Theory of Absolute Advantage

The theory of absolute advantage was presented by Adam Smith in his famous book “The Wealth of Nations” published in 1776. He put emphasis on the division of labor and also indicated the importance of specialization in production.

Smith, in his theory of absolute advantage, described that the countries’ trading should be based on absolute advantage. If a country has more efficiency in producing a certain item, then she has an absolute advantage in the production of that particular item. Similarly, the other country might have an absolute advantage over the production of some other item. As a result,  both the countries should specialize in the production of goods in which they have absolute advantages of their own and then exchange the products with each other. This is how, both the countries will be benefited by specializing in and trading the products in which they have an absolute advantage.

Example:

  Rice Cloth
U.K. 4 8
Japan 15 6

It is clear from the table above that U.K. needs 4 man-hours to produce a single unit of rice whereas, Japan needs 15 man-hours to produce the similar unit of Rice. On the other hand, you can see that U.K. requires 8 man-hours to produce a unit of cloth and Japan requires only 6 man-hours to produce a unit of cloth.

So, it is quite clear that U.K. has an absolute advantage in the production of Rice and Japan has an absolute advantage in the production of Cloth. As per Adam Smith’s conception, these two countries should specialize in the production of a single commodity (i.e. in which they have absolute advantages) and trade with each other.

The net effect of Specialization:

  U.K. Japan Output
Gain in Rice +2 -1 +1
Gain in Cloth -1 +2.5 +1.5

However, after specializing in a single commodity. U.K. will lose one unit of cloth and will gain 2 units of rice. Similarly, Japan will lose one unit of rice and will gain 2.5 units of clothes. However, it will result in the net gain of one unit of Rice and 1.5 unit of Cloth. Both the countries can now enter into trade and exchange products voluntarily. So, it is gem clear from the above example that division and specialization of labor result in expanded world output and wealth.

 

 

 

 

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