Absolute Cost Advantage Theory Of Internaional Trade With Example

The concept of absolute advantage, developed by Adam Smith in his book The Wealth of Nations, demonstrates how countries can benefit from trade. It refers to one entity's ability to produce more of a good or service than another, while comparative advantage is based on opportunity cost analysis. This theory assumes that only bilateral trade can occur between nations and only in two commodities. The purpose of the theory is to showcase the advantages of specialization and international trade. Absolute advantage is often used in foreign exchange protocols and refers to a party's superior production capability in the world of consumer goods. However, this assumption of only two commodities being traded was heavily criticized.

The absolute cost advantage theory of international trade, proposed by Adam Smith in his book The Wealth of Nations, illustrates how countries can benefit from trade. According to this theory, a country has an absolute advantage when it can produce a good using fewer resources than another country. This allows the country to produce the good at a lower cost, potentially leading to trade gains.

For example, consider two countries, Country A and Country B. Country A can produce both wheat and cloth more efficiently than Country B. However, it can produce wheat with a greater absolute advantage compared to cloth. On the other hand, Country B has an absolute advantage in cloth production. According to the theory, it would be beneficial for both countries to specialize in the production of the good in which they have an absolute advantage and then trade with each other. This would allow them to obtain both goods at a lower combined cost than if each country tried to be self-sufficient.

This theory emphasizes the benefits of specialization and trade, as countries can focus on producing the goods in which they have an absolute advantage and then trade for other goods they need, leading to overall economic welfare and efficiency.

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