The All important theory of Absolute Advantage by Adam Smith

Absolute Advantage vs. Comparative Advantage

Absolute advantage occurs when one producer can make a product using fewer resources or more efficiently than another producer. This can be compared to comparative advantage, which exists when a producer has a lower opportunity cost to produce a good or service. Opportunity cost is what you give up in choosing one option over another. For instance, if you spend time playing video games instead of studying, your opportunity cost is the studying you missed.

Absolute advantage leads to clear gains from specialization and trade, but only in scenarios where each producer has an absolute advantage in producing some goods. For example, if one country is very good at making wine and another is excellent at producing computers, both countries benefit by specializing and trading with each other.

However, even without absolute advantage, countries can still gain from trade through comparative advantages. David Ricardo, a famous economist, explained that even if a country is less efficient in producing all goods, it can still benefit from trade by focusing on goods where it has the least disadvantage.

Assumptions of the Theory of Absolute Advantage

The theory of absolute advantage, like the theory of comparative advantage, makes several assumptions for simplicity. It assumes there are no trade barriers like tariffs and no costs related to shipping goods between countries. It also assumes factors of production, like labor and capital, do not move across borders, which was a realistic assumption in the 1700s but less so today due to globalization.

Moreover, these theories assume that the advantages a country has are constant and do not change, which isn't always true in reality. Countries can improve their production capabilities or might suffer setbacks due to natural disasters or economic changes.

Pros and Cons of Absolute Advantage

The main benefit of the theory of absolute advantage is its simplicity in explaining why countries benefit from trading based on their strengths. However, this theory has limitations. It doesn't consider the costs of trading and the dynamic nature of advantages. It also has been criticized for justifying policies that exploit less developed countries, encouraging them to stick to agricultural outputs rather than developing diverse industries.

Example of Absolute Advantage

Imagine two countries, Atlantica and Pacifica, both needing butter and bacon to survive. Atlantica can produce more butter, while Pacifica can produce more bacon efficiently. If Atlantica focuses on butter and Pacifica on bacon, and then they trade, both countries end up with more of both goods than if they tried to produce both on their own.

How Can Absolute Advantage Benefit a Nation?

By specializing in products that they are good at making and trading for what they are less efficient at producing, countries can maximize their productivity and economic well-being. This specialization is based on absolute advantage—each country focuses on producing goods where they are the most efficient compared to others.

How Does Absolute Advantage Differ From Comparative Advantage?

Absolute advantage is about producing more efficiently using fewer resources, while comparative advantage focuses on lower opportunity costs. Even if a country is not the best at producing something, if it has the lowest opportunity cost, it still makes sense for it to specialize and trade in that product.

Examples of Nations With an Absolute Advantage

Saudi Arabia in oil production and Colombia in coffee are examples of countries with absolute advantages due to their natural resources and climate.

The bottom line is, understanding absolute advantage helps explain why countries trade and how they benefit by focusing on their strengths and trading for their weaknesses.

Adam Smith, the man behind this concept

The theory of absolute advantage was developed by Adam Smith, a Scottish economist and philosopher, widely known as the father of modern economics. Born on June 16, 1723, in Kirkcaldy, Scotland, Smith was a key figure of the Scottish Enlightenment, a period of intellectual and scientific accomplishments in Scotland. He attended the University of Glasgow at the age of fourteen and later went on to study at Balliol College, Oxford. Adam Smith is best known for his seminal work, "The Wealth of Nations," published in 1776, which lays the foundations of classical economics and introduces the concept of absolute advantage. This work argues that if countries specialize in producing goods where they have an absolute advantage and engage in trade, they will achieve greater economic prosperity. Smith's ideas have had a profound impact on economic policies and the study of economics. He passed away on July 17, 1790, but his theories continue to influence economic thought and practice to this day.