This document discusses Adam Smith's theory of absolute advantage from his famous book The Wealth of Nations published in 1776. Smith argued that countries should specialize and trade based on what they can produce most efficiently. A country has an absolute advantage if it takes fewer resources to produce a good compared to another country. Through international trade based on absolute advantage, overall world productivity and wealth increases as countries obtain goods more efficiently than if each produced everything themselves.

1. INTERNATIONAL TRADE AND
FINANCE

2. Theories of International
Trade
II

3. THE THEORY OF MERCANTILISM

4. THE THEORY OF ABSOLUTE
ADVANTAGE

5. HAVE YOU EVER HEARD
OF ADAM SMITH?

6. ADAM SMITH’S THEORY OF ABSOLUTE
ADVANTAGE
• In 1776, Adam Smith published his famous book, An Inquiry into the Nature
and Causes of the Wealth of Nations*.
• In Smith’s world, costs are based on the value of labour, and the cost to
produce a good depends on the amount of labour needed to produce the
good.
• Smith argued that countries differ in their ability to produce goods efficiently.
• In this book, he attacked the Mercantilist belief that trade is a zero-sum game
where one trading partner must win at the other’s expense.
• Smith argued that the world’s wealth is not fixed because when nations
engage in international trade world productivity increases. This happens
because individual nations do what they do most efficiently and pass on
the gains from this efficiency to all trading partners.
• What is “Absolute Advantage”?
• Country A is said to have an absolute advantage in the production of a good X
when it takes fewer units of labour to produce good X in Country A than in
Country B.
*Smith, Adam. 1776. An Inquiry into the Nature and Causes of the Wealth of Nations. 3 vols. Dublin: Whitestone.

7. REFERENCES
Hill, Charles W. L., Global Business Today, Tata McGraw Hill, Chapter
5.