THEORY OF ABSOLUTE ADVANTAGE

 The Theory of Absolute Advantage

• Adam Smith was the first to put across the possibility that international trade is not a zero-sum game. According to Adam Smith who supported unrestricted trade and free international competition, absolute cost advantage is the determinant of mutually beneficial international trade.
•  The absolute cost advantage theory points out that a country will specialize in the production and export of a commodity in which it has an absolute cost advantage. In other words, exchange of goods between two countries will take place only if each of the two countries can produce one commodity at an absolutely lower production cost than the other country.
• Smith’s thoughts on the principle of division of labour constitute the basis for his theory of international trade and therefore, the value of goods is determined by measuring the labour incorporated in them.
•  The theory is generally presented with an example of a hypothetical two countries and two commodities model (2x2 model). Absolute advantage exists between nations when they differ in their ability to produce goods. Each nation can produce one good with less expenditure of human labour or more cheaply than the other.
•  As a result, each nation has an absolute advantage in the production of one good. Absolute advantage can be explained with a simple numerical example 

                                Output per Hour of Labour

Commodity	Country A	Country B
Wheat (bushels/hour)	6	1
Cloth (yards/hour)	4	5

As can be seen from the above table, one hour of labour time produces 6 bushels and 1 bushel of wheat respectively in country A and country B. On the other hand, one hour of labour time produces 4 yards of cloth in country A and 5 in country B. Country A is more efficient than country B, or has an absolute advantage over country B in production of wheat. Similarly, country B is more efficient than country A, or has an absolute advantage over country A in the production of cloth. If both nations can engage in trade with each other, each nation will specialize in the production of the good it has an absolute advantage in and obtain the other commodity through international trade. Therefore, country A would specialise completely in production of wheat and country B in cloth.

If country A exchanges six bushels of wheat (6W) for six yards of country B’s cloth (6C), then country A gains 2C or saves half an hour or 30 minutes of labour time (since the country A can only exchange 6W for 4C domestically). Similarly, the 6W that country B receives from country A is equivalent to or would require six hours of labour time to produce in country B. These same six hours can produce 30C in country B (6 hours x 5 yards of cloth per hour). By being able to exchange 6C (requiring a little over one hour to produce in the country B) for 6W, country B gains 24C, or saves nearly five hours of work.

This example shows trade is advantageous, although gains may not be distributed equally, because their given resources are utilised more efficiently, and, therefore, both countries can produce larger quantities of commodities which they specialize in. By specialising and trading freely, global output is , thus, maximized and more of both goods are available to the consumers in both the countries . If they specialise but do not trade freely, country A’s consumers would have no wheat, and country B’s consumers would have no rice. That is not desireable situation.

The theory discussed above gives us the impression that mutually gainful trade is possible only when one country has absolute advantage and the other has absolute disadvantage in the production of at least one commodity. What happens if a country had higher productivity in both commodities compared to another country? Let us now think of a situation where country A makes both wheat and cloth with fewer resources than country B. In other words, country A has absolute advantage in the production of both commodities and country B has absolute disadvantage in the production of both commodities. This is the question that Ricardo attempted to answer when he formalized the concept of ‘comparative advantage’ to espouse the argument that even when one country is technologically superior in both goods, it could still be advantageous for them to trade.