For example, the British climate is too cold to grow coffee trees, and Jamaica has no petroleum. But large resources of petroleum exist in the North Sea and coffee trees can easily be grown in Jamaica. Britons and Jamaicans could clearly benefit by exchanging oil for coffee.
Smith's theory of absolute advantage - or absolute productivity differences - remains useful in explaining present-day trade between similar countries such as France and Germany. The average cost of employing a worker in Germany is about the same as it is in France, and capital moves freely between the two countries; and so returns are roughly equals. Therefore, to compete successfully with a cost advantage in the French market, any particular German export must use absolutely less labour and capital when produced in Germany than if the identical item were produced in France.
Trade between similar countries can occur so long as the tastes and incomes of individuals within each country differ and so long as there are absolute cost differences in producing various goods. Thus, people in France and Germany who have modest incomes and require basic transportation, and whose hearts are not set on a high-powered sports car, might purchase Citroens made in France. ...Show more