Consider two hypothetical countries, Atlantica and Krasnovia, with equivalent populations and resource endowments, with each producing two products: guns and bacon. Each year, Atlantica can produce either 12 guns or six slabs of bacon, while Krasnovia can produce either six guns or 12 slabs of bacon.
Each country needs a minimum of four guns and four slabs of bacon to survive. In a state of
autarky, producing solely on their own for their own needs, Atlantica can spend one-third of the year making guns and two-thirds of the year making bacon, for a total of four guns and four slabs of bacon.
Krasnovia can spend one-third of the year making bacon and two-thirds making guns to produce the same: four guns and four slabs of bacon. This leaves each country at the brink of survival, with barely enough guns and bacon to go around. However, note that Atlantica has an absolute advantage in producing guns and Krasnovia has an absolute advantage in producing bacon.
Absolute advantage also explains why it makes sense for individuals, businesses, and countries to trade. Since each has advantages in producing certain goods and services, both entities can benefit from
trade.
If each country were to specialize in their absolute advantage, Atlantica could make 12 guns and no bacon in a year, while Krasnovia makes no guns and 12 slabs of bacon. By specializing, the two countries divide the tasks of their labor between them.
If they then trade six guns for six slabs of bacon, each country would then have six of each. Both countries would now be better off than before, because each would have six guns and six slabs of bacon, as opposed to four of each good which they could produce on their own.
This mutual gain from trade forms the basis of Adam Smith’s argument that specialization, the division of labor, and subsequent trade leads to an overall increase of wealth from which all can benefit. This, Smith believed, was the root cause of the eponymous "Wealth of Nations."
www.economicshelp.org
www.theneweuropean.co.uk
