Comparative advantage refers to the ability of one entity to produce goods and services at a lower opportunity cost than its competitors in the same industry. Under the concept, the entity decides to specialize in production of a given product based on the opportunity cost rather than the efficiency of production of the same product (Hunt, Shelby and Morgan 239).
For instance, assume that both Hungary and Denmark can produce either eggs or milk on the international market, but not both. If Hungary can produce 20 units of eggs or 10 units of milk. The opportunity cost of each unit of eggs is 0.5 units of milk. The opportunity cost of each unit of milk is 2 units of eggs. Denmark is able to produce 30 units of eggs or 22 units of milk. The opportunity cost of milk is 1.36 units of eggs while the opportunity cost of eggs is 0.73 units of milk. Because Hungary's opportunity cost for the production of eggs is lower than Denmark's, it has the comparative advantage despite Denmark being the more efficient producer of eggs.
Absolute advantage, on the other hand, refers to an entity’s ability to produce a given product more efficiently than its competitors in the same industry. The efficiency here views from a perspective that the cost of production per unit is kept low by either using a more efficient processor using a lesser amount of input than its competitors (Leamer, Edward n.p). This concept looks only at the financial value of producing a product rather than considering its opportunity cost.
For instance, assume Brazil and Colombia produce sugar to sell on the international market. If Brazil has the capacity to produce high-quality sugar at a faster rate, then this country is considered to have an absolute advantage in the sugar industry. In this case, we do not go into the details of looking at the opportunity cost of producing sugar in each country, but rather, we focus on the country’s efficiency in production. The differentiation between the varying abilities of countries to produce goods efficiently is the basis for this concept of absolute advantage.
In today’s economic conditions, absolute and comparative advantages are the main concepts used to determine which country has a higher competitive advantage over others because these two are used by policy makers to allocate limited resources in various production plans in order to maximize production of particular products (Hunt, Shelby and Morgan 243). When a country has a competitive advantage over others in a given industry such as agriculture, it means that has efficient process and cost per unit of production is kept as low as possible.
Since the absolute advantage is concerned with a country’s superior production capabilities, it champions specialization, though it is not an important idea to consider when we look at it in the context of trading especially among countries (Jones, Ronald 157). Comparative advantage, on the other hand, puts a lot of emphasis on opportunity cost which implies that production of one product relative to another has been considered and, therefore, promotes trading. Jones and Ronald (159) note that trading improves market value by creating a market which is an arena, bringing together both buyers and sellers, who exchange goods and services. This fact connotes that opportunity cost is a key concept underpinning trade.
Works Cited
Hunt, Shelby D., and Robert M. Morgan. "The comparative advantage theory of competition." The Journal of Marketing (1995): 1-15
Leamer, Edward E. Sources of international comparative advantage: Theory and evidence. Cambridge, MA: MIT press, 1984.
Jones, Ronald W. "Comparative and absolute advantage." Swiss Journal of Economics and Statistics (SJES) 116.III (1980): 235-260.
