What is the absolute advantage and comparative advantage whe

Solution

Absolute advantage and relative advantage are two concepts used in international trade. When a country enjoys a clear edge in the manufacturing of a product, it is known as absolute advantage. It can be explained by an example.

Suppose there are two countries A and B. Two products are manufactured. They are Rice and wheat. also assume that both counntries have two laborers to produce them. Each of them are engaged in producing one crop. The quantity produced are:

Here one worker is engaged in producing rice and second one in the manufacturing wheat. Assumed that workers of the countries are equally efficient and have same facilities. Note that total production is 12 quintol. But country A can produce higher quantity of wheat by employing same inputs. So it has absolute advantage in the production of wheat. similarly country B has clear advantage in the production of rice. Thus A has absolute advantage in wheat and B has absolute advantage in the production of rice.

According to Adam Smith when absolute advantages are observed for two separate products, then international trade is possible. In this example, A will employ both laborers in production of wheat. Then it will manufacture 8x2=16 quintols of wheat. Country B will specialize in production of Rice by employing both laborers in this crop. So the country will produce 7x2=14 quintols. Surplus wheat of country B will be exchaged for surplus rice of country A. So total crop produced by the two countries are 16+14=30 quintols. It is much higher than existing production. So from interational trade both country will be benefitted.

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Now consider the following example where quantity produced are as follows:

Note that Country A now has absolute advantage in both crops. so according To smith international trade is not possible. But Economist Ricardo contrdicted it. He is concerned with comparative advantage. International trade is each of them has comparative advantage in one product. It occurs if a country can manufacture more effeciently one product tha other.

In the above example, country A is producing wheat comparatively more effeciently than rice. Note that rice production is 6/4=1.5 times of quantity produced by country B. But wheat production is 8/4 = 2 times higher than production of country B. Thus A has absolute as well as comparative advantage in the production of wheat.

Now consider country B. It is producing rice equivalent to 4/6=0.67 times the production of rice by country A. For wheat it is 4/8=0.5 times of the production of country A. Thus B is producing comparatively higher quantity of rice than wheat. So it has comparative advantage in Rice.

Thus international trade is possible. A will specialize in wheat. By engaging both workers in wheat production it will produce 8x2= 16 quintols and B will employ both worker in rice to get 8 quintols of Rice. So total production of two countries is now 16+8=24 quintols. It is higher than initial total of 10+12=22 quintols. Thus surplus of wheat of A will be exchanged with the surplus rice of country B.