Explain Adam Smith's Theory of Absolute Advantage

Question 4: Question Number - 4. Explain Adam Smith's theory of absolute advantage. What are the potential limitations of this theory for helping policy makers when making decisions related to international trade? How does Ricardo's theory of comparative advantage differ for the theory of absolute advantage?

Kristin Kauffman,

Thank you for writing this informative post. There was a lot of useful information. I read this theory before in undergrad years ago and this was a good post to reeducate myself on the meaning. I would like to add Absolute advantage refers to the ability of a country to produce a product or service at a lower price than another country. This could be a result of inputs, such as natural resources, or because of the cost or productivity levels of labor. Absolute advantage may also arise from the level of available capital, such as factories or infrastructure. Adam Smith had some assumptions about absolute advantage. Those assumptions are lack of mobility for factors of production, trade barriers, trade balance, and constant returns to scale (Agarwal 2017). An example of absolute value would be India. India has an absolute value over the Philippines because of their low cost of labor and labor force (Investopedia, 2015).

A comparative advantage is when a country can produce goods and services at a lower cost than another country. Some factors affecting comparative advantage are factors of production, exchange rates, trade barriers, and inflation. Some assumptions if comparative advantage are constant returns to scale, mobility, costs, and free trade (Agarwal 201). Even though an absolute advantage has its perks, a comparative advantage is better.

References

Investopedia. (2015, April 14). What are some real life examples of absolute advantage? Retrieved November 11, 2017, from https://www.investopedia.com/ask/answers/041415/what-are-some-real-life-examples-absolute-advantage.asp

Agarwal, P. (2017, November 05). Absolute advantage and comparative advantage. Retrieved November 11, 2017, from https://www.intelligenteconomist.com/absolute-advantage/