The Absolute Advantage of Cheap International Trade

In the world of business, the term absolute advantage is used to describe a specific set of circumstances. The best definition of absolute advantage is “the ability of one party to make a better product or service more cheaply than its competitors.” By itself, this phrase does not define anything in particular; however it does provide a useful starting point for understanding comparative market strength. Smith’s original use of the term refers to the competitive advantage of the master or manufacturer over the worker or the customer. Smith further defined the principle of absolute advantage by identifying labor as the sole input in manufacturing.

Comparative economic analysis provides information about the relative prices of products and services in domestic and foreign markets. Because international trade has become so important to the United States economy, comparative analysis is an important part of most studies of the American economy. Comparative political economy traces its roots back to the advent of the nation-state system in modern Europe and the rise of the industrial revolution in England. The distinguishing characteristics of classical political economy and classical social science are the focus on market instead of state-provided goods and the absence of a centrally planned economy. Absolute advantage refers to a condition in which the prices of selected goods and services are determined by supply and demand conditions in the domestic market, with no external constraints.

For instance, when a firm in America decides to produce widgets from widgets that it currently own, it will have absolute advantage because the widgets it produces will be sold in all the nations of the world. However, if that firm were to start production of widgets from widgets that it wanted to purchase from other countries, it would lose its absolute advantage. Absolute advantage is one of the major elements of modern economic theory.

A key concept of classical social science is bargaining, which is related to absolute advantage. Bargaining helps to establish the boundaries of markets, as well as provide information about why certain firms produce the goods or services they do. Without bargaining, there would be no markets to sell the products and services, and no information about why firms choose not to sell their products and services to consumers within a specific country. Markets often have internal barriers to entry, which can be overcome through bargaining. If one country is able to secure a monopoly on a good or service, it can undercut the prices of competitors who want to enter the market.

Absolute advantage is closely related to comparative advantage. By promoting cooperation among nations, comparative advantage creates a situation in which there is less competition for the same goods and services, and consequently, buyers in a market have more choices. An obvious example of comparative advantage is a lower cost of doing business. This can happen if there are fewer potential competitors in a given location. However, this is not an absolute advantage because competitors may be forced to lower their costs to remain competitive.

Absolute advantage is also related to efficiency. A firm that uses less energy and creates fewer waste products will gain an absolute advantage over other firms that use more efficient technology and create more waste. Thus, it makes sense to invest in efficient machinery and to reduce the number of wasted goods to gain the absolute advantage of lower cost goods or services.

There are many competing theories of the world economy. Free-trade theories assume that competition between firms within a country will lead to a reduction in overall costs of production. In a competitive environment, firms will be motivated to sell their wares at lower prices than competitors to keep their costs down. By allowing international trade to occur, costs can be lowered and barriers to entry can be waived, leading to greater levels of competitiveness. However, some free-trade theorists argue that an increase in productivity can only be achieved if international trade is liberalized, which some feel may lead to increased inequality and the failure of economic policies to redistribute wealth.

Relative to free-trade theory, an increase in productivity can only be achieved by raising the costs of production so that the relative advantages of firms with lower costs of production exceed those of firms with higher costs of production. By lowering the costs of production, it is possible to realize an absolute advantage through production efficiency. By raising the costs of production to the level associated with optimal levels of production, increased opportunities for research and development can be made available and increased prosperity and income can be realized.