Absolute Advantage Theory

Absolute Advantage Theory

The theory of absolute advantage destroys the mercantilist idea that international trade is a zero-sum game. Unlike mercantilism this theory measures the nation’s wealth by the living standards of its people and not by gold and silver. There is a strong disadvantage with absolute advantage theory. If there exists a nation that does not have an absolute advantage in the manufacture of any product, will there still be gain to trade? It can further be extended to “will trade even occur?” To clarify such questions the theory of comparative advantage is proposed as an extension to absolute advantage theory.

Drawbacks and Merits

 If salaries were similar in the two nations prior to the inception of trade, the home country might have a ‘competitive’ or absolute advantage in both goods: it can sell at a low price than the foreign country in both the commodities. Foreign businessmen would obviously fear their lack of grip over the market. This “universal bankruptcy” cannot be equilibrium. But as the foreign workers would have no earning to afford for home produced goods. The inequity between spending and profits would also reflect the lack of exports to pay for imports. Market equilibrium would be attained through price alterations, lowering the foreign wage or raising the home wage until the foreign workers could be engaged in the industry in which the foreign economy has the comparative advantage. More generalized models of production lead us to the same inference: equilibrium costs will regulate to offer absolute advantage in the material in which each country has a comparative advantage.  Thus the theory of absolute advantage is feeble in the mathematical logic in the case where both nations continue to produce the material (Bloom & Durlauf 1986).