Comparative Advantage vs Absolute Advantage

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.

Absolute Advantage

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?

Solution

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.

Question

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

Solution

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



Isha Shahid
Isha Shahid
2020-11-21
Literally the best youtube teacher out there. I prefer taking his lectures than my own course lecturer cause he explains with such clarity and simplicity.
Artur Stypułkowski
Artur Stypułkowski
2020-11-06
Excellent quality, free materials. Great work!
Ahmad S. Hilal
Ahmad S. Hilal
2020-11-03
One of the best FRM material provider. Very helpful chapters explanations on youtube by professor James Forjan.
Rodolfo Blasser
Rodolfo Blasser
2020-10-15
The content is masters degree-level, very well explained and for sure a valuable resource for every finance professional that aims to have a deep understanding of quantitative methods.
Mirah R
Mirah R
2020-10-15
Great course! Very helpful
Priyanka
Priyanka
2020-09-29
Analyst Prep has actually been my soul guide towards this journey of FRM.I really appreciate the videos ad they are ALIGNED , good speed, and the Professor just keeps everything Super CASUAL. If I Clear my exams Ultimately credit goes to you guys. Keep sharing. God bless.
Sar Dino
Sar Dino
2020-09-29
Had a test on actuarial science coming up and was dead on all the concepts (had to start from ground zero). came across the channel as it had small bits of FM chapters consolidated by the professor Stephen paris. this made it easy for me to look at the chapters i was having trouble with (basically everything lol). I love the way he explains the questions, and the visualization! its so helpful for me to see the diagrams and how the formulas move around. he really did a great job explaining, and i understand so much better. 7 weeks worth of lessons condensed into 3 days of binge watching their videos.... Amazing and i am truly baffled as to why the videos have not gained traction as they should have!

Share:


Related Posts

Percentage Change in a Currency Relative to Another Currency

Calculating Percentage Appreciation/Depreciation To calculate the percentage change one needs to have a...

Compare Nominal and Real GDP and Calculate and Interpret the GDP Deflator

It is economically healthy to exclude the effect of general price changes when...