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Comparative Advantage vs Absolute Advantage

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 the production of a particular good if it can produce that good at a lower relative opportunity cost.

Absolute Advantage

Absolute advantage is used to compare different economies or producers. A producer that requires fewer inputs in the production of a good has an absolute advantage. Even when a country has a comparative advantage over its trading partner, 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 efforts on the production of the product for which it is best known. Comparative advantage influences the production of goods because most resources are limited in any given country.

Trade allows nations to specialize in the production of goods whose optimal production they can sustain or those that they can produce at the lowest cost. Specialization has the effect of reducing production costs. It is worth noting that the lower the production cost of a product, the lower its price is. After specialization, a nation develops a comparative advantage and exports its products in exchange for goods from other countries.

Countries that have 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 such as Germany export a wide range of products.

Comparative advantage enables both sides to benefit from trade. 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 in a situation of absolute advantage.

Example of Comparative Advantage and Absolute Advantage

In any given week, Russia can produce 30 million liters of beer and 6 million liters of vodka, at maximum capacity. In comparison, 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 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, while Russia should produce beer. The two nations should, then, trade these two products for total welfare to be maximized.

Question

Which of the following statements is the 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. Similarly, it does not imply absolute advantage. Absolute advantage refers to the production of 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 another party.

Reading 17 LOS 17c:

Distinguish between comparative advantage and absolute advantage

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