Absolute cost advantages describe the fact that one country has financial advantages over another country in the production of a commodity. In this case, the other country does not produce the particular commodity itself, but decides to trade.
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Definition / explanation
The theory of absolute cost benefits was developed by Adam Smith in 1776. It is part of foreign trade theory and is intended to help countries make economically favorable decisions. A country then has an absolute cost advantage with regard to a commodity if it can produce it more cheaply than any other country.
According to Smith, this country should specialize in the production of this commodity. The subsequent distribution of all types of goods is carried out through foreign trade. Each of the countries should benefit from this approach.
Example: Absolute cost advantages
- Country A produces armbands in 20 working hours
- Country X produces armbands in 30 working hours
- = 10 hours difference - Country X has a greater effort
- the absolute cost advantage for the production of this product lies with country A.
- Country A produces beach balls in 60 working hours
- Country X produces beach balls in 40 working hours
- = 20 hours difference - Country A has a greater effort
- the absolute cost advantage for the production of this product lies with country X.
If country A restricts itself to the production of armbands and country X to the manufacture of beach balls, country A can import the beach balls from country X, while country X can obtain water wings from country A.
So können – von einer aufbereiteten Situation ohne Trade barriers ausgegangen – beide Länder Arbeitsstunden einsparen und effizienter Produzieren.
Barriers to trade
However, in reality it is not as easy as it is in theory because this is where trade barriers arise. These can be so extensive that the production advantages of a country are neutralized again by the restriction or even reversed into the opposite.
Trade barriers are all conditions that have a negative impact on free trade. These can be all kinds of customs duties or import restrictions.
Another problem with the theory is that, according to this, there are countries that cannot produce any good at all (because they have nowhere an absolute cost advantage). In this case you do not take part in export trade.