It can also produce other combinations of oil and corn if it wants to consume both goods, such as at point C. Here it chooses to produce/consume 60 barrels of oil, leaving 40 work hours that can be allocated to producing 10 bushels of corn, using the data in Table 1. (b) If the United States produces only oil, it can produce, at maximum, 50 barrels and zero corn (point A’), or at the other extreme, it can produce a maximum of 100 bushels of corn and no oil (point B’).
Country A can produce more quantity of chairs; hence, country A has an absolute advantage in the production of chairs. Then, In country A, 10 workers can produce 40 chairs or 20 tables and each worker can produce 4 chairs or 2 tables. While in country B, 10 workers can produce 20 chairs or 40 tables and each worker can produce 2 chairs or 4 tables. A country has an absolute advantage in the production of that good, which it can produce in greater quantity with the same quantity of resources than another country.
- Absolute advantage is important for explaining why some countries produce goods or services more efficiently than others.
- In the examples in this chapter, we draw the PPFs as straight lines, which means that opportunity costs are constant.
- The gain from trade for country A is +20 units of X and -10 units of Y so that net gain to it from trade is +10 units of X.
Worker A has the absolute advantage for glue sticks, while Worker B has the absolute advantage for foam pads. For example, let’s assume that China has the resources to produce either smartphones or computers, such that it can produce either 10 million computers or 10 million smartphones. Computers generate a higher profit, so the opportunity cost is the difference in value lost from producing a smartphone rather than a computer. If China earns $100 for a computer and $50 for a smartphone, then the opportunity cost is $500 million.
What are some Absolute Advantage examples for nations?
The cost of producing these commodities is measured in terms of labour involved in their production. If each country has at its disposal 2 man-days and 1 man-day is devoted to the production of each of the two commodities, the respective production absolute advantage theory in two countries can be shown through the hypothetical Table 2.1. In the continuing evolution of international trade theories, Michael Porter of Harvard Business School developed a new model to explain national competitive advantage in 1990.
Each country needs a minimum of four tubs of butter and four slabs of bacon to survive. In a state of autarky, producing solely on their own for their own needs, Atlantica can spend one-third of the year making butter and two-thirds of the year making bacon, for a total of four tubs of butter and four slabs of bacon. Absolute advantage can be accomplished by creating the good or service at a lower absolute cost per unit using a smaller number of inputs, or by a more efficient process. It has also been used to describe how the personal computer (PC) went through its product cycle.
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The Absolute Advantage Theory also assumed that free trade exists between nations. It did not take into account the protectionist measures that are adopted by countries. The protectionist measures included quantitative restrictions, technical barriers to trade, and restrictions on trade on account of environmental protection or public policy. The ability to produce more of a good or service while using fewer resources compared to a competing entity. Acquired advantage includes advantages in technology and level of skill development.
The theory assumes barter trade, but in reality, most international trade is conducted through monetary exchange. It is possible for an https://1investing.in/ economy to have an absolute advantage in everything. Whilst, some countries may have no absolute advantage in any goods or services.
Problem with the Theory of Absolute Advantage
Scottish economist Adam Smith is credited with developing the theory behind absolute and creative advantage. According to Smith, countries should focus on goods they can produce efficiently and use trade to acquire anything they can’t make themselves. The theory assumes that all factors of production are fixed and cannot be increased or decreased. In reality, factors of production are not fixed and can be increased or decreased through investment and innovation.
Absolute advantage leads to unambiguous gains from specialization and trade only in cases where each producer has an absolute advantage in producing some good. If a producer lacks any absolute advantage, then Adam Smith’s argument would not necessarily apply. Absolute advantage can be contrasted with comparative advantage, which is when a producer has a lower opportunity cost to produce a good or service than another producer. An opportunity cost is the potential benefits an individual, investor, or business misses out on when choosing one alternative over another.
Undoubtedly, the slogans of self- reliance and protectionism have been raised from time to time, but the self-reliance has eluded all the countries even up to the recent times. The free and unfettered international trade can make the countries specialise in the production and exchange of such commodities in case of which they command some absolute advantage, when compared with the other countries. In contrast to classical, country-based trade theories, the category of modern, firm-based theories emerged after World War II and was developed in large part by business school professors, not economists. The firm-based theories evolved with the growth of the multinational company (MNC). The country-based theories couldn’t adequately address the expansion of either MNCs or intraindustry trade, which refers to trade between two countries of goods produced in the same industry.
The theory of comparative advantage, developed by David Ricardo in the early 18th century, is another important economic theory that explains the benefits of international trade. The theory of comparative advantage suggests that countries should specialise in producing goods and services for which they have a lower opportunity cost of production than other countries. This means that a country should produce the goods and services in which it is relatively more efficient, even if it is not absolutely efficient in producing them.
The theory does not account for the impact of technological change on trade. The theory does not account for the impact of government policies, such as subsidies and taxation, on trade. Take your learning and productivity to the next level with our Premium Templates. Access and download collection of free Templates to help power your productivity and performance.
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Both theories assumed that free and open markets would lead countries and producers to determine which goods they could produce more efficiently. Their theory is based on a country’s production factors—land, labor, and capital, which provide the funds for investment in plants and equipment. They determined that the cost of any factor or resource was a function of supply and demand. Factors that were in great supply relative to demand would be cheaper; factors in great demand relative to supply would be more expensive. Their theory, also called the factor proportions theory, stated that countries would produce and export goods that required resources or factors that were in great supply and, therefore, cheaper production factors. In contrast, countries would import goods that required resources that were in short supply, but higher demand.
Saudi Arabia can produce oil with fewer resources, while the United States can produce corn with fewer resources. Table 1 illustrates the advantages of the two countries, expressed in terms of how many hours it takes to produce one unit of each good. To simplify, let’s say that Saudi Arabia and the United States each have 100 worker hours (see Table 20.2). Figure 20.2 illustrates what each country is capable of producing on its own using a production possibility frontier (PPF) graph. Table 20.1 illustrates the advantages of the two countries, expressed in terms of how many hours it takes to produce one unit of each good. To simplify, let’s say that Saudi Arabia and the United States each have 100 worker hours (see Table 33.2).
Furthermore, when a producer has an absolute advantage, it also means that fewer resources and less time are needed to provide the same amount of goods as compared to the other producer. This greater overall efficiency in production creates an absolute advantage, which allows for beneficial trade—this is because producers are able to specialize and then, through trade, benefit from other producers’ specialization. China has an absolute advantage in textile production due to its low labour costs and large workforce.
