Economics - Adam Smith's Theory

According to Adam Smith's theory, a party is known to possess absolute advantage when the party generates more of a good or service than their competitors given similar amount of resources being utilized. It is assumed only labour is contributed as key input as this theory is mainly based on labour productivity. The theory asserts that a party benefits in focusing production and exportation of a good or services which have absolute advantage and leverage on imports of those products that do not have an absolute advantage in producing (Seligman, A. Edwin, p.113).

As for David Ricardo's law of comparative advantage, a party should operate at a level where a good or service is produced at a lower opportunity cost when compared to competitors. However, in contrast to Smith's theory, Ricardo's concept argues a party is still capable to trade profitably with another even when the real cost involved in production is found to be higher in every product that it produces (Chakravarty, R. Satya, p.617). After all it relies on the differences in comparative cost—rather than absolute cost (Smith's theory). In other words, this principle places more significance for a nation to produce a product most efficiently with all its resources available for production.

Ricardo's theory emerges to be more superior or useful because Smith's theory is found to be disadvantageous to a nation that lack an absolute advantage or possess only subtle advantages; whereas in Ricardo's theory, a party still benefits from the international trade even when they lack an absolute advantage (Chakravarty,R.Satya). Ricardo's theory says that even if a nation may possess adequate variety of production factors in generating every kind of products and services, the same nation may still fail to produce goods and services more efficiently when compared to another competitor given the similar resources available.

Since the emergence of the Ricardo's theory, this has not only enhanced higher participation level of international trade among nations, many nations begin to reap the real benefits and gains from this pure theory of international trade. These net benefits of outcome from trading with other nations with comparatively advantageous good are referred as gains from trade; which have contributed immensely to the main concept of the pure theory of international trade today in contrast to autarky (no trade) with another nation.

First of all, the practice of trade based on comparative advantage will influence the prices and the production levels of the goods in different nations involved due to technology differences; hence a party's comparatively advantageous price of good is lower than the similar good in other country. With the assumption that trade between countries is liberalised, there will be stimulation of trade due to the initial differences in relative prices of