Absolute Advantage and Comparative Advantage (with examples) | International Business

Summary

This video from 'Business School 101' explores the concepts of absolute and comparative advantage in international trade. It explains how countries, even if wealthy like the U.S., can benefit from trading by specializing in goods where they have an absolute advantage (producing more efficiently) or a comparative advantage (lower opportunity cost). The video uses simplified examples to illustrate these economic theories, which are fundamental to understanding global trade, despite their limitations.

Takeaways

• 🌐 The United States, despite being a wealthy nation, engages in international trade to benefit from the exchange of goods with other countries.
• 🔍 Understanding international trade involves grasping the concepts of absolute and comparative advantage in international business.
• 💡 Absolute advantage means a country uses fewer resources to manufacture a product more efficiently than others, like Saudi Arabia's oil production.
• 🔄 Countries can benefit from trade by specializing in producing goods where they have an absolute advantage, exemplified by a hypothetical trade between the US and China.
• 🛠️ The US has an absolute advantage in plane production, while China has it in truck production, according to the simplified example provided.
• 🚚 By trading, the US can save resources by producing planes and trading them for trucks, and China can do the opposite, highlighting mutual benefits.
• 🔄 Comparative advantage is about producing a product at a lower opportunity cost compared to another country, even if one has an absolute advantage in all products.
• 📉 Opportunity cost is the loss of potential gain from choosing one alternative over another, a key factor in determining comparative advantage.
• 🔄 Even if the US has an absolute advantage in both planes and trucks, it still benefits from trading by focusing on comparative advantage, like producing planes over trucks.
• 🚧 The theories of absolute and comparative advantage, while foundational, have limitations, such as not accounting for product features, quality, and real-world constraints like trade wars and pandemics.

Q & A

Why do wealthy nations like the United States engage in international trade?

Wealthy nations engage in international trade to benefit from the specialization in the production of goods where they have an absolute or comparative advantage, allowing them to obtain goods more efficiently and at a lower cost than producing them domestically.

What is the definition of absolute advantage in the context of international trade?

A country has an absolute advantage in manufacturing a product if it uses fewer resources to produce that product compared to another country. It means it can produce the same output with less input, making it more efficient.

Can you provide an example of a country with an absolute advantage in oil production?

Saudi Arabia is an example of a country with an absolute advantage in oil production because it requires fewer resources to extract oil compared to other countries, often just a matter of drilling a hole.

How does the concept of absolute advantage influence trade decisions between countries?

Countries with an absolute advantage in certain goods will tend to specialize in producing those goods, and then trade with other countries to obtain goods in which they do not have an absolute advantage.

What is the significance of the simplified example involving the United States and China in the script?

The simplified example is used to illustrate how the principle of absolute advantage works in international trade. It shows that even if one country can produce all goods more efficiently, it can still benefit from specializing in the production of goods where it has the greatest advantage.

What is the opportunity cost, and how does it relate to the concept of comparative advantage?

Opportunity cost refers to the potential gain that is lost when one alternative is chosen over another. It is used to determine comparative advantage, which is the ability to produce a good at a lower opportunity cost compared to another country.

Why is it beneficial for the United States to trade planes for trucks with China, as per the script?

It is beneficial for the United States to trade planes for trucks with China because it can produce planes more efficiently (lower percentage of total resources) and trade them for trucks, saving resources compared to producing trucks domestically.

How does the concept of comparative advantage differ from absolute advantage?

Comparative advantage is based on the opportunity cost of producing goods. A country has a comparative advantage in producing a good if it can produce it at a lower opportunity cost than another country, even if it does not have an absolute advantage.

What are some limitations of the absolute and comparative advantage theories as mentioned in the script?

Some limitations include not considering product features and quality, the assumption that resources can move freely between industries, and overlooking transportation costs. These theories also do not account for real-world complexities such as trade wars or global pandemics.

Why are the absolute and comparative advantage theories still valuable despite their limitations?

These theories are valuable because they provide a fundamental understanding of the logic behind global trade, explaining why countries engage in trade even when one country has an absolute advantage in all goods.

How can countries benefit from trading even if one country has an absolute advantage in all products?

Countries can still benefit from trading by focusing on the production of goods where they have a comparative advantage, which allows them to produce certain goods at a lower opportunity cost than other countries.