Adam Smith theory of absolute advantage

May 24, 2016
Effects of Globalization and

Absolute advantage is a concept coined by Adam Smith in his theories for international trade. He is known as the founder of modern economics as he was one of the earliest thinkers and supporters of free trade. Smith was a renowned Scottish philosopher of political economy best known for his classic works, especially The Wealth of Nations in 1776.

Adam Smith’s absolute advantage theory suggests that countries, companies, or entities will produce the good or offer the service that they can provide at a lower cost per unit than any other entity. Countries that can produce the same good with fewer number of inputs are more productive than those who produce the same units of goods with more inputs. Practicing absolute advantage allows nations to minimize costs and maximize profits.

Historically speaking, Smith believed that trade was a natural behavior among humans as they truck, barter, and exchange one good for another. However, trade will only be pursued if there are clear benefits to the parties involved. Smith believes that in addition to those individual entities that trade, society as a whole is also better off by trading on the principles of absolute advantage.

The concept of division of labor in society is the basis and justification for pursuing absolute advantage. Take the example of a garment factory where theory suggests work should be divided according to specific units such us cutting, stitching, dying, and packaging. With division of labor, the set of workers devoted to each unit will become experts in their unit. Soon, more products will be completed with the same amount of people, simply because workers will be in better practice and save time from lack of movement across units. This form of specialization enables companies and countries to focus on providing the goods they have an absolute advantage in, in terms of productivity levels.

Smith also believed that some countries have no absolute advantage in any good. To explain absolute advantage, Smith used labor as the only input. Smith thought it was possible that when simply comparing labor productivities, a country could be unproductive at producing all goods due to expensive labor for every good. In this case, market determines that no trade will occur with that party as trade only occurs for mutual benefits.

Adam Smith was a supporter of a lassiez faire economy that lets the forces of absolute advantage determine the desirable ends and net benefits to society. He believed that competitive markets with their self-regulating behavior are perfectly equipped to maximize profits without the need for government intervention. Smith called this phenomenon “the invisible hand” of the free market.

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