Absolute and Comparative Advantage

In trade, absolute advantage is when a country can produce a greater quantity of a good or service with the same input (typically labor) at a lower cost. The theory of absolute advantage was developed by the Scottish economist Adam Smith in his book The Wealth of Nations. 

Comparative advantage is a theory developed by the English political economist David Ricardo in his book On the Principles of Political Economy and Taxation. Comparative advantage, also called Ricardian advantage, describes one country's ability to produce a good or service at a lower opportunity cost than another country. Opportunity cost is the idea that making and selling one product or service is a trade-off, since you forfeit the opportunity to produce another product instead.

Read this section and answer the questions at the end.

A Numerical Example of Absolute and Comparative Advantage

Consider a hypothetical world with two countries, Saudi Arabia and the United States, and two products, oil and corn. Further assume that consumers in both countries desire both these goods. These goods are homogeneous, meaning that consumers/producers cannot differentiate between corn or oil from either country. There is only one resource available in both countries, labor hours. Saudi Arabia can produce oil with fewer resources, while the United States can produce corn with fewer resources. Table 1 illustrates the advantages of the two countries, expressed in terms of how many hours it takes to produce one unit of each good.

Country Oil (hours per barrel) Corn (hours per bushel)
Saudi Arabia 1 4
United States 2 1
Table 1. How Many Hours It Takes to Produce Oil and Corn

In Table 1, Saudi Arabia has an absolute advantage in the production of oil because it only takes an hour to produce a barrel of oil compared to two hours in the United States. The United States has an absolute advantage in the production of corn.

To simplify, let's say that Saudi Arabia and the United States each have 100 worker hours (see Table 2). We illustrate what each country is capable of producing on its own using a production possibility frontier (PPF) graph, shown in Figure 1. Recall from Choice in a World of Scarcity that the production possibilities frontier shows the maximum amount that each country can produce given its limited resources, in this case workers, and its level of technology.

Country Oil Production using 100 worker hours (barrels) Corn Production using 100 worker hours (bushels)
Saudi Arabia 100 or 25
United States 50 or 100
Table 2. Production Possibilities before Trade



Figure 1. Production Possibilities Frontiers. (a) Saudi Arabia can produce 100 barrels of oil at maximum and zero corn (point A), or 25 bushels of corn and zero oil (point B). It can also produce other combinations of oil and corn if it wants to consume both goods, such as at point C. Here it chooses to produce/consume 60 barrels of oil, leaving 40 work hours that can be allocated to producing 10 bushels of corn, using the data in Table 1. (b) If the United States produces only oil, it can produce, at maximum, 50 barrels and zero corn (point A'), or at the other extreme, it can produce a maximum of 100 bushels of corn and no oil (point B'). Other combinations of both oil and corn are possible, such as point C'. All points above the frontiers are impossible to produce given the current level of resources and technology.

Arguably Saudi and U.S. consumers desire both oil and corn to live. Let's say that before trade occurs, both countries produce and consume at point C or C'. Thus, before trade, the Saudi Arabian economy will devote 60 worker hours to produce oil, as shown in Table 3. Given the information in Table 1, this choice implies that it produces/consumes 60 barrels of oil. With the remaining 40 worker hours, since it needs four hours to produce a bushel of corn, it can produce only 10 bushels. To be at point C', the U.S. economy devotes 40 worker hours to produce 20 barrels of oil and the remaining worker hours can be allocated to produce 60 bushels of corn.

Country Oil Production (barrels) Corn Production (bushels)
Saudi Arabia (C) 60 10
United States (C') 20 60
Total World Production 80 70
Table 3. Production before Trade


The slope of the production possibility frontier illustrates the opportunity cost of producing oil in terms of corn. Using all its resources, the United States can produce 50 barrels of oil or 100 bushels of corn. So the opportunity cost of one barrel of oil is two bushels of corn - or the slope is 1/2. Thus, in the U.S. production possibility frontier graph, every increase in oil production of one barrel implies a decrease of two bushels of corn. Saudi Arabia can produce 100 barrels of oil or 25 bushels of corn. The opportunity cost of producing one barrel of oil is the loss of 1/4 of a bushel of corn that Saudi workers could otherwise have produced. In terms of corn, notice that Saudi Arabia gives up the least to produce a barrel of oil. These calculations are summarized in Table 4.

Country Opportunity cost of one unit - Oil (in terms of corn) Opportunity cost of one unit - Corn (in terms of oil)
Saudi Arabia ¼ 4
United States 2 ½
Table 4. Opportunity Cost and Comparative Advantage

Again recall that comparative advantage was defined as the opportunity cost of producing goods. Since Saudi Arabia gives up the least to produce a barrel of oil, (1414 < 22 in Table 4) it has a comparative advantage in oil production. The United States gives up the least to produce a bushel of corn, so it has a comparative advantage in corn production.

In this example, there is symmetry between absolute and comparative advantage. Saudi Arabia needs fewer worker hours to produce oil (absolute advantage, see Table 1), and also gives up the least in terms of other goods to produce oil (comparative advantage, see Table 4). Such symmetry is not always the case, as we will show after we have discussed gains from trade fully. But first, read the following Clear It Up feature to make sure you understand why the PPF line in the graphs is straight.