This document discusses the absolute cost advantage theory of international trade. It originated with Adam Smith who argued that countries should specialize in producing goods where they have an absolute advantage in labor costs. Specialization and trade allows both countries to increase total production. The document provides an example where India has an absolute advantage in cloth and Sri Lanka in coffee. Through trade, both countries can increase total production of both goods from 150 to 400 units. However, the theory has limitations as it only considers labor costs and assumes stable exchange rates.

1. ABSOLUTE COST
ADVANTAGE
THEORY
INTERNA
TIONAL
TRADE
THEORY

2. INTRODUCTION
•How determinestrade?
•Whydoestradearise?
•Whydocountriesgainbytrading?
 To address all these questions, classical economists
such as Heberler, Ohlin, J. S. Mill, Ricardo, and Adam
Smith have proposed the absolute cost theory of
internationaltrade.

3. 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.

4. 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
5. Factor mobility
6. Zero transport cost
7. Full employment

5. GAINS OF TRADE
NUMERICAL EXAMPLE
& GRAPHICAL
PRESENTATION
ABSOLUTE
ADV
ANT
AGE
THEORY

6. Countries
Goods (Units) Ratio
Cloth Coffee
India 100 50 2 : 1 2 Cloth = 1
Coffee
Sri Lanka 50 100 1 : 2 1 Cloth = 2 Coffee
Total 150 150 300
Countries
Goods (Units) Ratio
Cloth Coffee
India 200 -- 4 : 1 4 Cloth = 1 Coffee
Sri Lanka -- 200 1 : 4 1 Cloth = 4 Coffee
Total 200 200 400

7. 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

8. 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.