FACULTY OF ECONOMICS

Kardan University

International
Economics
Chapter 04: International Trade Theories II
Absolute Advantage Theory

Ahsanullah Mohsen M.Sc.

a.mohsen@Kardan.edu.af
Ahsanullah.Mohsen@rub.de

Kardan.edu.af
FACULTY OF ECONOMICS
Adam Smith and the
Attack on Mercantilism and Economic Nationalism
• In 1776, Adam Smith published the first modern statement of
economic theory, An Inquiry into the Nature and Causes of the
Wealth of Nations
• The Wealth of Nations attacked mercantilism—the system
of which dominated economic thought in the 1700s
• Smith proved wrong the belief that trade was a zero sum
game—that the gain of one nation from trade was the loss
of another
• On the other hand… Voluntary exchange (trade) is a
positive sum game —both nations can gain
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Simple Philosophy
• Smith started with the simple truth that for two
nations to trade with each other voluntarily, both
nations must gain.
• If one nation gained nothing or lost, it would simply
refuse to trade.
• But how does this mutually beneficial trade take
place, and from where do these gains from trade
come
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Theory of absolute advantage

• Adam Smith ideas based on…

• The capability of one country to produce more of a

product with the same amount of input than another
country
• (same thing) The ability of a country to produce a good
using fewer resources than another country (lower
opportunity cost)
FACULTY OF ECONOMICS

Theory of absolute advantage

• Adam Smith argued:

• A country should produce only goods where it is most

efficient …. and trade for those goods where it is not
efficient

• Trade between countries is, therefore, beneficial

FACULTY OF ECONOMICS

Theory of absolute advantage

• … destroys the mercantilist (trade surplus) idea,
since in this theory there are gains to be had by
both countries party to an exchange
• … questions the objective of national governments
to acquire “wealth”: through restrictive trade
policies
• … also measures a nation’s wealth by the living
standards of its people
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An example of absolute advantage

• Countries
• Scotland
• Mexico Units produced per hour

• Goods 10
• Coffee beans 9
8
• Wool
7
The figure illustrates that Scotland is efficient 6 Coffee
beans
5
in producing wool, since it produces four 4
Wool

units of it in the same time but only one unit 3

of coffee. 2
1
Nevertheless, Mexico seems to be more 0

efficient in producing coffee, since, It Scotland Mexico

produces ten units of coffee but only two

units of wool given the same resources.
2-7
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An example of absolute advantage

• How does Units produced per hour

specialization and
10
trade advantage 9
Scotland? 8
– By reducing coffee 7
bean production, 6 Coffee
beans
resources are freed 5
Wool
for producing more 4
wool 3
– Each hour of 2
1
production change
0
costs 1 unit of coffee
Scotland Mexico
beans but gains 4
units of wool

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An example of absolute advantage

• How does Gains per hour of

specialization and production moved
trade advantage 10
Scotland? 9
– Scotland can send 3 8
7
units of wool to Coffee
6
Mexico and receive 7 5
beans
units of coffee beans 4
Wool
back 3
– Thus, by specializing 2
1
in production Scotland
0
gains 1 unit of wool
Scotland Mexico
and 6 units of coffee
per hour of production
moved

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An example of absolute advantage

• Does specialization Units produced per hour
and trade also
10
advantage Mexico? 9
– By reducing wool 8
production, resources 7
are freed for 6 Coffee
beans
producing more coffee 5
Wool
beans 4
– Each hour of 3
production change 2
costs 2 units of wool 1

but gains 10 units of 0

Scotland Mexico
coffee beans

10
FACULTY OF ECONOMICS

An example of absolute advantage

• Does specialization Gains per hour of
and trade also production moved
advantage Mexico? 10
– Mexico can send 7 9
units of coffee beans 8
to Scotland and 7
6 Coffee
receive 3 units of wool beans
5
back 4
Wool
– Thus, by specializing 3
in production Mexico 2
gains 1 unit of wool 1
and 3 units of coffee 0
Scotland Mexico
beans per hour of
production moved

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 FACULTY OF ECONOMICS

Implications of Adam Smith’s Theory

• Access to foreign markets helps create wealth
• If no nation imports, every company will be limited by
the size of its home country market
• Imports enable a country to obtain goods that it cannot
make itself or can make only at very high costs
• Trade barriers decrease the size of the potential
market, hampering the prospects of specialization,
technological progress, mutually beneficial exchange,
and, ultimately, wealth creation
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Adam Smith and Trade Barriers

• Smith was highly critical of trade barriers (Tariffs,
Quotas, Subsidies…)

• Trade barriers decrease

- Specialization
- Technological progress
- Wealth creation

• The modern view of trade shares Smith’s dislike for

trade barriers
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Policy recommendations from absolute advantage

• Specialization and trade advantage both countries
• Therefore, the best policy is to allow producers
and consumers in both countries unrestricted
access to goods from both countries to maximize
the number of advantageous trades that can occur.
• In other words, laissez-faire.
It is the policy of minimum government interference with economic
activity.

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FACULTY OF ECONOMICS

A fatal flaw?
• Absolute advantage requires one country to be better at
production of one product and another country to be better
at production of another good for specialization and trade to
be mutually advantageous.
• What if one country is better at everything?
• The theory of comparative advantage provides this answer.

 You will know this in Next chapter ….

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