Absolute Advantage and Comparative Advantage Trade Theories

Subject: Case Studies
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Absolute advantage and comparative advantage trade theories help countries make decisions concerning the production of goods, imports and exports, specialization, and resource allocation. Absolute advantage shows which country can produce a given good more effectively, ceteris paribus. In turn, comparative advantage indicates the country’s ability to produce a given good at a lower opportunity cost than another. Both concepts are crucial since they influence nations’ decisions in international trade. Trade benefits both parties involved if they specialize in producing goods they have a comparative advantage in, not an absolute advantage. For instance, the U.S. and Germany both build airplanes, but the number of final products presented every month is 15 for Germany and 40 for the U.S.

In other words, it takes Germany 2 days to produce an airplane, in contrast to 0.75 days for the U.S. Hence, the U.S. has an absolute advantage due to the quicker rate of production. However, to decide what the country should specialize in, the comparative advantage needs to be considered. For example, if the U.S. can manufacture either 40 airplanes or 90 cars. Thus, the opportunity cost of producing one airplane is 2.25 cars, while the opportunity cost of producing one car is 0.44 of an airplane. If Germany’s opportunity cost for manufacturing cars is lower than 0.44 of an airplane, it has a comparative advantage for cars production. In this case, both nations will benefit if the U.S. specializes in airplanes and Germany specializes in cars. The gains from trade should be based on comparative advantage.