International-Business-Dr-R-Chandran-E-book

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International Business- Dr. R. Chandran
However, it is important to understand, interpret and modify these concepts
and apply them to current practices in business, especially the functions of
labour productivity, resource exploration and demand forecasting.
THE THEORY OF ABSOLUTE ADVANTAGE
The classical theories of international trade that were propounded by Adam
Smith, David Ricardo, John Stuart Mill and others were based mainly on
differences in the cost of labour between different nations. Among the
classical theories, the most discussed theory was the theory of ‘Absolute
Advantages’ put forward by Adam Smith, which was widely accepted and
relevant during his contemporary era.
Adam Smith was a champion of free trade and he claimed that free trade
always leads to better division of labour and thereby encourages
specialization both in national and international markets. He advocated that
every country is specialized in certain production function and ultimately
will be able to enjoy the benefits. Countries can exchange the products they
produce at a lower cost with each other. He remarked that, “it is the wise
decision of every prudent master never to make goods at home, which will
cost him more, but to buy them, which is cheaper”. For example a cobbler
does not attempt to make his own shoe, but he buys them from the
shoemaker and vice versa. An individual select the occupation for which he
thinks himself best fitted. Similarly, every country tries to specialise in the
production of those commodities, in which it enjoys greater advantages e.g,
Malta produces glass. China produces soft toys, South Korea produces
synthetic fibres, and India produces metal ware and Myanmar produces good
quality timber,
The theory of absolute advantage can be explained with the help of an
example, consider two countries A and B, each in which produces two
different types of goods, namely X and Y. With one unit of labour, country
A can produce either 20 units of commodity X or 10 units of commodity Y.
On the other hand, with one unit of labour, country B can produce either 10
units of X or 20 units of Y. This clearly shows that country A has an
absolute advantage in the production of goods of the type X and country B
has an absolute advantage in the production of goods of the type Y. In this
case, trade between countries A and B will be mutually beneficial, as with
two units of labour, A can produce 40 units of X and B can produce 40 units
of Y, i.e 80 units of X and Y between them. On the other hand without
international trade, they can produce only 60 units of X and Y between them
with the same amount of labour. Thus country A should specialize in the
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