Adam Smith's Theory Of Absolute Differences In Cost
Adam Smith strongly opposed the mercantilism and advocated cause of free trade. He argued that free trade gives the advantage of division of labour and specialization in the international trade. It is the central point of absolute cost advantage theory. Adam Smith says that trade between two nations is based on absolute advantage. When one nation is most efficient than another nation in the production of a commodity but it is less efficient than the other nation in the production of second commodity, then both nations can gain by each specializing in the production of its absolute advantage and exchanging part of its output with the other nation for the commodity of its absolute disadvantage. This process helps to utilize the resources in the most efficient way and the output of both products will rise. Such an increase in the output measures the gains from specialization in production available to be shared between the two nations through trade.
For Example: Country A is efficient in producing product X but inefficient in producing product Y whereas country B is efficient in production of product Y but inefficient in producing product X. Hence country A has an absolute advantage over country B in the production of product X but as absolute disadvantage in the production of Y. This position is just opposite for country B. Under these circumstances, both countries would gain if each specialized in the production of product of its absolute advantage and traded with the other country. As a result both the products would be produced and consumed in more quantities and both the nations would benefit.
In this respect, nations would behave like an individual those who produce only the commodity which he can produce more efficiently and exchanges part of his commodity for other commodities which he needs. This way, total output and welfare of the individuals are maximized. From the above discussion, it is clear that though mercantilists believed that one nation could benefit only at the expense of another nation Adam Smith believed that all nations would gain from free trade and strongly advocated a policy of laissez-faire i.e. free trade.