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Absolute Advantage in Goods and Services

The term “absolute advantage“ was first described in the context of international trade by Adam Smith in his book „An Inquiry into the Nature and Causes of the Wealth of Nations“.According to him, an absolute advantage exists when a nation or economic region is able to produce a good or service more efficiently (using the same amount of resources) than a second nation or region.The origin of said advantage could be natural(climate, soil, abundance of various natural resources…) or acquired(knowledge, skills, special man-made resources…). He also regarded labour as the only true input and therefore used it for calculating productivity.

abs adv Absolute Advantage in Goods and Services

Adam Smith also argued that, without trade, it was impossible for all nations to be rich at the same time. He used the theory of absolute advantages to prove that and said that, if each country specialized in making the product it can produce most efficiently, and traded some of that production for other goods it needed, everyone would prosper.

As an example, we’ll take two economic regions, Frownyville and Happytown, that produce (and consume) only two products, cars and stuffed toy bunnies. Before specialization we see that by using one unit of labour, Frownyville is able to produce 6 cars, while Happytown, using the same amount of labour, is able to produce only 3 cars.At the same time, using one unit of labour, Frownyville is able to produce 2 bunnies, while Happytown is able to produce 7! Together they’ve produced 9 cars and 9 bunnies. Now let’s say both regions decided to specialize. Happytown decided to dedicate both units of labour to making bunnies, and Frownyville dedicated its labour to making cars. We can see that the total amount of produced bunnies increased to 14 units and the amount of cars increased to 12. Compared to the results before specialization, we can see a significant increase in production and, in this case, achieved a higher standard for the people of Happytown and Frownyville.

Before specialization

Frownyville Happytown Total
Cars 6 3 9
Stuffed Toy Bunnies 2 7 9

After specialization

Frownyville Happytown Total
Cars 12 0 12
Stuffed Toy Bunnies 0 14 14
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