An absolute advantage assessment evaluates the efficiency of creating a single product, helping the entity avoid producing goods with little to no demand or profit. Whether the entity has an absolute advantage in that field may play a role in determining what its leaders decide to produce.

For example, if Germany and France both produce automobile engines, business analysts can use an absolute advantage assessment to determine which country has the best manufacturing results according to time, quality and profit. If Germany produces high-quality engines at a faster rate and with a greater profit, it has an absolute advantage in that particular industry. As a result, France might consider allocating funds and labor to other industries, such as motorcycle engine manufacturing, where it may have the absolute advantage.

Related: The Value of Increasing Your Business Vocabulary

What is comparative advantage?

Comparative advantage evaluates a business, company or nation's ability to manufacture a product according to profit and cost, but it also takes into consideration the opportunity costs involved with choosing to produce a variety of goods with limited resources. Opportunity costs are benefits—or profits—that an entity loses when choosing one option over another. 

For example, Italy has enough resources to produce either white wine or red wine. It can produce 100,000 bottles of each. The white wine sells for $100 a bottle and the red wine for $50 a bottle. The white wine generates a higher profit at $100 a bottle compared to $50 for a bottle of red wine. The opportunity cost is value lost by producing more red wine than white. The comparative advantage indicates that if Italy had to choose between producing white or red wine, it will select white.

Professionals who work in international trade may use comparative advantage assessments to determine which country might produce a product for the lowest opportunity cost (value lost), thus having a higher comparative advantage versus its closest competitors. Calculating comparative advantage may encourage countries to consider trading with one another, which can have positive effects for all involved. 

For example, Italy may have the lowest opportunity cost for white wine while Spain has the lowest opportunity cost for red wine. If the two countries engage in wine trade, it could create job opportunities and help to diversify labor forces by introducing new professional roles.

Related: 6 Comparative Advantage Examples

Absolute vs. comparative advantage 

Absolute advantages and comparative advantages can both be used to help international trade professionals determine what the best choices are regarding domestic production of goods, import, export and resource allocation. While the absolute advantage refers to one entity’s superior production capabilities vs. another’s in a single industry, comparative advantages also consider lowering opportunity costs.

There are certain differences between absolute advantage and comparative advantage and knowing how they differ can help you know when it may be appropriate to use one or the other. Some differences between absolute and comparative advantage may include:

Economic effectiveness

Calculating a comparative advantage may facilitate more economic effectiveness than an absolute advantage. This is because the concept of absolute advantage concentrates on maximizing production with the same resources available without accounting for the possibility of cost reduction. Alternatively, the concept of comparative advantage can help find the lowest-cost option for all involved and encourage resource reallocation and import-export relationships between entities, improving the economic effectiveness for all entities involved.

Production specialization

A comparative advantage encourages entities to allocate their resources to specialize in areas where they may have the lowest opportunity costs and therefore manufacture and produce it at a lower cost in terms of other goods.

An absolute advantage encourages specialization in an area where the entity has exceptional production capabilities regarding the quality of the product and the total manufacturing time. While comparative advantage encourages specialization in relation to production costs and comparative advantages of other nations, absolute advantage emphasizes specialization in an industry where an entity is ultimately superior.

Production costs

Production costs can include employee wages, materials, factory maintenance and shipping expenses. International trade professionals can calculate both absolute advantages and comparative advantages to help determine which entity offers the lowest production costs for the highest profit. However, when determining a comparative advantage, they also take opportunity cost into account.

Absolute advantage refers to lowering production cost where comparative advantage refers to lowering opportunity cost to sell goods and services at prices lower than competitors, yielding greater profitability and stronger sales margins. With comparative advantage, an entity has the lower opportunity cost, but may not produce goods at a higher quality or increased volume.

Related: What Is Cost of Production?

Trade benefits

In international trade, an absolute advantage may not create economic benefits for all involved, considering it is about determining a clearly better manufacturer regarding production speed, gross profit and quality of the product. However, comparative advantage can be mutually beneficial for both entities because it is more effective in facilitating resource allocation, domestic production and the import and export of goods.

While entities that have an abundance of a product may have the absolute advantage in that industry, they may not have a comparative advantage. For example, If an entity had the absolute advantage for oil but had no bodies of water for fishing and a neighboring entity will trade oil for fish, the country with oil would have the comparative advantage with oil. The entity with many bodies of water would have the comparative advantage for fishing. Ultimately, both countries would gain something from the trade relationship.

Related: How To Become an International Trade Specialist