Question

Explain the differences between the principle of absolute advantage and comparative advantage. Illustrate your answer with a real-world example.

Answer 1

Absolute advantage for a country occurs when the nation is efficient in producing goods and services. Cost is the primary factor in order to determine the absolute advantage. So, it is the ability of the country to produce goods at a lower cost per unit. Trading is not mutually beneficial for the two countries in such case.

Comparative advantage occurs when one country is efficient in producing goods as compared to other countries in the market. In this case, the firm is able to produce goods at less opportunity cost than its rival nations. Trade is mutually beneficial and benefits both country engaging in trade. it is the ability of the country to produce goods at a lower Opportunity Cost.

For Example, China has an absolute advantage in producing inputs for car manufacturing as it can produce at a faster rate with lower per unit cost. But it does not imply that it has comparative advantage in producing inputs. In other country, let say, Italy. It can produce same products with less opportunity cost than what is incurred by China. In such case, Italy is said to have comparative advantage and will specialize in production of inputs.