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The Theory of Absolute Advantage

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Let us make in-depth study of the theory of absolute advantage.

The theory of absolute advantage was put forward by Adam Smith who argued that different countries enjoyed absolute advantage in the production of some goods which formed the basis of trade between the countries.

Consider Table 23.1 where man-hours required to produce a unit of wheat or cloth in the U.S.A. and India are given:

Man-Hours Required to Produce One Unit of Wheat and Cloth

It will be seen from the above table that to produce one unit of wheat in the U.S.A. 3 man-hours and in India 10 man-hours are required. On the other hand, to produce one unit of cloth, in the U.S.A. 6 man-hours and in India 4 man-hours are required. Thus the U.S.A. can produce wheat more efficiently (that is, at a lower cost), while India can produce cloth more efficiently.

To put it in other words, while the U.S.A. has an absolute advantage in the production of wheat, India has an absolute advantage in the production of cloth. Adam Smith showed that the two countries would benefit and world output will increase if the two countries specialize in the production of goods in which they have absolute advantage and trade with each other. How such specialization and trade would lead to gain in output and would be mutually beneficial for the two countries is shown in Table 23.2.

Gain in Output when Labour Resources are Transferred

Suppose to specialize in the production of Wheat, the U.S.A. withdraws 6 man-hours from the production of cloth and devote them to the production of wheat, it will lose 1 unit of cloth and gain 2 units of wheat.

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Similarly, to specialize in the production of cloth if India withdraws 10 hours of labour from wheat and use them for the production of cloth, it will lose one unit of wheat but gain 2.5 units of cloth.

In this way, transfer of labour resources to the goods in which they have absolute advantage, will result in the net gain of one unit of wheat and 2.5 units of cloth. The gain in output can be distributed between the two countries through voluntary exchange.

It is also clear from above that without any increase in productive resources international divi­sion of labour and trade leads to the expansion in world output and wealth. According to Adam Smith, given perfect competition in the industries and free trade between the countries, it is the market forces that would ensure specialization and trade on the lines of absolute advantage.

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