Here are your brief notes on Absolute Cost Difference

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Possibility of trade under the condition of absolute cost difference shows that the produc­tion possibility curves II and EE for India and England respectively have different slopes which mean that both the countries have difference cost ratios. India has an ab­solute cost advantage (80 – 40 = 40) in the production of wheat.

On the other hand, England has an absolute cost advantage (80-40 = 40) in the production of cloth. Since both the countries have absolute cost advantage in different products, both of them can benefit through mutual exchange of goods.

The same argument can be understood with the help of offer curves. Line I is the offer curve of India which has been drawn on the basis of India’s domestic barter rate (or cost ratio), i.e., 1 Wheat = .5 Cloth.

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On the other hand, England’s offer curve (line E) is drawn on the basis of its domestic barter rate (or cost ratio), i.e., 1 Wheat = 2 Cloth. In this case, international trade is bound to take place because India wants more than .5 units of cloth for one unit of wheat exported.

On the other hand, England is willing to give any price less than 2 units of cloth for one unit of wheat imported. Thus, when there is absolute cost difference a country will specialise in the production of the commodity in which it has absolute cost advantage and will gain by exporting it.

Adam Smith, however, did not visualise a less favourable situation for international trade. Instead of being capable of producing one commodity absolutely cheaper than the other, a country may be able to produce both commodities absolutely cheaper than the other country.

What will be the direction of trade in this case? Ricardo’s analysis of comparative cost difference gives the answer.

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