Distinguish between the Absolute advantage and the Comparative advantage theory of trade.

 Absolute Advantage

The differentiation between the varying abilities of companies and nations to  produce goods efficiently is the basis for the concept of absolute advantage.  Absolute advantage looks at the efficiency of producing a single product. This  analysis helps countries avoid the production of products that would yield little  or no demand, leading to losses. A country’s absolute advantage, or  disadvantage, in a particular industry, can play an important role in the types  of goods it chooses to produce. 

As an example, if Japan and Italy can both produce automobiles, but Italy can  produce sports cars of a higher quality and at a faster rate with greater profit,  then Italy is said to have an absolute advantage in that particular industry. In  this example, Japan may be better served to devote the limited resources and  manpower to another industry or other types of vehicles, such as electric cars,  in which it may enjoy an absolute advantage, rather than trying to compete  with Italy's efficiency. 

Comparative Advantage

Comparative advantage takes a more holistic view, with the perspective that a  country or business has the resources to produce a variety of goods.  The opportunity cost of a given option is equal to the forfeited benefits that could have been achieved by choosing an available alternative in comparison. In general, when the profit from two products is identified, analysts would calculate the opportunity cost of choosing one option over the other. 

For example, assume that China has enough resources to produce either smartphones or computers. China can produce 10 computers or 10 smartphones. Computers generate a higher profit. Therefore, the opportunity cost is the difference in value lost from producing a smartphone rather than a computer. If China earns $100 for a computer and $50 for a smartphone then the opportunity cost is $50. If China has to choose between producing computers over smartphones it will select computers. 

History of Absolute Advantage & Comparative Advantage

Adam Smith helped to originate the concepts of absolute and comparative advantage in his book, An Inquiry into the Nature and Causes of the Wealth of Nations. Smith argued that countries should specialize in the goods they can produce most efficiently and trade for those goods they can't produce as well.

Smith described specialization and international trade as they relate to  absolute advantages. He suggested that England can produce more textiles  per labor hour and Spain can produce more wine per labor hour so England should export textiles and import  wine and Spain should do the opposite.  Following Adam Smith's research, British economist David Ricardo built on his  concepts by more broadly introducing comparative advantage in the early  19th century.

Ricardo has become well-known throughout history for his musings on  comparative advantage. Building on research from Adam Smith along with  Robert Torrens, Ricardo explains how nations can benefit from trading even if  one of them has an absolute advantage in producing everything. In other  words, countries must choose to diversify the goods and services they  produce which requires them to consider opportunity costs.

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