This slides covers Adam Smith's Theory of Absolute advantage and David Ricardo's Theory of Comparative advantage.

1. INTERNATIONALECONOMIC
ENVIRONMENT
By,
Bhargavi K Upadhya

2. Theory of Absolute Advantage :
♫ This theory is given by Adam Smith in this book “Wealth of Nations” in
1776.
♫ This theory states that, “ One country would have absolute advantage over
the other if it can produce same amount of goods with fewer resources”.
♫ This is the ability of the country to produce more goods than the other
countries using same or less resources.
♫ This theory was stated in terms of International trade.

3. Adam Smith argued that,
Countries differ in their ability to produce goods efficiently.
Example :
Adam Smith argued that,
English
France
Textiles
Wine
Absolute
advantage
on textiles
Absolute
advantage
on wine

4. Specialization :
Adam Smith says, Countries should specialize in the production of goods for which they have
absolute advantage and trade the same for those who produced by other countries.
Example :
2 counties : Ghana and South Korea
Condition : 200 units of resources are available in each country
PPF :
Ghana
1) 20 tons of cocoa and no rice. ( 200/10) => Absolute advantage.
2) 10 tons of rice and no cocoa. ( 200/ 20)
3) Other combination of rice and cocoa.
South Korea :
1) 5 tons of cocoa and no rice. (200/40)
2) 20 tons of rice and no cocoa. ( 200/10) => Absolute advantage.
3) Other combination of rice and cocoa.

5. . Country Cocoa Rice
Resource required to produce 1 ton of Cocoa and Rice
Ghana
South Korea
10
40
20
10
Production and consumption without trade
Ghana
South Korea
10
2.5
5
10
Total production 12.5 15
Production with specialization
Ghana
South Korea
20
0
0
20
Total production 20 20

6. 2.5
5
10
15
20
0
15105 20
Rice
COCOA
Ghana
South Korea
Country Cocoa Rice
Consumption after Ghana trades 6 tons of cocoa for 6 tons of South Korea rice
Ghana
South Korea
14
6
6
14
K
K
G
G
A
B

7. Theory of Comparative Advantage :
♫ This theory was given by David Ricardo in his book, “Principles of
Political Economy” (1817).
♫ when one country has an absolute advantage in the production of all
goods.
♫ countries should specialize in the production of those goods they
produce most efficiently and buy goods that they produce less
efficiently from other countries.

8. Example :
2 counties : Ghana and South Korea
Condition : 200 units of resources are available in each country
PPF :
Ghana
1)20 tons of cocoa and no rice. ( 200/10) => Absolute advantage. (CA)
2)15 tons of rice and no cocoa. ( 200/ 13.5) =>Absolute advantage.
3)Other combination of rice and cocoa.
South Korea :
1) 5 tons of cocoa and no rice. (200/40) => Absolute advantage.
2) 10 tons of rice and no cocoa. ( 200/20) => Absolute advantage.
3) Other combination of rice and cocoa.

9. Country Cocoa Rice
Resource required to produce 1 ton of Cocoa and Rice
Ghana
South Korea
10
40
13.5
20
Production and consumption without trade
Ghana
South Korea
10
2.5
7.5
5
Total production 12.5 12.5
Production with specialization
Ghana
South Korea
15
0
3.75
10
Total production 15 13.75

10. 2.5
5
10
15
20
0
15105 20
Rice
COCOA
Ghana
South Korea
Country Cocoa Rice
Consumption after Ghana trades 4 tons of cocoa for 4 tons of South Korea rice
Ghana
South Korea
11
4
7.75
6
7.53.75
C
K
B
A
K
G
G

11. Assumptions :
1) Only 2 countries.
2) No transportation cost.
3) No price discrimination.
4) Each country has fixed stock of resources.
5) Free mobility of resources.

12. Thank You