You are on page 1of 2

Question: Describe Adam Smiths absolute cost theory in international trade.

Answer: Father of Economics Adam Smith expressed his absolute cost theory of international trade in his book named An Inquiry into the Nature and Causes of The Wealth of Nations published in 1776. In the theory he has expressed the reason of being involved in international trade of two countries. Theory: According to Adam Smith, a country can get absolute advantage of producing a certain commodity than other country. In this case, the country should produce only that commodity which it holds the absolute advantage. Other Commodity which it not holds absolute advantage should not produce. Rather than, the particular commodity should be imported from other county which holds its absolute advantage. Assumptions: 1. Two countries. 2. Two commodities. 3. Labor is the unit factor. 4. No transportation cost. Explanation: Country A B Commodity-X 10 5 Commodity-Y 5 10 Ratio 10:5 = 2:1 5:10 = 1:2

In the above diagram we can see, by using a certain labor Country-A can produce commodity-X 10 units or commodity-Y 5 units. Country-B can produce commodity-X 5 units or commodity-Y 10 units. That means Country-A has absolute advantage of producing X and Country-B has absolute advantage of producing Y. So, according to Adam Smith, Country-A should only produce commodity-X and import commodity-Y from Country-B. Country-B should only produce commodity-Y and import commodityX from Country-A. Country Commodity-X Commodity-Y

A B

20 0

0 20

This is how two countries can gain from international business/trade. Criticisms: 1. The theory is comparatively an easier analysis. 2. The assumptions are confusing. 3. Many times it has not adjustments with reality. 4. In other conditions trade can be happened. 5. This theory cannot explain the modern trade reason. Though this theory cannot compete with modern time but on the basis of that time (1776) it was a great achievement of Adam Smith.

Mir Abdullah Shahneaz (Major) Ph.D Fellow JU DBA, SMUCT.