Absolute advantage arises when a country or company produces goods and services using resources more efficiently than others. It means, to produce an equivalent quantity, they by using fewer inputs. Or, when using the same resources, the company or country produces more goods and services.
The difference between absolute and comparative advantage
Comparative and absolute advantage are two different concepts. Comparative advantage refers to the benefits that arise from lower opportunity costs. David Ricardo introduced it as a critique of Adam Smith’s absolute advantage concept.
For example, two countries, Indonesia and Malaysia, produce shoes and clothing products. Hourly outputs from each country are in the table above.
Indonesia has absolute advantages in the production of clothes and shoes. Indonesia produces 6 shoes and 3 clothes, more than Malaysia, which only produces 1 shoe and 2 clothes.
However, from the perspective of David Ricardo, Malaysia, and Indonesia, both have a comparative advantage. Malaysia has a lower opportunity cost in clothing. In Indonesia, the opportunity cost of producing 1 unit of clothing is 2 units of shoes (6/3). But, in Malaysia, the opportunity cost for producing 1 unit of clothing is only 0.5 units of shoes (1/2). Therefore, Malaysia has a comparative advantage in clothing production.
Meanwhile, for shoe production, Indonesia has a comparative advantage. Indonesia can produce 1 shoe by an opportunity cost of 0.5 units of clothing (3/6). And Malaysia has an opportunity cost of 2 units of clothing (2/1).
Implications for international trade
Adam Smith argued that a country must specialize in products that have an absolute advantage by selling abroad. Then, money can be used to buy products that have no absolute advantage. In the example above, Indonesia will not trade with Malaysia because it has an absolute advantage over both products.
Conversely, in David Ricardo’s argument, a country should specialize in goods that have a comparative advantage and, for the rest, trade with other countries. According to this argument, Indonesia and Malaysia will trade. Indonesia buys clothes from Malaysia, and Malaysia buys shoes from Indonesia.
Why should Indonesia buy clothes from Malaysia?
We can answer it by tracing the prices of clothes and shoes. Malaysia has lower clothing production costs because it bears a cheaper opportunity cost than Indonesia. Thus, by specializing, clothing prices in Malaysia will be lower than in Indonesia. Likewise, Indonesia can produce more affordable shoes because it has a lower opportunity cost.
By trading, Indonesia gets clothes at a lower price than domestic production. And Malaysia also bought Indonesian shoes because they were cheaper than domestic production.