Question

Absolute cost theory of international trade

Answer 1

$Adam smith’s  theory of absolute cost advantage:$
According to Adam Smith, if one country has absolute cost advantage over another country in one commodity, and the other country has absolute cost advantage over the first country in another commodity, both the countries could gain by trading. (It may be noted that between two countries, a country is aid to have absolute advantage or absolute cost advantage in a commodity, if it can produce that commodity absolutely more efficiently and cheaply than the other country).

The theory of absolute cost advantaged can be explained with an example. Suppose it takes 10units of labour to produce 1 unit of product in country A, but 20 units of labour to produce one unit of the same product in country B, and it takes 20 units of labour A, but 10 units of labour to produce 1 unit of the same product in country B. In this case, both the countries would gain, if country a speacialises in the production and export of product X, and country B speacialise in the production and export of production Y. country A can get 1 unit of production Y in exchange of 1 unit of product X. Similarly, country B can get 1 unit of product X in exchange of 1 unit of production Y.
Assumption
$assumption$

He assumed that the costs of the commodities were determined by the relative amounts of labour involved in their production.He assumed that labour was mobile within the country but immobile between the countries.He took into considerations only two countries and only two commodities for his analysis.He argued that trade between the two countries would take place if each of the two countries has absolutely lower cost in the production of one of the commodities.

 

Adam Smith’s analysis of the causes for and benefits of international trade was no doubt simple. But it was not deep.Adam Smith’s analysis was based on the assumption that for international trade, an exporting country should have, an absolute cost advantage.