Absolute cost Advantage theory-Adam Smith

Absolute cost Advantage theory-Adam Smith

Introduction :- The oldest and most popular theory of international trade is the classical theory of comparative costs or profit. Adam Smith was the first economist to emphasize that different countries can reach better living standards if they trade freely with each other. Mercantilists, before Adam Smith also expressed their views on international trade. According to him, trade should be done only by the government and it should be kept in mind that in exchange for exports, the treasury of other government countries should only increase the gold reserves of precious metals or other precious metals.

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


Adam K. Smith let them know that the country is Opposed narrow-mindedness and placed more emphasis on open trade, meaning that different countries should exchange goods without interruption. Doing so would increase the distribution of labor internationally and benefit all trading nations. Adam Smith thinks that in such a situation every country is better than before The economic situation will be reached while no country will be in a worse economic situation than before. Smith's view of mercantilists is that any country can only make a profit if it pushes other countries doing business with it into a worse economic situation than before, i.e. one country benefits from international trade at the expense of other countries. It is the exact opposite of what one can earn. According to Adam Smith, every country should export what it has an absolute advantage in producing. According to him, the cost can only be measured in terms of labor cost and production of the commodity
According to Smith, it is important for the exporting industry to produce a greater amount of labor than any other industry by investing a given amount of labor and capital. . This principle is explained by the following list:

From the list above, it is clear that in the United States it takes 20 labor hours to produce one unit of textile and 10 labor hours to produce one unit of wheat. Similarly in England it takes 10 labor hours to produce one unit of cloth and 20 labor hours to produce one unit of wheat. It is clear that the United States has a net profit in wheat production and England has a net profit in textile production. In such a case, if the two countries trade with each other, then both Will benefit Naturally, the US will export wheat and England will export textiles. In other words, the US will import textiles from England and England will import wheat from the US. One thing to note here is how the two countries will exchange cloth and wheat. This international exchange rate will depend on the internal exchange rate of the two commodities produced by the two countries. In the above list the exchange rate of cloth and wheat in the United States is 12 and in the United Kingdom it is 2: 1, i.e. two units of wheat for one unit of cloth in the United States and one unit of wheat for two units of cloth in England. In other words, two units of wheat can be produced at the same cost as one unit of cloth produced in the United States. It is clear that the international exchange rate will be between 1: 2 and 1: 1/2. That is the international price of a unit of cloth or the international price of a unit of wheat If the price is between 1/2 and 2 units of cloth (whichever is between 12 and 2 units of wheat) then both the countries - USA and England will benefit from the trade in wheat and cloth. If the two countries exchange the two commodities with each other on a 1: 1 basis, that is, exchange one unit of wheat for one unit of cloth, then both will benefit.

The explanation is as follows: The United States will exchange a unit of wheat for a unit of English cloth, or England will give a unit of wheat produced by itself to the United States in exchange for a unit of wheat. By doing so, the United States would get one unit of cloth for only 10 labor hours and England would also get one unit of wheat for only 10 labor hours.
That is, if the United States produces two units of wheat instead of one, one for domestic consumption and the other for England, The production cost will be only 20 labor hours. Now he can give England a unit of wheat and get a unit of cloth from him. By doing so, the United States can get a single unit of wheat and clothing in just 20 working hours. Similarly, England can get a single unit of wheat and cloth for only 20 working hours. Now look at that situation Suppose the United States and England did not start trading with each other. In that case, the United States would have to spend 30 labor hours (10 plus 20) to produce a single unit of wheat and cloth. Similarly, England had to spend 30 labor hours (10 plus 20) to get one unit of cloth and wheat. However, by exchanging their production with each other, both the countries can get the same amount of cloth and wheat in just 20-20 working hours. It is clear that the two countries can save 10-10 labor hours by trading with each other and use that labor either for surplus production or to facilitate labor. The two will continue to benefit from mutual trade as long as their exchange is far between international (domestic) exchange rates between the two countries. The farther the international exchange is from the domestic exchange rate of a country, the more the country will benefit from trade. Conversely, the smaller the difference between a country's domestic exchange rate and an international exchange rate, the less that country will benefit from trade. If the international exchange rate and the domestic exchange rate are equal then there will be no profit from trade. Of course this is a very simple and simple form of trade but one thing that is very important, is that the two countries start trading with each other and get a greater amount of both commodities than before with a given amount of labor. Can Or they can get the same amount of labor for less than before. Adam Smith's concept of free trade or non-interference in trade is also based on his above explanation.

Of course by Smith the above argument for profit from trade is plausible but it is no better. The other side of Smith's theory above is that trade is primarily a means by which the country's surplus production can be absorbed by sending it to other countries. In other words, trade paves the way for surplus production in the country. The same additional production routes Is the principle of (vent for surplus doctrine). There are two main aspects to this. First, international specialization is part of the development second, The country must have real or potential surplus production capacity before starting a business. This unused production capacity can be utilized once the business is started.

CRITICISM OF THE THEORY :-

Adam Smith's theory emphasizes the benefits of trading. According to him, doing business with each other will definitely benefit all the countries to some extent. But in such a situation, it may be possible for one country to benefit more from trade and the other less. In that case, the gap between the two will widen.

Second, according to Smith, trade would only be possible and profitable if each country had a net profit in the production of one commodity or another. That doesn't have to be. It is also possible for a country to produce any commodity There is no net benefit in What would that country do in that situation? Adam Smith's theory is unable to answer this.
Adam Smith's theory of exporting surplus production is also complete Not satisfying. According to him, freedom of trade is essential for everlasting growth. But Smith's theory about the rules of trade is silent. In fact, Smith's theory, which is a bit of a crunch, was Done later better presented by Mynt and Findley.
Similarly, Smith's theory of absolute profit was later further refined by Torres and Ricardo, who called it the theory of comparative costs.Of course, Smith's business model is incomplete and does not answer the question of what is the basis of trade between different countries, but it must be admitted that Smith did this to economists Forced to think after him.