Explain the difference between Absolute and Comparative Advantages.

The terms absolute advantage and comparative advantage are
used when trade between two countries is being considered. If one of them has the
ability to produce all the goods which are being considered for trade at a lesser cost,
it is referred to as absolute advantage. A lesser cost
implies the use of a lesser quantity of all resources.

Even
if one country has an absolute advantage in all products that can be traded. it does not
rule out trade between them in a rational world. This is due to what is called
comparative advantage.

To
better understand the concept of comparative advantage let us consider an example of two
products A and B and two countries C1 and C2 between which A and B can be
traded.

If C1 is capable of producing A as well as B at a
lesser cost than C2 it would seem pointless for C1 to buy anything from C2. Now let us
assume that with the resources C1 has it can produce 10 items of A and 20 items of B. On
the other hand C2 can produce with the resources it has 8 items of A and 10 items of B.
We see that for each of A that C1 produces it has to sacrifice producing 2 of B, while
for each of A that C2 produces it sacrifices producing only 1.25 of B. This gives C2 a
comparative advantage over C1 in producing A. To maximize the total production C2 should
only produce A and C1 should only produce B. The extra quantities that each of them
produce can be traded between them.

This shows how trade
between C1 and C2 is possible in spite of the fact that C1 can produce both of A and B
at a lower cost than C2.

Comparative advantage explains the
trade between nations even where one of the nations can produce all products that can be
traded at a lower absolute cost than the other nations.