Dear camielle-ga,
Good day!
The theory of absolute advantage can be stated in simlpe terms as
follows:
X has absolute advantage over Y in producing Z if X takes less
resources to perform a task (produce Z) than Y, i.e., one person (or a
country) takes fewer hours to perform a task than the other person (or
another country).
The theory of comparative advantage, on the other states that X has
comparative advantage over Y in producing Z if X’s opportunity cost of
producing Z is less than the opportunity cost for Y. This theory was
developed by the British economist David Ricardo who realised that
absolute advantage was a limited case of a more general theory.
Opportunity cost means the benefit lost by not doing the alternative.
It must be stressed that absolute advantage (or for that matter any
advantage) comes into play only when there are two parties involved.
Thus, there is no such thing as permanent absolute advantage of Cuba.
The following example only clarifies the theory of absolute advantage.
Absolute advantage of Cuba vis-a-vis the United States
Assumptions:
- Cost is measured in hours of labor
- There is no difference in cost of labor.
- Days of labor to produce wheat or sugar
Commodity United States Cuba
10 bushels of wheat 1 2
5 pounds of sugar 2 1
Compare the United States and Cuba in terms of producing wheat and
sugar. US can make wheat more efficiently owing to its climate and
soil whereas Cuba's climate and soil are more conducive to production
of sugar.
Total wheat and sugar produced in the two countries in two days
without specialization, i.e., two days spent making wheat and two
simultaneous days making sugar
In U.S. In Cuba Total
Wheat 20 bu + 10 bu = 30 bu
Sugar 5 lb + 10 lb = 15 lb
Total wheat and sugar produced in the two countries in two days with
specialization, i.e., 4 days (2 simultaneous two-day work periods)
spent by US making wheat and 4 days spent by Cuba in making sugar
In U.S. In Cuba Total
Wheat 40 bu + 0 bu = 40 bu
Sugar 0 lb + 20 lb = 20 lb
Conclusion: More total wheat and total sugar is produced with the same
amount of input by division of labor, specialization, and trade. This
means that both countries are better off by specializing in the
product that they can produce more efficiently than the other country.
The opportunity cost paid by each country, i.e., the value of each
product in each country in terms of the other product (based on the
labor value)
U.S. Cuba
10 bu. of wheat 2.5 lb sugar 10.0 lb sugar
5 lb. of sugar 20.0 bu wheat 5.0 bu wheat
Bases for exchange:
- A U.S. wheat producer takes 10 bu of wheat to Cuba, exchanges it for
10 lb of sugar, returns to the US and trades the 10 lb of sugar for 40
bu of wheat, making a profit of 30 bu of wheat.
- A Cuban sugar producer, on the other hand, takes 5 lb of sugar to
the US, exchanges it for 20 bu of wheat, returns to Cuba and trades
the 20 bu of wheat for 20 lb of sugar, making a profit of 15 lb of
sugar.
Net effect:
- Specialization will lead to higher total production
- Both countries’ citizens will have more product to consume
- Trading will occur because it is possible for the producers in both
countries to make a profit doing it.
Additional links:
A document on the theory of absolute advantage
http://www.courses.dsu.edu/finance/bus405/absolute.doc
Lecture notes (in pdf format) by Prof. Martin Berka of the Department
of Economics of the University of British Columbia
http://www.econ.ubc.ca/berka/L3.pdf
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