Adam Smith argued that all nations can be benefitted when there is free trade and specialisation in terms of their absolute cost advantage
The Theory
(i) According to Adam Smith, the basis of international trade was absolute cost advantage.
(ii) Trade between two countries would be mutually beneficial when one country produces a commodity at an absolute cost advantage over the other country which in turn produces another commodity at an absolute cost advantage over the first country.
Assumptions
1. There are two countries and two commodities (2 x 2 model).
2. Labour is the only factor of production
3. Labour units are homogeneous
4. The cost or price of a commodity is measured by the amount of labour required to produce it.
5. There is no transport cost.
Illustration
Absolute cost advantage theory can be illustrated with the help of the following example.

(iii) From the illustration, it is clear that India has an absolute advantage in the production of wheat over China and China has an absolute advantage in the production of cloth over India
(iv) Therefore, India should specialize in the production of wheat and import cloth from China. China should specialize in the production of cloth and import wheat from India
(v) This kind of trade would be mutually beneficial to both India and China.

Introduction
(i) The early 1990s witnessed reforms in the economic policy. This helped to open up Indian markets to FDI
(ii) FDI in India has increased over the years
(iii) In India, FDI has been advantageous in terms of free flow of capital, improved technology, management expertise and access to international markets
The major sectors benefited from FDI in India are:
(i) financial sector (banking and nonbanking)
(ii) insurance
(iii) telecommunication
(iv) hospitality and tourism
(v) pharmaceuticals and
(vi) software and information technology
FDI is not permitted in the industrial sectors like
(i) Arms and ammunition
(ii) atomic energy,
(iii) railways,
(iv) coal and lignite and
(v) mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper etc.,
Latest trend of FDI in India
i. FDI inflow in India has increased from ＄97 million in 1990-91 to ＄5,535 million in 2004-2005.
ii. It amounted to ＄32,955 million in 2011-2012.
iii. UNCTAD’s World Investment Report 2018 reveals that FDI to India declined to ＄40 billion in 2017 from ＄44 billion in 2016

Types of Exchange Rate:
(i) Nominal Exchange Rate
(ii) Real Exchange Rate
(iii) Nominal Effective Exchange Rate
(iv) Real Effective Exchange Rate If 1US Dollar = Rs.75 
(i) Nominal Exchange Rate:
Nominal Exchange Rate =\(\cfrac { 75 }{ 1 } \)
This is the bilateral nominal exchange rate.
(ii) Real Exchange Rate:
(1) Real Exchange Rate = \(\cfrac { { eP }_{ r } }{ P } \)
P = Price level in India
PF = Price level in abroad (say US)
e = Nominal Exchange Rate 
(2) If a pen costs Rs.50 in India and it costs 5 USD in the US.
\(\therefore \text {Real Exchange Rate}=\cfrac { 75\times 5 }{ 50 } =7.5\)
(3) If real exchange rate is equal to 1, the currencies are at purchasing power parity.
(4) If the price of the pen in US is 0:66 USD, then the real exchange rate

Then it could be said that the USD and Indian rupee are at purchasing power parity.