Adam Smith’s

Absolute Advantage Theory

David Ricardo’s
Comparative Advantage Theory
By Velvet Benicourt & Blossom Walker
 ABSOLUTE
ADVANTAGE
THEORY
According to online Cambridge University dictionary,
Absolute advantage is a scenario where a business or a
country is wholly sufficient to continuously produce a higher
quality product at better rates compared to others. A country
has an absolute advantage over another country in
producing a good if it uses fewer resources to produce that
good. Absolute advantage can be the result of a country’s
natural endowment.
BACKGROUND

Introduced By Adam Based on research as an Adam Smith attacked

Smith in his 1776 alternative to then the theory of
Publication of Wealth of popular mercantilism. mercantilism and
a Nation introduced a new way
of thinking, thus the
absolute advantage
theory emerged.
 KEY FACTORS

Assumptions Cost Factor Allocation

● Slow to no mobility of the
factors of production Cost plays the main role Since opportunity cost
● Trade balance whereas exports and not opportunity is no the main priority,
must be equal to imports cost. resource allocation is
● Trade barriers for the exchange not relevant.
of goods.
● Persistent return to scale.
 Table

Country Orange/units produces per unit of time Olive/units produced per unit of time

Country A 5 20

Country B 15 3
Production Possibility Curve Absolute Advantage
 COMPARATIVE
ADVANTAGE
THEORY

“A country has a comparative advantage in producing a good if

the opportunity cost of producing that good in terms of other
goods is lower in that country than it is in other countries.”
(Krugman, Obstfeld, & Melitz, 2018)
BACKGROUND

Introduced by David Based on research by: Main Difference:

Ricardo in 19th Adam Smith Opportunity Cost in
Century Robert Torrens Manufacturing Goods
 Key Factors + Comparison
Assumptions: Absolute Advantage Comparative Advantage

Two countries + 1 good ✘ ✔

Single FOP: Labour ✘ ✔
Returns to Scale ✔ ✔
Mutual & Reciprocal Trade ✘ ✔
No trade barriers ✔ ✔
Mobility ✘ ✔
Cost Factor:

Opportunity Cost ✘ ✔
Resource Allocation ✘ ✔
Table

Country Orange/units produces per Opportunity Cost of Orange Olive/units produced per unit Opportunity Cost of Olive
unit of time of time

Country A 10 5/10 5 10/5

= 0.5 =2

Country B 20 15/20 = 15 20/15

0.75 = 1.33
Production Possibility Curve
Production Possibility Curves
 Assumptions: Absolute Advantage Comparative Advantage

Two countries + 1 good ✘ ✔

Single FOP: Labour ✘ ✔

Returns to Scale ✔ ✔

Mutual & Reciprocal Trade ✘ ✔

No trade barriers ✔ ✔

Trade Balance ✔ ✘

Mobility ✘ ✔

Cost Factor:

Cost ✔ ✘

Opportunity Cost ✘ ✔

Resource Allocation ✘ ✔
 Advantages of Absolute Advantage
● Specialization: if a country specializes in labour, this leads to greater
productivity and this in turn leads to a decreased labour cost per unit of
output.
● Sustainability - the skills of labour within the country with respect to certain
goods are preserved.
● Economies of Scales - this helps to reduce the labour cost per unit of output.
● Countries with a natural and climatic advantage tend to benefit more from
this theory.
● Higher quantity of both goods being produced.
● Increased standard of living for both countries, due to income from trade.
● Increased production efficiency, due to workers becoming skilled at their
jobs.
 Limitations of Absolute Advantage
● More factors of production: In the real world, the production of goods are
dependent of various factors, such as land, labour, capital and many
other factors. Thus, the goods cannot be divided according to their
absolute advantage for a country in production basis.
● Country size is a determining factor.
● There are differences in each country’s specialization
● theory is dependent on the assumption that exchange rates are stable
and fixed.
● Assumes that labour can be alternated between products readily and
work with the same efficiency. In theory it stands but in reality it does not.
● There are no absolute advantages for many countries.
● Other factors of production besides labour are neglected.
 Advantages of Comparative Advantage
● The ability to produce a good or service for a lower opportunity cost.
● Entering into trade with other countries can also create job opportunities where they
may have been done before.
● higher profit margins
● Increased efficiency
Limitations of Comparative Advantage
● Transport costs may outweigh any comparative advantage
● Increased specialisation may lead to diseconomies of scale
● Governments may restrict trade
● Comparative advantage measures static advantage but not any dynamic
advantage
● Cost of trade.
● External costs of trade.
● Diminishing returns/diseconomies of scale.
● Static comparative advantage
● Dutch disease
● Trade – not a Pareto improvement.
● Gravity theory.
● Complexity of global trade
 Recommendations for Absolute Advantage
Adam Smith does not consider the question if every country has an absolute advantage in
the production of some goods. Adam Smith’s theory suggests that absolute advantages
develop as a consequence of trade and trade might be the incentive ways that leads to the
creation of absolute advantages. However, presently international trade is widely spread
and the countries do not start equally. To this effect poor countries might be able to compete
in the agricultural sector with rich, more productive countries and equalize the playing field.

Since this competition exists internationally Developed countries benefit from technology to
a greater extent than underdeveloped countries since they are able to make use of
technological developments. As a result, a rich country benefits more from trade with
another rich country than from trade with an underdeveloped country. A recommendation
can be that when countries are settling on their terms of trade, the poorer countries
incorporate an agreement with respect to technology in order to aid in their advancements
also.
 Recommendations for Comparative Advantage
The theory assumes that markets are perfectly competitive, that, there is perfect mobility of
factors without any diminishing returns and with no transport costs. The reality is differents.
The will PPF for each country would be non-linear and curved outwards. That is,, there is an
increasing opportunity cost associated with increasing specialisation. Allowances should
therefore be made for this phenomenon.

It may overstate the benefits of specialisation by ignoring a number of costs associated

with trade, to this regard, we recommend that allowances be made for same to accurately
depict the cost factor

Since complete specialisation might create structural unemployment as some workers

cannot transfer from one sector to another, we recommend a compromise be made and try
to distribute the labour. Countries still produce other goods domestically in order to promote
sustainability and that should ease the problem of structural unemployment.
 Recommendations for Comparative Advantage
Due to the fact that not every country exports/specializes in food related products, in order
to combat food scarcity, which may be a literal threat to the country, that country could keep
a minimum level of food production domestically.

Comparative advantage is not a rigid concept it may change over time. For example,
nonrenewable resources can slowly run out, increasing the costs of production, and
reducing the gains from trade. Countries can develop new advantages to not feel the effects
as much, an example of this is Vietnam and coffee production.
 Key Points Absolute & Comparative Advantage

● A country that has an absolute advantage can produce a good at lower marginal cost.
● A country with an absolute advantage can sell the good for less than the country that does not have the absolute
advantage.
● Absolute advantage differs from comparative advantage, which refers to the ability to produce specific goods at a lower
opportunity cost.
● Even if one country has an absolute advantage in the production of all goods, it can still benefit from trade.
● Countries should import goods if the opportunity cost of importing is lower than the cost of producing them locally.
● Specialization according to comparative advantage results in a more efficient allocation of world resources. A larger
quantity of outputs becomes available to the trading nations.
● Competitive advantage is distinct from comparative advantage because it has to do with distinguishing attributes which are
not necessarily related to a lower opportunity cost.
● The producer that requires a smaller quantity inputs to produce a good is said to have an absolute advantage in producing
that good.
● The existence of a comparative advantage allows both parties to benefit from trading, because each party will receive a
good at a price that is lower than its opportunity cost of producing that good.
 What If?

● What if transport costs were taken into account in the Comparative

Advantage theory?

● What if Absolute Advantage took into account more than 1 good?

Conclusions

Both Theories aid in understanding international trade as it shows the basic

baselines that countries use in trade decisions

Both theories have weaknesses & strengths, however both of them cannot be used
to fully aid in modern global trade.

Comparative Theory > Absolute Theory:

While both theories are unrealistic, the Comparative theory is that of superior as
it shows that countries should engage in trade where they are able to use their
strength, concerning their opportunity to their advantage. This is true and
accurate of modern trade. Meanwhile, Absolute theory is completely theoretical.
What’s Next?
We are of the opinion that Absolute Advantage isa theory that is dated and not
practical for trade presently. In 1776 when Adam Smith was seeking an alternative to a
failing mercantilism system, the proposed theory made sense theoretically. However
only theoretically and not practically. We are of the belief that at this point in time, that
Absolute Advantage offered a plausible alternative to mercantilism but there is no
sustainability and reality to that system of trade. There is no country in reality that
would have an absolute advantage. Specialization may have pros attached to it
however, the omission of key factors, made Comparative Analysis more practical and
suitable to international trade. Adam Smith’s research, planted the basis for the
theories however David Ricardo went a step further and spoke on Comparative
Advantage.
 What’s Next?
Though we are of the opinion that Comparative Advantage is more beneficial and practical
than Absolute Advantage, it is not met without some challenges. To this effect, we believe
that neither theory would be completely adequate to govern trade by. They concepts of the
theories are useful and aspects of them may be used, however, we believe that there are
theories that are updated and would address certain nuances that both theories did not
address and would beneficial to economies of the countries involved.
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