ASSIGNMENT#2

SUBJECT: INTERNATIONAL TRADE

SUBMITTED TO: MA’AM ZAINAB JEHAN

SUBMITTED BY: KAINAT BIBI

ROLL NO: 2019-M. ECON-010

SUBMISSION DATE: 17-04-2020

Differentiate between Absolute and Comparative Advantage Trade Theories.
Absolute Advantage Trade Theory:
The greater efficiency that one nation may have another in the production of commodity. This
was the basis for trade for Adam smith. Absolute Advantage is the ability with which an
increased number of goods and services can be produced and that too at a better quality as
compared to competitors. Countries can gain from international trade without the loss of the
other country.
Comparative Advantage Trade Theory:

Comparative advantage is based on the opportunity cost of producing a good. If a Country can
produce a particular good at a lower opportunity cost (by losing an opportunity for the
production of other goods) than any other country then it is said to have a comparative
advantage. Even if one nation less efficient in the production of both commodities (has absolute
disadvantage in both commodities) than other nation. There is still a basis for mutually
beneficial trade.

Absolute vs Comparative Advantage Trade Theory

Basis Absolute Advantage Comparative Advantage

The ability of a country to produce The ability of the country to produce good
Definition more goods with the same amount of better than another country with the same
resources than another country amount of resources

1. Trade is not mutually beneficial

1. Trade is mutually beneficial
Benefits 2. Benefits the Country with absolute
2.Benefits of both the countries
advantage

The absolute cost of producing goods The opportunity cost of producing goods
Cost impacts if the country has an absolute impact the Country’s comparative
advantage advantage

Economic
It is not mutual and reciprocal It is mutual and reciprocal
nature

Determine the basis trade and justify your answer with the support of relevant theories.
Case 1:
Commodit Case 1
y
Nation 1 Nation 2
A/Hour 4 1
B/Hour 2 3

The situation is Basis for trade Absolute Advantage trade theory when one nation is more
efficient than(has absolute advantage over)then the other nation in the production of one
commodity but is less efficient then(has an absolute disadvantage over)the other nation in the
production of another second commodities, then both countries can gain by specializing in the
production of its absolute advantage commodities and exchanging part of its output with the
other nation for the commodity of its absolute disadvantages. According to situation case one is
based on Absolute Advantage trade theory. According to this theory its result in more
efficient utilization of resources then output of both commodities increase in each nation. N1
has absolute advantage in A and totally absolute disadvantage in B. N2 has absolute advantage
in B and absolute disadvantage in A. So, this situation of case is from Absolute Advantage trade
theory by ADAM SMITH.
Case 2:

Commodity Case 2
Nation 1 Nation 2
A/Hour 5 1
B/Hour 4 3

The situation of case 2 is “Even if one nation is less efficient in the producti0n of both
commodities (has absolute disadvantage in both commodities) then other nation, there is still
basis for mutually beneficial trade. The first nation should specialize in the production and
export of the commodity in which its absolute disadvantage is smaller (this is commodity of its
comparative advantage) and import the commodity in which its absolute disadvantage is
greater) this is the commodity of its comparative disadvantage. N1 has comparative advantage
in A commodity. And comparative Advantage of N2 in B commodity because absolute
disadvantage in A. A commodity is the comparative disadvantage product. N2 has higher
absolute disadvantage. So, basically these things fulfil the basis for trade about Comparative
Advantage trade theory by David Ricardo.
Case 3:

Commodity Case 3
Nation 1 Nation 2
A/Hour 8 4
B/Hour 4 2

This case occurs when the absolute disadvantage that one nation has with respect to another
nation is the same in both commodities. As in the case 3, the N2 would be exactly half as
productive as the N1 in both commodities A & B. The N2 and N1 would then have a
comparative advantage in neither commodity and no mutual beneficial trade could take place.
The reason for this is that the n1 will trade only if it can exchange 8A for more than 4B.
However, the n2 is not willing to give up more 4B to obtain 8A from the n1 because the n2 can
produce either 8A or 4b with four hours domestically. Under these circumstances, no mutually
Beneficial trade can take place. So, this is modified law of comparative advantage.

If there are basis for trade, calculate the gains from trade for each nation.

and Japan have an