The trade theory that first indicated importance of specialization in production and division of labor is based on the idea of theory of absolute advantage which is developed first by Adam Smith in his famous book The Wealth of Nations published in 1776. 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 exchanges. Adam Smith argued that a country has an absolute advantage in the production of a product when it is more efficient than any other country producing it. Countries should specialize in the production of goods for which they have an absolute advantage and then trade these goods for the goods produced by other countries In economics, principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources.

1. ABSOLUTE ADVANTAGE
THEORY
INTERNATIO
NAL
TRADE
THEORY

2. INTENATIONAL TRADE
International trade is the exchange of capital,
goods, and services across international
borders or territories.
international trade has existed throughout
history (for example Uttarapatha, Silk Road,
Amber Road, salt roads), its economic, social,
and political importance has been on the rise
in recent centuries.

3. INTERNATIONAL TRADE
THEORIES
To understand the pattern in international trade, Different
trade theories are postulated. Some famous trade theories are:
1. Mercantilism
2.Absolute Advantage Theory
3. Comparative Advantage Theory
4. Hecksher-Ohlin Factor endowment theory
5. Product Life Cycle Theory
6. New Trade Theory
7. Porter’s Diamond Theory for competitive advantage

4. ABSOLUTE ADVANTAGE
THEORY: ORIGIN
The trade theory that first indicated importance of specialization
in production and division of labor is based on the idea of theory
of absolute advantage which is developed first by Adam Smith in
his famous book The Wealth of Nations published in 1776.
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 exchanges.

5. DRAWBACKS OF
MERCANTILISM THEORY
OR NEO-MERCANTILISM
THEORY
1. Mercantilism weakens a country
2. Restrictions on free trade decreases country’s
wealth
3. Overlooks other factors such as natural
resources, manpower and its skill level, capital
etc.
4. Restrictive Policies promoting exports and
restrict imports creating trade barriers
5. Colonial Exploitation

6. ABSOLUTE ADVANTAGE
THEORY : ASSUMPTIONS
1. Trade is between two countries
2. Only two commodities are traded
3. Free Trade exists between the countries
4. The only element of cost of production is
labour

7. ABSOLUTE ADVANTAGE
THEORY
Adam Smith argued that a country has an absolute
advantage in the production of a product when it is more
efficient than any other country producing it.
Countries should specialize in the production of goods
for which they have an absolute advantage and then
trade these goods for the goods produced by other
countries
In economics, principle of absolute advantage refers to
the ability of a party (an individual, or firm, or country) to
produce more of a good or service than
competitors, using the same amount of resources.

8. ABSOLUTE ADVANTAGE
THEORY : SIMPLE TERMS
1. Theory is based upon principle of division of labour.
2. Free Trade among countries can increase a country’s wealth
3. Free Trade enables a country to provide a variety of goods and
services to its people by specializing in the production of some
goods and services and importing others.
4. Every country should specialize in producing those products at
cost less than that of other countries and exchange these
products with other products produced cheaply by others.
5. When one country produces a product at a lower cost and
another country produces another product alt lower cost, both
can exchange required quantity and can enjoy benefits of
absolute cost advantage.

9. GAINS OF TRADE
NUMERICAL EXAMPLE
& GRAPHICAL
PRESENTATION
ABSOLUTE
ADVANTAGE
THEORY

11. PPF – Production Possibility
Frontier
The slope of the curve reflects the ‘trade-off’ of producing one
product over the other, representing opportunity cost.

15. ADVANTAGES,
SIGNIFICANCE &
LIMITATIONS
ABSOLUTE
ADVANTAGE
THEORY

16. ABSOLUTE ADVANTAGE
THEORY: ADVANTAGES
ABSOLUTE COST ADVANTAGE
1.Specialization : Specialization of labour leads to higher
productivity and allows to achieve less
labour cost per unit of output.
2.Suitablity : Suitability of the skills of labour of the
country in producing certain products
3.Economies of : Economies of Scale helps to reduce
Scale the labour cost per unit of output

17. NATURAL ADVANTAGE
1.Natural Resources
2.Climatic Conditions
Example:
A.India - Production of Rice, wheat, sweet
mangoes, grapes, Tea,
Coconuts, Cashew nuts, cotton, etc.
B.Sri Lanka - Production of Tea & Rubber
C.USA - Production of wheat

18. AQUIREDADVANTAGE
1.Technology
2.Skills
Example : Japan - Advantages in steel
production through
imports of steel & coal
England - Production of Textiles
France - Production of Wine

19. ABSOLUTE ADVANTAGE
THEORY: SIGNIFICANCE
1. More quantity of both products
2. Increased standard of living for both
countries
3. Increased production efficiency
4. Increase in global efficiency and
effectiveness
5. Maximization of global productivity and
other resources productivity

20. ABSOLUTE ADVANTAGE
THEORY: LIMITATIONS
1. No absolute advantages for many countries
2. Country size varries
3. Country by country differences in specializations
4. Deals with labour only and neglects other factors of
production
5. Neglected Transport cost
6. Theory is based on an assumption that Exchange rates
are stable and fixed.
7. It also assumes that labor can switch between products
easily and they will work with same efficiency which
in reality cannot happen.