Absoute Advantage Theory Explained -- With Examples!

Absoute Advantage Theory Explained -- With Examples!
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Explaining Absolute Advantage

Absolute advantage theory is concerned with the reasons why it may be beneficial for countries to engage in international trade. The theory proposes that certain countries will obtain a benefit in terms of increased national income if they specialize in certain areas of production and trade with other countries. According to the theory of absolute advantage, it makes sense for a country to specialize in the production of goods if it is more efficient at producing them than other countries. The country will increase its wealth by specializing in this way and engaging in international trade to export these products and import those that it does not make. If all countries follow this path, then according to the theory of absolute advantage they may all increase their wealth. More of their resources will be devoted to producing the goods and services that they are most efficient in producing, and fewer resources will be given over to inefficient production. A country that did not have an absolute advantage in the production of any goods or services would however have less reason to engage in international trade.

The theory of absolute advantage was put forward by Adam Smith to demonstrate that the mercantilist ideas that were prevailing in Europe at the time were not helping the national or international economy. The mercantilist policies meant that there were high tariff barriers against foreign imports and other restrictions on trade.

Examples of Absolute Advantage

Alpinia produces cuckoo clocks at a prodigious rate, requiring only 60 worker hours to produce each clock. Nearby Oceania is relatively inefficient at producing such clocks, and it needs 100 hours to make each one. However the artisans of Oceania are dab hands at making rocking horses, producing each one in just 50 worker hours. The clockmakers of Alpinia are unable to transfer their clockmaking skills to other forms of manufacturing and the Alpinians require 80 worker hours to produce a rocking horse.

As Alpinia can make a cuckoo clock in 60 hours while Oceania needs 100 hours for the same task, Alpinia has an absolute advantage in this activity and would increase its national income by specializing in this form of manufacture. In the case of rocking horses, Oceania can complete each one in 50 worker hours while the Alpinians need 80 worker hours, so Oceania clearly has an absolute advantage in the manufacture of rocking horses and should specialize in their manufacture.

This specialization combined with international trade would benefit both parties. However if we look at the statistics for a third country, Desertia, we find that this country requires 120 hours to produce a cuckoo clock and 90 hours to produce a rocking horse. Desertia does not have an absolute advantage in either of these activities and according to the theory of absolute advantage it would not benefit by specializing in either activity.

Problems with the Theory of Absolute Advantage

Absolute Advantage

The theory of absolute advantage was a step forward in explaining the need for countries to specialize in certain products and engage in international trade to increase their productivity. The theory was however not helpful to those countries who did not have an absolute advantage in certain goods. Such countries would, according to the theory, not gain any benefit from specializing. The countries that had an absolute advantage from specializing in certain goods and services would benefit from international trade, but those countries without any absolute advantage would not necessarily gain any benefit. The theory of absolute advantage does not offer any reason why those countries with no absolute advantage in any goods should specialize or engage in international trade.

Absolute Advantage and Comparative Advantage

Comparative Advantage

Some of the deficiencies in the theory of absolute advantage were resolved by the development of the theory of comparative advantage by David Ricardo in the first part of the nineteenth century. Ricardo explained that even where a country did not have an absolute advantage in producing a certain good it may still benefit from specialization and international trade where it has a comparative advantage in particular goods or services. Comparative advantage may be established by examining the opportunity cost of producing a certain item, in other words looking at the benefit foregone by producing those goods rather than the next best alternative.

Although absolute advantage theory is too much of an over-simplification to be of great use in analyzing the complex trading patterns of the modern world, the theory as put forward in the work of Adam Smith represented an important step towards a justification of free trade on an international scale. The increasing specialization in international and domestic markets since the time of Adam Smith shows that the basic concept contained in the theory of absolute advantage was sound, and that specialization and international trade may bring benefits to all the parties engaged in trade and enable the income of all the nations to be increased.