Question 18 . Define the theory of Absolute Advantage theory of International trade.
Answer 18. In economics , Principle of absolute advantage refers to the ability of an individual , firm or country to produce more of a goods or service than competitors , using the same amount of resources. The theory says that trade occurs when one country, individual or company is absolutely more productive than another company in the production of goods. A person , company or country has an absolute advantage if its output per unit of input of all goods and services produced is higher than that of another entity producing that goods or services . ADAM SMITH described the principle of absolute advantage in the context of international trade , using labour as the only input. The main concept of Absolute advantage is generally attribute to Adam smith for his 1776 publication. "AN ENQUIRY INTO THE NATURE AND CAUSES OF WEALTH OF NATIONS " . in which he has described mercantilist ideas.
ASSUMPTIONS :
1. Production follows law of constant return.
2. There is only one factor of production i.e labour .
3. Existence of full employment.
4. Labour is perfectly mobile within the country but is immobile between the countries.
5. Transportation cost is not applicable .
6. 2 goods , 2 nations and one factor i.e labour .
7. Law of constant cost return to scale is applicable.
CRITICISM :
According to this theory one country should be able to produce atleast one product. Comparatively low cost but reality most of the developing countries do not have absolute advantage of producing any products at lower cost.
Adam Smith's theory was criticised as it neglects the equal difference in costs and the comparative difference in cost among various countries of the world. Also it was criticised because it did not explain what happens to trade if one country has an absolute advantage in both products. Hence the shortcomings of this theory were improved upon by the theory of comparative advantage given by DAVID RICARDO.