TRADE based on ABSOLUTE ADVANTAGE

According to Adam Smith, trade between two nations is based on absolute advantage when one nation is more efficient than the other in the production of one commodity but is less efficient in the production of another commodity then both nations can gain by each specializing in the production of the commodity of its efficiency and exchange part of its output with the nation for the commodity of its less efficiency. By this process, there will be the efficient utilization of resources and output of both commodities will rise. This increase in the output of both commodities measures the gains from specialization in the products available to be divided between two nations through trade.

For example: If the United States is efficient in the production of wheat but inefficient in the production of cloth. On the other hand, the United Kingdom is efficient in the production of cloth but is inefficient in the production of wheat. Thus the United States has an absolute advantage over the United Kingdom in the production of wheat and absolute disadvantage in the production of cloth. Whereas, the United Kingdom has an absolute advantage over the United States in the production of cloth and absolute disadvantage in the production of wheat.

Under these circumstances, both nations would benefit if each nation specialized in the production of the commodity of its absolute advantage and then trade with the other nation.

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