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 This theory introduced by Adam Smith in 1776
 He was of the view that productive efficiency differed
among different countries because of diversity in the
natural and acquired resources possessed by them.
 Definition:
 It explains that a country having absolute cost advantage
in the production of a product on account of greater
efficiency should specialise in it production and export.
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Cont.
 A particular country should specialise in producing
only those goods that is able to produce with greater
efficiency, that is at lower cost
 And exchange those goods with other goods of their
requirement from a country that produce those other
goods with greater efficiency or at lower cost.
 This will lead to optimal utilisation of resources in
both the countries.
 Both the countries will gain from trade because both
of them will get the goods at the least cost.
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Cont.
 In following example; both the countries has 100 units
of labour.
 One half of labour used for rice and 2nd half for wheat
 In Bangladesh, 10 units of labor are required to
produce 1 kg of rice and 20 units for producing 1 kg
wheat.
 In Pakistan, 20 units of labor are required to produce 1
kg of rice and 10 units of labor for producing 1 kg
wheat.
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Cont.
Amount of production in absence of Trade
Countries
Units of
Labour
Rice
Wheat
100 ( 50 + 50)
5 kg
2.5 kg
Pakistan
100 ( 50 + 50)
2.5 kg
5 kg
Total Output in two countries : 15 Kg
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Cont.
Countries
Rice
Wheat
Units of
Labour
100 (50 + 50)
10 kg
Nil
Pakistan
100 (50 + 50)
Nil
10 kg
Total Output in Two Countries: 20 Kg
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Conclusion
 This theory explains how trade helps increase the total
output in the two countries.
 But it fails to explain whether trade will exist if any of
the two countries produces both the goods at lower
cost.
 In fact, this was the deficiency of this theory, which led
David Ricardo to formulate the theory of comparative
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Theory
 This theory introduced by David Ricardo.
 This theory focuses not only on absolute efficiency but
on relative efficiency of the countries for producing
goods.
 In a two country and two commodity model, he
explains that a country will produce only that product
which it is able to produce more efficiently.
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Cont.
 Definition:
 This theory explains that a country should
specialise in the production and export of that
commodity in which it possesses a greatest
 This theory introduced in order to remove the limitation
of previous theory, called Absolute Advantage Thoery.
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Cont.
 In following example; both the countries has 100 units
of labour.
 One half of labour used for rice and 2nd half for wheat
 In Bangladesh, 10 units of labor are required to
produce either 1 kg of rice or 1 kg wheat.
 In India, 5 units of labor are required to produce 1 kg
of wheat and 8 units of labor for producing 1 kg rice.
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Cont.
Amount of Output in Absence of Trade
Countries
Rice
Wheat
Units of
Labour
100 (50 + 50)
5 kg
5 kg
India
100 (50 + 50)
6.25 kg
10 kg
Total Output in two countries: 26.25 kg
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Cont.
Countries
Rice
Wheat
Units of
Labour
100 (50 + 50)
10 kg
Nil
India
100 (50 + 50)
Nil
20 kg
Total Output in two Countries: 30 kg
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 Static Gain:
 Static gain manifest in the increase in the trading
country’s real income, based on efficient international
resource allocation.
 If output and consumption increases as a result of trade
the increase is called gains from trade.
 Static gain is short term in nature.
 Organizations get gains from trade by producing goods
at greater efficiency and export to another country.
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 Dynamic Gains:
 The increase in output and consumption is not once
over, rather its is a continual phenomenon manifesting
in higher rate of growth in income over a period of time.
 This type of continuity indicates dynamic gains from
 Widening the market and the resultant improvement in
the process of production indicated dynamic gains.
resources leads to reducing real cost per unit. So this
reduction also dynamic gains from trade.
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