TheoryofAbsoluteAdvantage.doc

Theory of Absolute AdvantageCollected By Teenchee SunDefinitionWhen country A can produce a unit of a good with less labor than country B we say that country A has an absolute advantage in producing that good.Major views of the theory Adam Smith (1723-1790), one of the most influential classical economists was leading advocate of free trade on the ground that it promoted the international division of the labor. According to his theory of absolute advantage, nations could concentrate their production on goods they could make most cheaply, with all the consequent benefits of division of labor. In further explaining his principle of absolute advantage he used some suppositions. “In a two-country two-product world”, he said, international trade and specialization will be beneficial when one country has an absolute cost advantage (that is, it can produce goods using fewer resources) in the production of one product, whereas the other country has absolute cost advantage in the other production. For nations to benefit from the international division of labor, each nation must have a kind of goods that it is absolutely more efficient in producing than its trading partner. Smith felt it was far better for a country to import goods that could be produced overseas more efficiently than to manufacture them itself. Countries would import goods in the production of which they had an absolute disadvantage against the exporting country. They would export goods in the production of which they had an absolute advantage over the importing country. More of his theory of absolute advantage can be found in his landmark book The Wealth of Nations written in 1776 in which Adam Smith attacked the mercantilist assumption that trade was a zero-sum game. In Smiths opinion each country had some sort of absolute advantage in the production of certain goods. If it could specialize in the production of them and then exchange the goods with each other, every country would receive a benefit.Illustration of the theory of absolute advantage Suppose there is a two-country, two-product world in which Ghana produces cocoa and South Korea rice. Assume that Ghana and South Korea both have 200 units of resources and that these resources can be used to produce either. Further imagine that in Ghana (due to its favorable climate, good soil and ready access to world shipping routes) it takes 10 units of resources to produce one ton of cocoa and 20 units of resources to produce of one ton of rice. Thus, Ghana could produce 20 tons of cocoa and no rice, 10 tons of rice and no cocoa, or some combination of rice and cocoa in between the two extremes. Similarly imagine that in South Korea it takes 40 units of resources to produce one ton of cocoa and 10 units of resources to produce one ton of rice. Thus, South Korea could produce 5 tons of cocoa and no rice, 20 tons of rice and no cocoa, or some combination between the two extremes. Clearly, Ghana has an absolute advantage in the production of cocoa and South Korea has an absolute advantage in the production of rice as shown in the following figure. So it is mutually beneficial for Ghana and South Korea to sell the product in the production of which they have absolute advantage.PostscriptChen Qingbai, Wang Jingxian. College English For International Business (2nd Edition).University of International Business Economics Press.2007.