Free Trade, Absolute Advantage and Comparative Advantage

Free Trade is the execution of trade activities independently of the state.

Adam Smith defines “wealth” as the sum of what a nation’s individuals produce. As long as humans existed, trade existed. there used to be a system of barter, trade flourished as people developed and interacted with each other and met goods from far away. Although trade develops, the only thing that does not change is that trade takes place between individuals.

Absolute Advantage:
Adam Smith claims that society will prosper if a country specializes in what it produces best and trades these products freely. this is called absolute advantage.

Comparative Advantage:
According to David Ricardo, a country should specialize in the good it can produce at the lowest opportunity cost. Comparative advantage exists if you can produce a good at a lower opportunity cost than another. It is not the absolute costs of production that matters, but the opportunity cost.

An example:
Consider two countries named country X and country Z. Country X is a developed country, any high school student has much more opportunities for the future than country Z. If these two countries concentrate on toy production, potential doctors, engineers and teachers in country X will be compromised.

Any high school student in country Z doesn’t have many opportunities for the future. The opportunity cost of producing toys is much lower in country Z than in country X. Most high school students in country Z do not have the opportunity to become an engineer, doctor or teacher as in country X. therefore country Z has a comparative advantage in toy production, it should focus on this issue. Although country X has a more efficient toy production capacity (absolute advantage), it makes economic sense for the toy to sell know-how, capital equipment.