The division and specialization of production in the global economy is shaped by two key principles of capitalism: absolute advantage and comparative advantage. While absolute advantage indicates which nation is best at producing a given good, comparative advantage is an indication of which nation stands to lose the least by choosing to produce one good versus another.
A nation is said to have an absolute advantage if it requires fewer resources – generally raw materials, manpower or time – to produce a given item. For example, assume France and the United States both produce airplanes. In one month, France can produce 14 planes while the U.S can churn out 45 of comparable quality. This means that it takes France 2.14 days to manufacture each plane versus the U.S. rate of 0.67 days. The U.S. has absolute advantage because its ability to produce high-quality products at a quicker rate than its competition indicates a more efficient production model.
Comparative advantage is all about reducing the opportunity cost of a given production strategy. The opportunity cost of producing a particular item is equal to the potential benefit that could have been gained by choosing an alternative. Assume that, utilizing the same amount of time and resources, China can produce either 30 computers or 45 cellphones. The opportunity cost of manufacturing one computer is 45 / 30, or 1.5 cellphones. Conversely, the opportunity cost of producing one cellphone is 30 / 45, or 0.67 computer. Comparative advantage comes into play when neighboring Thailand decides it can also produce computers or cellphones, but not both. If Thailand's opportunity cost for producing cellphones is lower than 0.67 computer, then it has the comparative advantage for the production of cellphones. In this case, it is mutually beneficial for Thailand to produce phones and China to produce computers. Even if China is more efficient at producing both items, giving it the absolute advantage, establishing specialized production and arranging an international trade agreement allows both countries to benefit.
Read more: What is the difference between absolute and comparative advantage? | Investopedia http://www.investopedia.com/ask/answers/040715/what-difference-between-absolute-and-comparative-advantage.asp#ixzz4EdhAHgp2
Follow us: Investopedia on Facebook