Absolute advantage Theory

1.The main concept of absolute advantage is

generally attributed to Adam Smith.
2.Smith argued that it was impossible for all
nations to become rich simultaneously by
following mercantilism because the export of
one nation is another nation’s import.
3.Instead stated that all nations would gain
simultaneously if they practiced free trade and
specialized in accordance with their absolute
advantage.
 Absolute advantage Theory

Principle of absolute advantage refers to the ability

of a party (an individual, or firm, or country) to
produce more of a good or service than competitors,
using the same amount of resources Adam Smith first
described the Principle of absolute advantage in the
context of international trade, using labor as the only
input.
 Absolute advantage Theory

Smith also stated that the wealth of nations depends

upon the goods and services available to their
citizens, rather than their gold reserves.
While there are possible gains from trade with
absolute advantage, the gains may not be mutually
beneficial.
Comparative advantage focuses on the range of
possible mutually beneficial exchanges.
Absolute advantage Theory
 Absolute advantage Theory

• Party A can produce 5 widgets per hour with 3

employees.
• Party B can produce 10 widgets per hour with 3
employees.
• Assuming that the employees of both parties are
paid equally, Party B has an absolute advantage
over Party A in producing widgets per hour. This is
because Party B can produce twice as many
widgets as Party A can with the same number of
employees.
Absolute advantage Theory
 Absolute advantage Theory

Country A can produce 1000 parts per hour with 200

workers.

Country B can produce 2500 parts per hour with 200

workers.

Country C can produce 10000 parts per hour with 200

workers.
 Absolute advantage Theory
Considering that labor and material costs are all
equivalent, Country C has the absolute advantage
over both Country B and Country A because it can
produce the most parts per hour at the same cost as
other nations. Country B has an absolute advantage
over Country A because it can produce more parts per
hour with the same number of employees. Country A
has no absolute advantage because it can't produce
more goods than either Country B or Country C given
the same input.
 comparative advantage
comparative advantage refers to the ability of a
party (an individual, a firm, or a country) to
produce a particular good or service at a lower
opportunity cost than another party.
It is the ability to produce a product with the
highest relative efficiency given all the other
products that could be produced. It can be
contrasted with absolute advantage which refers
to the ability of a party to produce a particular
good using less resources than the other.
 comparative advantage
Comparative advantage explains how trade
can create value for both parties even when
one can produce all goods with fewer
resources than the other.
The net benefits of such an outcome are called
gains from trade.
It is the main concept of the pure theory of
international trade.
 comparative advantage
Two men live alone on an isolated island. To
survive they must undertake a few basic economic
activities like water carrying, fishing, cooking and
shelter construction and maintenance.
The first man is young, strong, and educated. He is
also faster, better, and more productive at
everything. He has an absolute advantage in all
activities. The second man is old, weak, and
uneducated. He has an absolute disadvantage in all
economic activities. In some activities the difference
between the two is great; in others it is small.
 comparative advantage
Despite the fact that the younger man has absolute
advantage in all activities, it is not in the interest of
either of them to work in isolation since they both can
benefit from specialization and exchange.
If the two men divide the work according to
comparative advantage then the young man will
specialize in tasks at which he is most productive,
while the older man will concentrate on tasks where
his productivity is only a little less than that of the
young man. Such an arrangement will increase total
production for a given amount of labor supplied by
both men and it will benefit both of them.