Introduction
In today's world, everything is centered around business, and business has become very competitive nowadays. International trade has become a growing phenomenon in today's economics, and related to this international trade and business are the economic terms, Absolute Advantage and Comparative Advantage. In the subject of economics, these are two important business-related theories developed by Adam Smith and David Ricardo. These two terms circulate over the idea of how efficient and effective goods and services can be produced using the limited available resources of a particular nation.
Absolute Advantage vs Comparative Advantage
Absolute Advantage refers to a particular economic situation where a particular nation can produce more effective goods and services than another nation at a lower cost using few resources. Comparative Advantage is when one nation can produce more efficient goods and services than another nation but at a lower opportunity price. A business entity or a particular nation can produce goods faster, at a good quality, and with higher profits in comparison to the government or any other competitive business in absolute advantage. But in comparative advantage, there is only the lower opportunity cost of producing.
Difference Between Absolute Advantage and Comparative Advantage in Tabular Form
| Parameters of Comparison | Absolute Advantage | Comparative Advantage |
| Meaning | Absolute Advantage is a particular country's capacity to produce efficient goods and services at a low per-unit cost in comparison to another country. | Comparative Advantage is also when a particular business entity or a nation can provide good commodities at a lower opportunity cost than another country. |
| Trading Benefit | In this case, both the countries do not mutually benefit from trading. | In this case, both countries mutually benefit from trading. |
| Developer | Absolute Advantage was developed by Adam Smith. | Comparative Advantage was developed by David Ricardo. |
| Comparison Basis | Both the countries’ productivity is compared. | It compares the amount of gain that gets lost in the production process. |
| Quality of Goods | Here, the country or business produces a large number of goods with the limited resources | In Comparative Advantage, a country or business is allowed to provide goods that are better in quality than another country. |
| Drawback | Absolute Advantage does not function when even one producer does not have an absolute advantage over any of the goods. | Comparative Advantage also faces obstruction in its functioning when domestic politics interferes with its process. |
What is Absolute Advantage?
Absolute Advantage refers to a particular nation or a business entity's capability to produce efficient goods and services at a lower rate than the other competitors. It is like a marketing advantage. When any country or business has this advantage, then that particular entity has to follow certain conditions for producing the goods and services. The commodities have to be made with fewer inputs or within a short period in comparison to the other competitors who are also producing the same products and services for that particular entity to have an absolute advantage over its competitors. This theory was developed by Adam Smith in his well-known book Wealth of Nations. Smith tried to explain through this theory that by absolute advantage a country can specialize in producing certain products and services that are also produced in other countries and trade them by exporting them. This gives the country the benefit of having the upper hand over other countries who are also producing the same commodities.
Here, the cost per unit of producing that commodity is less compared to other countries where the price is much higher, and based on this, a particular entity gains an absolute advantage over other entities regarding that product or service who are also engaged in the same work but at a much higher price. The profits earned by those nations that have an absolute advantage over certain products or services can be used to buy certain commodities from other countries that they do not have. Moreover, it would be more beneficial for all those countries having absolute advantage over certain commodities if they would exchange their products in this way. This would benefit them as they will be normally able to profit, but also, they would be able to acquire those commodities that they need. But this proves that it is not mutually beneficial as countries that do not have an absolute advantage over that product or service will not be able to benefit from this.
Some of the merits and demerits that an entity should know about absolute advantage are: -
Merits
- A country or a business entity experiences an absolute advantage over certain commodities when it specializes in the production of that commodity with the help of effective production methods leading to an overall massive production which in turn will lead to a higher amount being exported, thus increasing the economic efficiency of that entity.
- It offers trade advantages to countries and allows them to grow, develop, and make a good number of profits by only concentrating on the available resources and using them to their full potential efficiently.
- Absolute advantage not only leads to bulk production, but the processes of producing are efficient, and hence the output is also of high quality. This provides an added advantage as a country having an absolute advantage over certain products means huge sales of those products but higher quality also increases the competition in the international market.
- It is also a cost-saving marketing strategy as it follows a lower cost per unit for the production of its products. This also benefits both the entity and the customers, who get to receive the final products at a much lower price, which leads to huge sales of the products in the market.
Demerits
- Absolute advantage leads to bulk or massive production of the commodities, which can pose a major problem as when the needs are fulfilled, the excess products may not get sold to other countries, which would ultimately lead to loss of revenue. It is similar to the production of an excess amount of food, and when the needs are met, the surplus amount does not get sold anymore, and ultimately, it becomes a waste for the seller, leading to a huge number of losses for him.
- Absolute advantage is perfect for business entities having a limited number of resources since they use fewer resources for production. However, entities having a huge number of resources should not follow this strategy as it will lead to over-exploitation of those resources because more than enough resources are used here.
- Absolute advantage mainly depends on the international market, so a particular business entity following this marketing strategy may make that business vulnerable to changes in the demands in the international market.
What is Comparative Advantage?
Comparative Advantage is a particular country or a business entity's capacity to produce commodities not at a low cost per unit but at a lower opportunity cost in comparison to other business entities or governments. But it is not like an absolute advantage where the products and services are produced efficiently. There is no guarantee in that. This theory was developed by a person named David Ricardo in his well-known book named 'On the Principles of Political Economy' which was published in the year 1817. The idea of opportunity cost is the central point around which this marketing strategy revolves. It can be defined as when a particular alternative is chosen over another alternative then the potential gain that is lost is the opportunity cost. It is the amount of profit lost by a business entity when it selects one option over another. So, lower opportunity cost means less amount of profit is lost which is beneficial.
So, when a particular entity produces goods and services at a lower opportunity cost than other countries, then that entity exercises comparative advantage over those products and services. Comparative advantage can be considered as a more beneficial alternative than absolute advantage, although both of them have certain advantages and disadvantages in trade. The primary idea behind this is that if all the entities can volunteer and cooperate, then it will be mutually beneficial. All the concerned entities will benefit from this, so the advantage will be received by both sides. When an entity experiences comparative advantage, it produces a better-quality product at a lower price than other entities that are also producing the same product.
Comparative Marketing also has several merits and demerits, some of which are: -
Merits
- Comparative advantage not only helps in the business field but also helps in promoting volunteering and cooperation in the international market and nurtures peaceful relations among each country. The probability of conflict is much less here since every entity is mutually benefitting.
- Comparative advantage enables countries and entities to export only those commodities on which they exercise comparative advantage, and in return, they can import those products where they face the issue of high opportunity cost. This leads to a huge variety of products being available in the market, and through this, many times, customers also benefit by receiving products at reasonable prices.
- Specialization is an important part of comparative advantage as it allows business entities and countries to produce only those commodities that they can produce most efficiently. Consequently, efficient production and specialization lead to higher productivity, which results in more sales and rapid economic growth.
Demerits
- Comparative advantage is known to be producing better quality products and services than other competitive entities at a low opportunity cost which means that the wages to be given to the labourers should also be low or otherwise the business entity won't be able to make profits. This would lead to labor exploitation due to the low wages given to the laborers.
- Comparative advantage involves importing but outside this, there are also domestic industries where the products are produced within the country and are sold within the country. Due to comparative advantage, dependence on foreign products is increasing at a rapid rate, which may lead to the eroding of domestic industries.
- Environmental consequences should be thought of before pursuing any form of marketing or business strategy. Comparative advantage also leads to high production of commodities due to specialization. But it should also be thought of if this is not leading to excessive exploitation of resources and, as a result, harming the environment.
Main Difference Between Absolute Advantage and Comparative Advantage In Points
- Absolute Advantage and Comparative Advantage are both related to international trade. Absolute Advantage is a particular country or a business entity's capacity to produce efficient commodities at a lower cost per unit rate when compared to another country. Comparative Advantage, on the other hand, also deals with a particular country or a business entity's ability to produce better quality of goods than other countries but at a lower opportunity cost. The opportunity cost should be lower than in other countries. Absolute advantage is experienced by a country or an entity over certain goods when it specializes in the production of that good with the help of efficient production techniques. This leads to massive production and consequently massive amount of goods will be exported thus leading to higher profits. Comparative advantage also involves the production of specialized products on which the entity experiences comparative advantage and consequently exports them. Moreover, products that have a higher opportunity cost can be imported here.
- Absolute advantage is not mutually beneficial. The profits earned by a country experiencing absolute advantage over certain commodities can use those profits to buy products and services from other countries that they do not have. Moreover, if all the absolute advantage countries shared their products in this way, they would all benefit from it. But those countries that do not have absolute advantage will not be able to benefit from this. Comparative advantage is, on the other hand, mutually beneficial. It enables entities to export only those commodities on which they experience comparative advantage, and in return, they can import those products where they face a high opportunity cost.
- When even one entity producer does not exercise absolute advantage over any of the goods, then absolute advantage does not function for an entity. In the case of Comparative advantage, its functioning faces obstruction when domestic politics interferes with its process. The productivity of both countries is compared in the case of Absolute advantage, whereas in the case of comparative advantage, the opportunity cost is compared. The opportunity cost is the amount of gain that gets lost in the production process, and entities with lower opportunity costs than other countries are bound to get a comparative advantage over certain products and services.
Conclusion
Hence, to conclude, absolute advantage and comparative advantage are terms related to international trade. The theory of absolute advantage was developed by Adam Smith, whereas the theory of comparative advantage was developed by David Ricardo. Absolute Advantage is a particular country or a business entity’s capacity to produce efficient commodities at a lower cost per unit rate when compared to another country whereas in comparative advantage, an entity is supposed to produce better quality goods than other countries but at a lower opportunity price.
References
- https://www.wallstreetmojo.com/absolute-advantage-vs-comparative-advantage/
- https://www.indeed.com/career-advice/career-development/absolute-advantage-vs-comparative-advantage
