Absolute advantage theory Adam Smith

June 2, 2015
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Adam Smith is generally ignored as a trade theorist in text books of international economics because of the common belief that he only confirmed the rule of absolute advantages to explain the structure of foreign trade.

However, his vent-for-surplus approach may be interpreted as a pioneering study which stresses the importance of economies of scale in explaining the structure of trade.

Economists recognize the undeniable influence of Smith’s concepts such as “extent of the market”, “division of labour”, “improved dexterity in every particular workman”, and “simple inventions coming from workman” on trade theory.

Adam Smith propounded the theory of absolute cost advantage as the basis of foreign trade; under such circumstances an exchange of goods will take place only if each of the two countries can produce one commodity at an absolutely lower production cost than the other country.

Suppose, there are two countries I & II and two commodities A and B. For example, country can produce a unit of commodity (A) with 10 and a unit of commodity (B) with 20 labour units, and that in country II, the production of a unit of (A) costs 20 and a unit of (15) 10 labour units. Now country I has absolute cost advantage in tin- production of (A) and it will confine itself to the production of (A) and country II in the production of (B). Exactly the same would happen if I and II were two regions of one country. We speak of an absolute- differences in costs because each country can produce one commodity at an absolutely lower cost them the other. Thus, in such a situation, a division of labour between them must lead to an increase in total output.

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