1. International Business Delivered in: Islamia University Bahawalpur Presented By: Tasawar Javed

2. Theory of Absolute Advantage It’s a theory what it says?? – You produce something; and produce it on low cost than any one else; should you produce same item or any other which is expensive to produce?? – “By specializing in the production of goods which they can produce more efficiently than any other nations, it can increase their well- being” – Example now!!!

3. Theory of Absolute Advantage Example: – Assume that – two nations North and South – Both produce two goods (commodities) cloth and Grain – Assume further that Labor is the only factor of production and thus the only cost of production

4. Absolute Advantage Example – Labor cost (hours) of production for one Unit ClothGrain North1020 South2010 Labor is the only cost of production, lower labor hours per unit means lower production costs, and higher productivity per labor hour. Who has advantage??

5. Absolute Advantage North has absolute advantage in the production of cloth – Cost requires only 10 labor hour – Compared with 20 labor hours in South Similarly, south has absolute advantage in the production of Grain – Cost requires only 10 labor hour – Compared with 20 labor hours in North

6. Absolute advantage Who is Gain by this Trade? – Assume Again they specialize and exchange cloth for grain at a relative price of 1:1 – What you will do being the part of any Nation??? – Participation from Class?? – You will employ your resources to produce what???

7. Absolute Advantage Each country can employ their resources to produce a greater amount of goods. North Can import one unit of Grain in exchange for one unit of Cloth – what does it mean?? They can get Grain only for 10 labor hours rather than 20 labor hours if they produce their self. So who Gains?? North Gain 10 labor hours when import grain from South and similarly South gains 10 labor hours when they import Cloth from North

8. Absolute Advantage What’s wrong with this theory?? – It doesn’t predict the exchange ration between cloth and grain once trade is opened nor does it resolve the division of the gains from trade between the two countries. – We assumed 1:1; but it could be 2:1 or 1:2 – We need to know the total resources of each country (total labor hour & demand of each country)

9. Absolute Advantage Important implications 1. if one country has absolute advantage then there is potential for gains from Trade 2. The more a country is able to specialize in the production of the good it produces most efficiently, the greater its potential gains in national well-being 3. With in one country the competitive market does not evenly distribute the gains from Trade. Followed by example for 3 rd implication.

10. Absolute Advantage Prior to Trade: The Grain producers in North require 20 hours; production of one unit of grain could be exchanged for two units of Cloth. After Trade: Grain producer, who remain could exchange one unit of grain for only one unit of cloth. The remaining grain producers are worse off trade.

11. Absolute advantage Cloth producer in North, how-ever work 10 hours; produce one unit of cloth, & exchange it for one unit of grain. Where as previously they received only a half unit of grain. They are better off. If Grain producer in North switch to cloth production, then 20 hours of labor results production of 2 units of cloth production. They can exchange with 2 units of Grains. They are better off under this trade. Who is looser? Who is Gainer with this Trade???

12. Absolute Advantage If North doesn’t specialize completely in cloth, there will be gainer – Cloth producer and Grain producer now switched to cloth And losers? – Those who continue as Grain producer Why?? Example of Pakistan. Especially in Sugar scenario. What NEXT????

13. Other Theory What Next??? – If labor hour is same in both countries???? – Where the Trade will stand??? – Next lecture Theory of Comparative Advantage

14. Thank You!!!! Q&A