This is a very difficult endeavour requiring techniques to measure large intangibles. In this case, Susan has an absolute advantage in making cups of tea and filing reports. But absolute advantage is different than comparative advantage, and it's important to know the difference. Smith proposed that thesis as an to the then prevalent view called , which favoured strict government control on international trade and relied on the principle that countries should produce as much of everything as possible. Each nation is said to have a comparative advantage at producing a good if it can produce it at a lower opportunity cost. Obviously goods traded that are more useful and more durable are of better advantage than goods that are useless and disposable.
They determined that the cost of any factor or resource was a function of supply and demand. What are the differences between these theories, and how did the theories evolve? It takes them two labor hours to produce one good. More quantity of both products 2. Both terms deal with production, goods and services. While at the surface, this many sound very simple, there is a great deal of theory, policy, and business strategy that constitutes international trade. However, a comparative advantage is always accompanied by a comparative disadvantage.
In the end, people would not only look at absolute advantage, but they would also consider comparative advantage when deciding what goods to produce and for whom to produce them. It was Adam Smith who first described absolute advantage in the context of International trade. According to the absolute advantage theory, out of two or more parties, the one that produces more product with the same resources has the advantage. Consider a hypothetical situation where the U. The British colonial empire was one of the more successful examples; it sought to increase its wealth by using raw materials from places ranging from what are now the Americas and India. It is generally accepted that trade is beneficial for everyone, it helps economies grow, it encourages development and gives people access to more goods.
She is, in fact, better at doing both jobs than the clerical assistant she hires. Specialization of labor, or division of labor, results in a significantly higher productivity per unit of labor, and in turn, a lower cost of production. Maximization of Global productivity and other resources productivity Criticism No absolute advantages for many countries Country size varies Country by country differences in specialization Deals with labour only and neglects other factors Variety of resources Neglected Transport cost It plays significant role Scale economies Large scale economies reduces the cost of production and forms a part of absolute advantages, this theory neglects it Absolute advantage for many products. For example, China and India are home to cheap, large pools of labor. By having the assistant perform all the clerical work, the doctor is able to maximize her specialization and see more patients. But so long as the theory of comparative advantage limits the evaluation of a product to production costs it will not accurately predict which trade in goods result in benefits.
To remain competitive, large global firms benefit from having strong, efficient supporting and related industries to provide the inputs required by the industry. The absolute advantage is the belief that a nation will gain the most from producing products that take advantage of its most readily available resources. Technology itself is a nation-specific factor of production, rather than being a universal attribute of production. Barriers to trade may exist, and goods must be transported, stored, and distributed. Ricardo in the comparative advantage theory. Definitions: Absolute and Comparative Advantage The basis for trade in the Ricardian model is differences in technology between countries. Another way to describe comparative advantage is to look at the relative productivity advantages of a country.
International trade is not a zero-sum game, but a game with a positive result, i. France's comparative advantage good however, is that good in which it has the least productivity disadvantage in production, namely cheese. In his book, An Inquiry into the Nature and Causes of the Wealth of Nations, Smith argued that countries should specialize in the goods they can produce most efficiently and trade for those goods they can't produce as well. He perceived these advanced factors as providing a country with a sustainable competitive advantage. Because resources tend to be different in different countries. That means they have an absolute advantage because they can produce more of these goods in the same amount of time. .
Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves. A nation following the theory of absolute advantage would produce the products that work best with its resources. Thirdly, Smith applies the same principles of opportunity costs and specialization to international economic policy, and the principle of international trade. Both countries benefit from the specialization of each of them in the production of the goods they have absolute advantage in. Absolute vs Comparative Advantage Absolute advantage and comparative advantage two terms that are widely used in international trade.
It is not advisable to try and produce everything. The opportunity cost of a given option is equal to the forfeited benefits that could have been gained by choosing the alternative. Hence these countries have become the optimal locations for labor-intensive industries like textiles and garments. Which Trade Theory Is Dominant Today? Global Strategic Rivalry Theory Global strategic rivalry theory emerged in the 1980s and was based on the work of economists Paul Krugman and Kelvin Lancaster. This theory became known as the absolute advantage theory, because it was based on the absolute advantage: a country exports the goods, which costs of production are lower than in a partner country, and imports the goods, produced abroad with lower costs. These advantages in the factors of production have helped the United States become the largest and richest economy in the world.