An entity has absolute advantage over another when it is more efficient than the other in the production of all the goods or services which both produce. It means that the entity yielding absolute advantage has higher output per unit of resource in all the products and services.
The principle of absolute advantage is applied to countries in the study of international trade, though it also relevant to individuals and businesses.
- Long ago, Eurasia and Africa were the only two countries in the world. In those simple times, humans were carnivores, sufficient food and enough wood were all they needed. Africa hosted 120,000 people who collected 360,000 kg of hunted animals and 1.8 million tons of combustible wood per day. Eurasia was home to only 30,000 people who managed to collect only 30,000 kg of food and 0.4 million tons of fuel.
Africa seems to have absolute advantage in both collecting food and collecting fuel. Productivity of Africans was 3 kg (360,000 ÷ 120,000) of food and 15 kg (1,800,000 ÷ 120,000) of fuel per day. Eurasians on the other hand collected only 1 kg of food and 13.3 kg of fuel per day. Africans clearly have higher productivity than Eurasians in both collecting food and collecting fuel.
- Eastern Furnishing (EF) and Western Furnishers (WF) are two businesses engaged in production of chairs and tables. Both have 20 carpenters. EF produces 20 tables and 40 chair per day while WF produces 25 tables and 45 chairs per day.
WF has clear absolute advantage because it produces more tables and more chairs when compared to EF using the same amount of resources (carpenters).
- Katarina Neuhausova and Veronika Katocsova are partners in a professional consultancy firm engaged in providing audit and tax services. On average Katarina spends 4 hours each day on audit related work which earns $1,000, and 4 hours on tax related work which earns $1,200. Veronika too spends 4 hours on audit related work earning $900, and 4 hours on tax related work earning $1,100. Katarina has absolute advantage because she is more productive in both audit and tax.
Written by Obaidullah Jan, ACA, CFA