Theory of absolute and comparative advantage

Theory of Absolute Advantage and Competitive Advantage.

1. Theory Of Absolute and Comparative Advantage A class presentation by Olabode Desire

2. Key terms Theory: It can be defined as a belief that can guide behaviour or a well-substantiated explanation of some aspect of the natural world; an organized system of accepted knowledge that applies in a variety of circumstances to explain a specific set of phenomena.

3. Trade: According to a definition given by wealth of Nations (WN ), a book written by Adam Smith; trade is the consequence of the human “propensity to truck, barter, and exchange one thing for another.

4. Specialization: In international trade, specialization refers to a country’s decision to major in the production of a certain good or list of goods because of the advantages it possesses in their production. Opportunity cost: refers to what you sacrifice in making an economic choice.

5. Adam Smith and David Ricardo (Great philosophers). Adam Smith  (5 June 1723 – 19 th July, 1790) was a Scottish moral philosopher and a pioneer of political economy. The ideas that became associated with Smith not only became the foundation of the classical school of economics but also gained him a place in history as the father of economics. His work served as the basis for other lines of inquiry into the economics field, including the theory of absolute advantage and even after his death, his great ideas he promoted lives on. In 2007, the Bank of England placed his image on the £20 note.

6. ADAM SMITH (5 June 1723 – 19 th July, 1790)

7. David Ricardo David Ricardo, a British, lived between 18-4-1772 and 11-09-1823. Ricardo’s interest in economic questions arose in 1799 when he read Adam Smith’s Wealth of Nations. D avid Ricardo’s aspects that made him to be known across the world is his contribution to the law of comparative advantage. He wrote his first economics article at age thirty-seven and then spent the following fourteen years—his last ones—as a professional economist .

8. DAVID RICARDO 18 th April -1772 to 11 th September-1823

9. ABSOLUTE ADVANTAGE – This theory was developed by Adam Smith to counter Mercantilism (Zero-sum game) while ‘AA’ is a positive -sum game. Talks about who can do it better, cheaper and quicker.

10. ‘ AA’ says that one country would have an absolute advantage over the other if it can produce same amount of goods or greater output of a good or service than other countries using the same amount of resources or even less. EXAMPLE Party A can produce 5ton of cassava per hour with 6 employees and Party B can produce 10ton of cassava per hour with 6 employees. Assuming that the employees of both parties are paid equally, Party B has an absolute advantage over Party A in producing cassava per hour. This is because Party B can produce twice as many cassava as Party A can with the same number of employees.

11. COMPARATIVE ADVANTAGE Comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. The conclusion drawn is that each party can gain by specializing in the good where it has comparative advantage, and trading that good for the other.

12. Even if one party is more efficient in the production of all goods (absolute advantage in all goods) than the other, both countries will still gain by trading with each other, as long as they have different relative efficiencies. EXAMPLE – 2 parties producing 2 commodities with the same resources, time, all factors been equal. Output as shown below: Party A- 1000tons of cassava, 2500tons of cotton. Party B - 1000tons of cassava, 1000tons of cotton.

13. SIMILARITIES Both theories supports Free Trade approach unlike the mercantilism theory. Both theories elucidates a concept of Division of labour. They talk about gains for both home and host country.( positive sum game). Specialization. Among others.

14. Thank you.