Absolute Advantage

Definition: what is absolute advantage? Roughly speaking the absolute advantage is about division of labor and specialization. The basic idea behind the absolute cost advantage is to find out where a particular product can be produced more cost-effectively than in another country. On the other hand, comparative cost advantages are used when a country can produce a product at lower opportunity costs (= alternative costs) than another country.

Absolute cost advantages

The theory of absolute cost advantages was already developed in 1776 by the economist Adam Smith. In his opinion, each country should specialize in the production of goods, where it has an absolute cost advantage. In addition, he believes that the existence of absolute cost advantages would lead to the trade of nations with each other and the welfare of each individual national economy. In simple terms, one can say that every country is to produce what it can make cheaper or faster than the foreign competition.

Absolute cost advantage - example:

In Spain, a single wine can be produced in 10 working hours. In Germany it takes 15 working hours for a single wine. Spain therefore has the absolute cost advantage in wine production. For this, Germany only needs 30 working hours per unit when producing iron, while Spain needs 50 working hours per unit. Germany is thus much more effective in the production of iron, so it has the absolute cost advantage here.

For 10 units of wine and 10 units of iron, Germany needs 450 working hours (300 + 150). The Spaniards, on the other hand, have to spend a total of 600 working hours (100 + 500) for every ten units. Both countries would therefore need 1,050 working hours. On the basis of the absolute cost advantages one can now say that it would make sense that both nations specialize in producing a product because they are better and more effective in it. Spain has the absolute cost advantage in the field of wine production, Germany in the production of iron.

If Germany were to concentrate on the production of iron and almost produce iron for Spain, Germany would need a total of 600 working hours (30 hours per unit) for the production of 20 units of iron. Spain, on the other hand, undertakes the complete production of the 20 units of wine and needs 200 hours (10 hours per unit). Overall, both economies therefore only need 800 working hours. The division of labor and specialization on the basis of the absolute cost advantages thus results in a work saving of 250 hours.

Conditions and criticism

For the theory of absolute cost advantages to work as described above, however, it must be ensured, inter alia, that there are no trade barriers between the participating economies in the course of the division of labor. Such an obstacle to trade is represented, for example, by import duties and export duties. In addition, it is necessary that every national economy actually produces the goods which appears effective from absolute cost advantages. If in the above example Germany were to produce the wine and Spain the iron, the time expenditure for both would not fall, but would increase extremely.

The theory of the absolute cost advantages is criticized mainly because it assumes that participating economies have to produce a good, which can make them more cost-effectively, thus more effectively. If a country does not have the absolute cost advantage for any product, it does not take part in foreign trade, according to Adam Smith's theory. This approach, however, has been replaced by the theory of the comparative cost advantage of David Ricardo.