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Distinguish between absolute and comparative advantage, and show how a country could have an
absolute disadvantage in the production of a product relative to another country and still have a
comparative advantage in the production of the product. Provide a numerical example in your answer.

What Happens When a Country Has an Absolute Advantage in All Goods

What happens to the possibilities for trade if one country has an absolute advantage in
everything? This is typical for high-income countries that often have well-educated
workers, technologically advanced equipment, and the most up-to-date production
processes. These high-income countries can produce all products with fewer
resources than a low-income country. If the high-income country is more productive
across the board, will there still be gains from trade? Good students of Ricardo
understand that trade is about mutually beneficial exchange. Even when one country
has an absolute advantage in all products, trade can still benefit both sides. This is
because gains from trade come from specializing in one’s comparative advantage.

Absolute advantage means being more productive or cost-efficient than another country
whereas comparative advantage relates to how much productive or cost efficient one country is
than another.

Comparative advantage
This is arguably the single most powerful insight into economics.
Suppose country A is better than country B at making automobiles, and country B is better than country A at
making bread. It is obvious (the academics would say “trivial”) that both would benefit if A specialized in
automobiles, B specialized in bread and they traded their products. That is a case of absolute advantage.
But what if a country is bad at making everything? Will trade drive all producers out of business? The answer,
according to Ricardo, is no. The reason is the principle of comparative advantage.
It says, countries A and B still stand to benefit from trading with each other even if A is better than B at
making everything. If A is much more superior at making automobiles and only slightly superior at making
bread, then A should still invest resources in what it does best — producing automobiles — and export the
product to B. B should still invest in what it does best — making bread — and export that product to A, even if
it is not as efficient as A. Both would still benefit from the trade. A country does not have to be best at
anything to gain from trade. That is comparative advantage.
The theory dates back to classical economist David Ricardo. It is one of the most widely accepted among
economists. It is also one of the most misunderstood among non-economists because it is confused with
absolute advantage.
It is often claimed, for example, that some countries have no comparative advantage in anything. That is
virtually impossible.
What is absolute advantage?
Absolute advantage Smith claimed that a country should specialise in, and export, commodities in which
it had an absolute advantage. An absolute advantage existed when the country could produce a
commodity with less labour per unit produced than could its trading partner. By the same reasoning, it
should import commodities in which it had an absolute disadvantage. An absolute disadvantage existed
when the country could produce a commodity only with more labour per unit produced than could its
trading partner.

Table 2.1 Absolute advantage (arithmetical example)

Output per unit of labour UK US

Production of wheat 5 20

Production of cloth 10 6

Table 2.1 indicates that the UK has an absolute advantage in cloth production and

an absolute disadvantage in wheat production. The US has an absolute advantage in

wheat production and an absolute disadvantage in cloth production. Both countries will gain if the UK
specialises in cloth and exports it to the US, and the US specialises in wheat and exports it to the UK. In
modern terminology, trade is a positive sum game. Everyone gains from specialisation and exchange,
though we may note from the outset that there is no reason to expect everyone to gain equally.

The contribution of David Ricardo was to demonstrate that even though a country may be absolutely
more efficient than another in the production of all tradeable goods, nevertheless trade will be mutually
advantageous.

But suppose a country has an absolute advantage over its trading partner in respect of all commodities.
Is there any basis for mutually advantageous trade?Adam Smith thought not. If the trading partner had
no absolute advantage, then there would be no opportunity to trade.

Table 2.2 Comparative advantage (arithmetical example)

Output per unit of labour UK US

Production of wheat 5 20

Production of cloth 2 6

Based on Smith’s principle of absolute advantage, Table 2.2 suggests that there is

no basis for trade between the UK and the US. The US is absolutely more efficient in the production both
of wheat and cloth. But, looking again at Table 2.2, it is clear that the US is relatively more efficient in
the production of wheat (four times more efficient than the UK) than it is in the production of cloth,
where it is three times more efficient than the UK. The US has a comparative advantage in wheat
production. The UK, comparatively speaking, is more efficient in cloth production than wheat.

Even if one country is absolutely more productive at producing everything and the other country is
absolutely less productive, they both can gain by trading with each other as long as their relative
(dis)advantages in making different goods are different.Each country can benefit from trade by
exporting products in which it has the greatest relative advantage (or least relative disadvantage) and
importing products in which it has the least relative advantage (or the greatest relative disadvantage).

Adam Smith in his Wealth of Nations broke with the mercantilist tradition when he
argued that free trade is the best policy for all trading countries. He based his argument of the gains
from trade on absolute cost differences. Each country should specialise in the commodities which it
could produce more efficiently than other countries and import commodities which it would produce
less efficiently. Ricardo was later to widen the scope of the analysis to take account of comparative
cost differences. Even if a country had an absolute disadvantage in the production of both
commodities with respect to another country, mutually advantageous trade could still take place.
International specialisation of factors of production would result in an overall increase in output which
could be shared by all trading countries.

For comaparative advantage, lets consider two countries the United States and the United Kindom
with two commodities cloth and wheat

Country cloth wheat

US 4 units 6 unit

UK 2 units 1 units

Here the Us has an absolute advantage in producing both the goods. Still comparative advantage
theory proposes that instead of producing both the goods by th US, both countries can benefit by
specializing only in production of one commodity.

Therefore, US should specialize in producing wheat and UK in cloth as they have lower opportunity
costs in those products.

Both countries can still benefit as:

Us would be indifferent to trade if it received only 4 units of cloth from UK for every 6 units of wheat
which it exports and it would certainly no trade if it receives less than 4 units of cloth from UK for
every 6 units of wheat.

Similarly, UK would be indifferent to trade if it would have to give up 2 units of cloth for each unit of
wheat or 12 units of cloth for 6 units of wheat. And would no trade if it had to give up more than 12
unit of cloth to US for 6 unit of wheat.

Thus the exchange rate of 6 unit of wheat will be priced at more than 4 unit of cloht and less than 12
units of cloht. Lets suppose 6 unit of wheat is exchanged at 8 unit of cloth.

The united stated=s exchanes 6 units of wheat for 8 unit of cloths. it takes 1 hour for us to produce4
units of cloth and 2 hrs to produce 8 units of cloth. Similalry, it takes 1 hr to make 6 units of wheat,
therefore, it can make 12 units of wheat in 2 hrs. Thus united states is benefiiting by 6 units of wheat
through trading.

Similalry, the united kingdom can buy 6 units of wheat by paying 8 units of cloth. United kingdom can
1 unit of wheat in 1 hr. Therefore, it can make 6 units of wheat in 6 hr. Simialrly, it can produce 2 unirs
of cloth in hr and hence in 6 hrs it can product 12 units of cloth. Therefore, Uk benefits from 4 units of
cloth through trading

Therefore, trade would allow both the countries to consume more than if they do not trade with each
other.