Question

What is absolute advantage? What is comparative advantage?

Short answer

Absolute advantage occurs when a producer can produce a good or service more efficiently and at a lower cost than another producer, using the same resources. Comparative advantage refers to a producer's ability to produce a good or service at a lower opportunity cost than another producer. For example, Country A can produce 100 units of wheat and 10 cars with 20 workers, whereas Country B can produce 50 units of wheat and 20 cars with the same workers. Country A has an absolute advantage in wheat production, while Country B has an absolute advantage in car production. Country A has a comparative advantage in wheat production, with an opportunity cost of 0.1 cars per unit of wheat, whereas Country B has a comparative advantage in car production, with an opportunity cost of 0.025 units of wheat per car.

Step-by-step solution

Definition of Absolute Advantage

Absolute advantage is a situation in which a country, individual, or firm can produce a good or service at a lower cost and in a more efficient manner than another country, individual, or firm. In other words, it can produce more units of a product using the same resources compared to another producer.

Example of Absolute Advantage

Suppose there are two countries, Country A and Country B. Country A can produce 100 units of wheat in a week using 20 workers while Country B can produce only 50 units of wheat in a week using the same number of workers. In this case, Country A has an absolute advantage in producing wheat, as it can produce more wheat with the same resources compared to Country B.

Definition ofType Comparative Advantage

Comparative advantage refers to the ability of a country, individual, or firm to produce a good or service at a lower opportunity cost than another producer. This means that a producer has a comparative advantage if it can produce a good or service by giving up the least amount of another good or service, compared to other producers.

Example of Comparative Advantage

Let's continue with the example from before, with Country A and Country B. In addition to producing wheat, both countries can also produce cars. Let's say that Country A can produce 10 cars in a week using 20 workers, while Country B can produce 20 cars in a week using the same number of workers. To find the opportunity cost of producing one unit of wheat, we can look at how many cars must be given up. For Country A, the opportunity cost of producing one unit of wheat is \( \frac{10}{100} = 0.1 \) cars, while for Country B, it is \( \frac{20}{50} = 0.4 \) cars. Since Country A has a lower opportunity cost for producing wheat (0.1 cars compared to 0.4 cars), it has a comparative advantage in wheat production. On the other hand, Country B has a lower opportunity cost for producing cars (0.025 wheat compared to 0.1 wheat), so it has a comparative advantage in car production.