[MUSIC] Now that we have learned some of the critical language of international trade, let's dive now into its theory. Let's begin with one of the great intuitive theories of international trade that turns out to simply be dead wrong. At least when it comes to normatively prescribing the best patterns of trade. This flawed theory is know as the theory of absolute advantage. The idea of absolute advantage as a basis for trade, was set forth long ago by the 18th century British economist, Adam Smith. In this key definition, a country that can produce a good at a lower cost than another country, is said to have an absolute advantage in the production of that good. For example, the Saudi Arabia has millions of barrels of cheaply accessible oil. But growing food in its desert climate, in sandy soil, is very expensive. In contrast, the United States can grow food cheaply in its temperate climate and fertile soil, but American oil isn't as cheap to extract Saudi crude. Because it can produce a certain amount of oil with fewer resources, Saudi Arabia has an absolute advantage over the United States in producing oil, just as the United States has an absolute advantage over Saudi Arabia in producing food. And the theory of absolute advantage would predict, in this case, quite correctly, that America should sell food to Saudi Arabia and buy oil from it. At first glance, the principle of absolute advantage appears to make imminent sense. But the theory has one major implication that we will quickly see, doesn't make any sense at all. [SOUND] To see the flaw in this theory, take a look at this table. Here we have two countries, Germany and Algeria, producing two goods, food and autos, with the same amount of resources. So, which country has the absolute advantage in food production and which country has the absolute advantage in auto production? Take a minute now, look at this table, jot down your answers and please do so before moving on. [MUSIC] From the table, it should be clear that Germany is able to produce both food and autos, with fewer resources than Algeria. In other words, Germany has an absolute advantage in both food and auto production. And here's the key point. In such a case, the theory of absolute advantage would predict that Germany has nothing at all to gain from trading with Algeria. After all, why should Germany trade with a country that cannot produce anything as efficiently as it can? So can you think of a reason related to economics? Take a minute to think about this, before we introduce the competing theory of comparative advantage in our next module. [MUSIC]
