Adam smith theory on International Trade

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Adam smith theory on International Trade

  1. 1. Adam Smith contribution to International Trade.
  2. 2.  Adam Smith (5 June 1723 OS (16 June 1723 NS) – 17 July 1790) was a Scottish moral philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment,[1]Adam Smith is best known for two classic works: The Theory of Moral Sentiments (1759), and An Inquiry into the Nature and Causes of the Wealth of Nations (1776). The latter, usually abbreviated as The Wealth of Nations, is considered his magnum opus and the first modern work of economics. Smith is cited as the "father of modern economics" and is still among the most influential thinkers in the field of economics today
  3. 3. Adam Smith and David Hume were the founding fathers of anti-mercantilist thought. A number of scholars found important flaws with mercantilism long before Adam Smith developed an ideology that could fully replace it.
  4. 4. Adam smith “wealth of nations” was an attack on merchantilism.
  5. 5. •laissez-faire capitalism •Division of labour •Invisible hand Absolute advantage theory was derived from this book “wealth of nations”
  6. 6.  Adam Smith's Absolute Advantage Theory says that one country would have an absolute advantage over the other if it can produce same amount of goods with fewer resources. This is then the ability of a company or a country to produce more goods than its competitors using same or less resources. The principle was described by Adam Smith in the context of international trade.
  7. 7.  The main concept of absolute advantage is generally attributed to Adam Smith for his 1776 publication An Inquiry into the Nature and Causes of the Wealth of Nations in which he countered mercantilist ideas. Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism because the export of one nation is another nation’s import and instead stated that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage. Smith also stated that the wealth of nations depends upon the goods and services available to their citizens, rather than their gold reserves. While there are possible gains from trade with absolute advantage, the gains may not be mutually beneficial. Comparative advantage focuses on the range of possible mutually beneficial exchange
  8. 8.  Party A can produce 5 widgets per hour with 3 employees.  Party B can produce 10 widgets per hour with 3 employees.  Assuming that the employees of both parties are paid equally, Party B has an absolute advantage over Party A in producing widgets per hour. This is because Party B can produce twice as many widgets as Party A can with the same number of employees.
  9. 9.  Alpinia produces cuckoo clocks at a prodigious rate, requiring only 60 worker hours to produce each clock. Nearby Oceania is relatively inefficient at producing such clocks, and it needs 100 hours to make each one. However the artisans of Oceania are dab hands at making rocking horses, producing each one in just 50 worker hours. The clockmakers of Alpinia are unable to transfer their clockmaking skills to other forms of manufacturing and the Alpinians require 80 worker hours to produce a rocking horse.  As Alpinia can make a cuckoo clock in 60 hours while Oceania needs 100 hours for the same task, Alpinia has an absolute advantage in this activity and would increase its national income by specializing in this form of manufacture. In the case of rocking horses, Oceania can complete each one in 50 worker hours while the Alpinians need 80 worker hours, so Oceania clearly has an absolute advantage in the manufacture of rocking horses and should specialize in their manufacture.  This specialization combined with international trade would benefit both parties. However if we look at the statistics for a third country, Desertia, we find that this country requires 120 hours to produce a cuckoo clock and 90 hours to produce a rocking horse. Desertia does not have an absolute advantage in either of these activities and according to the theory of absolute advantage it would not benefit by specializing in either activity.
  10. 10.  The theory of absolute advantage was a step forward in explaining the need for countries to specialize in certain products and engage in international trade to increase their productivity. The theory was however not helpful to those countries who did not have an absolute advantage in certain goods. Such countries would, according to the theory, not gain any benefit from specializing.

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