ABSOLUTE ADVANTAGE

AND COMPARATIVE ADVANTAGE

ABSOLUTE ADVANTAGE
Adam Smith denied mercantilist assumption (Zero-sum trade) Countries differ in their ability to produce goods efficiently

English Superior manufacturing process, world's most efficient textile

manufacturers French combination of favorable climate, good soils, and accumulated expertise, worlds most efficient wine industry So, Absolute Advantage of English : Textile and French : Wine

 According to Smith, countries should specialize in the production of

goods for which they have an absolute advantage and then trade
these for goods produced by other countries Country should never produce goods at home that it can buy at a lower cost from other countries By specializing in the production of goods in which each has an absolute advantage, both countries benefit by engaging in trade Ex : Ghana and South Korea

Net Result : Positive Sum Game , net gains for all involved

Table : Absolute Advantage and the Gains from Trade

Resources Required to produce 1 Ton of Cocoa and Rice Cocoa Rice Ghana 10 20 South Korea 40 10 Production and Consumption without Trade Cocoa Ghana 10.0 South Korea 2.5 Total Production 12.5

Rice 5.0 10.0 15.0

Ghana South Korea Total Production

Production with Specialization Cocoa 20.0 0.0 20.0

Rice 0.0 20.0 20.0

Consumption after Trade of 6 Tons by each Countries Cocoa Rice Ghana 14.0 6.0 South Korea 6.0 14.0 Increase in Consumption as a Result of Specialization and Trade Cocoa Rice Ghana 4.0 1.0 South Korea 3.5 4.0

COMPARATIVE ADVANTAGE
David Ricardo took Adam Smiths theory one step further What might happen when one country has an absolute advantage in the production of all goods Ex : Ghana and South Korea Ghana : Efficient in the production of both cocoa and rice

Table : Comparative Advantage and the Gains from Trade

Resources Required to produce 1 Ton of Cocoa and Rice Cocoa Rice Ghana 10 13.33 South Korea 40 20 Production and Consumption without Trade Cocoa Ghana 10.0 South Korea 2.5 Total Production 12.5

Rice 7.5 5.0 12.5

Ghana South Korea Total Production

Production with Specialization Cocoa 15.0 0.0 15.0

Rice 3.75 10.0 13.75

Consumption after Trade of 4 Tons by each Countries Cocoa Rice Ghana 11.0 7.75 South Korea 4.0 6.0
Increase in Consumption as a Result of Specialization and Trade Cocoa Rice Ghana 1.0 0.25 South Korea 1.5 1.0

Basic message of comparative advantage theory is :

Potential world production is greater with unrestricted free

trade than it is with restricted trade