What is an Absolute Advantage?

//What is an Absolute Advantage?
What is an Absolute Advantage? 2017-09-30T03:39:08+00:00

Definition: An absolute advantage is a country or company’s ability to produce a product or service at the lowest cost compared with its competitors. In other words, it’s a company’s manufacturing processes, intellect, or any number of things that allows a company to produce products much more cost efficiently than other companies.

This concept was introduced by Adam Smith, and it may also refer to a person’s ability to perform a task better than any other.

What Does Absolute Advantage Mean?

The absolute advantage is used to compare a nation, firm, or individual’s efficiency to another. A country with an AA seeks to export the product or the service that it can produce at the lowest cost and to import the products or services that another country produces at the lowest cost. In doing so, countries are using their natural resources, thus lowering the production costs.

Furthermore, production costs are different between countries. The country with the lowest production costs at any level of labor typically has an advantage as well.

Let’s look at an example.

Example

China and Italy are involved in international trade. China produces textile at a lower cost than any other country because of its loose labor laws. Italy, on the other hand, produces wine at a lower cost than any other country because of its vast vineyards and climate.

Assuming that a working hour is equal to a monetary unit in both countries, then the prices for the production of textile in China and Italy are $100 and $150, respectively, whereas and the prices for the production of wine in China and Italy are $130 and $70, respectively.

Each country seeks to export the product that it produces at the lowest cost and to import the product that the other country produces at the lowest cost. Obviously, China seeks to export textile and import wine, whereas Italy seeks to export wine and import textile. The absolute advantage for each country is in the product that it produces at the lowest labor and production cost. In this case, China’s is in textile and Italy’s is in wine.

Companies work the same way, producing and selling what is most advantageous to them while purchasing things that they can’t make efficiently.