A country producing goods at a lower cost than its trading partner has an absolute advantage. On the other hand, a country is said to have a comparative advantage over others in producing a particular good if it can produce that good at a lower relative opportunity cost.
Different economies or producers are compared by absolute advantage. A producer requiring fewer inputs in producing a good has an absolute advantage. Even when a country has a comparative advantage over others, both parties can benefit from trading because each side will receive a good at a lower price.
Specialization and Comparative Advantage
Specialization is when a nation concentrates its productive efforts on producing what the country is best at producing. Comparative advantage influences the production of goods because most resources are limited in any given country.
Trade allows nations to usually specialize in what goods they can produce the most or at the lowest cost. Specialization has the effect of reducing the costs of production and, as a result, the price of goods decreases. This nation then develops a comparative advantage and can export these goods in exchange for goods from other countries.
Countries experiencing a low skilled labor force tend to specialize in the production of goods that have a predominant cost component. In the same vein, low-income countries are typically specialized in a narrow range of products whereas countries like Germany export a wide range of products.
Comparative advantage enables both sides to benefit from trading. This is because each side accesses goods at a lower price than its opportunity cost. On the other hand, producers could produce more goods using fewer resources if they were is a situation of absolute advantage.
Example of Comparative Advantage and Absolute Advantage
In any given week, Russia can produce, at maximum capacity, 30 million liters of beer and 6 million liters of vodka, while Ukraine can produce 35 million liters of beer and 21 million liters of vodka.
What should each country produce?
In this case, Ukraine has an absolute advantage in producing both products. However, it should not produce both products since it has a comparative advantage in one of the two products.
Ukraine is 3.5 times better at producing vodka than Russia, but only 1.17 times better at producing beer. Therefore, Ukraine should produce vodka and Russia should produce beer. Then, the two nations should trade these two products for total welfare to be maximized.
Which of the following statements is most accurate?
A. Comparative advantage implies absolute advantage
B. Comparative advantage does not require absolute advantage
C. Comparative advantage requires absolute advantage
The correct answer is B.
Comparative advantage does not require absolute advantage and also does not imply absolute advantage. Absolute advantage refers to producing a good with a smaller quantity of inputs, whereas comparative advantage refers to the ability to produce a particular good at a lower opportunity cost than the other party.
Reading 17 LOS 17c:
Distinguish between comparative advantage and absolute advantage