International Trade Ricardian Theory Of Comparative Cost
_____________________________________________• Introduction
• Ricardian Theory
• Criticism
_____________________________________________
Introduction
International trade deals with trade between the countries. It involves export and import of goods and services.
Why do countries trade with each other ? This fundamental question was raised by classical economists. They provided the answer too-by stating that, each country specialises in the production of some commodities which it.can produce at a lower cost and exports them,and imports other goods which can be produced at home, but at a higher cost.
Ricardian Theory Of Comparative Cost
David Ricardo agreed that absolute difference in cost gives a clear reason for trade to take place. He, however, went further to argue that even when a country has absolute advantage in the production
of both commodities it is beneficial for that country to specialise in the production of that commodity in which it has a greater comparative advantage. The other country can be left to specialise in the production of that commodity in which the first country has less comparative advantage.
•Assumptions
1.There are two countries and two commodities.
2.There is perfect competition both in commodity and factor markets.
3. Cost of production is expressed in terms of labour i.e. value of a commodity is measured in terms of labour hours/days required to produce it. Commodities are also exchanged on the basis of labour content of each good.
4. Labour is the only factor of production other than natural resources.
5. Labour is homogeneous i.e. identical in efficiency, in a particular country.
6. Labour is perfectly mobile within a country but perfectly immobile between countries.
7. There is free trade i.e. the movement of goods between countries is not hindered by any restrictions.
8. Production is subject to constant returns to scale.
9. There is no technological change.
10. Trade between two countries takes place on barter system.
11. Full employment exists in both countries.
12. There is no transport cost.
As pointed out in the assumptions, the cost is measured in terms of labour hours. Table explains the principle of comparative advantage expressed in labour hours.
Portugal requires less hours of labour for both wine and cloth. One unit of wine in Portugal is produced with the help of 80 labour hours as against 120 labour hours required in England. In the case of cloth too, Portugal requires less labour hours than England. From this it could be argued that there is no need for trade as Portugal produces both commodities at a lower cost. Ricardo however tried to prove that Portugal stands to gain by specialising in the commodity in which it has a greater comparative advantage. Comparative cost
advantage of Portugal can be expressed in terms of cost ratio.
Cost ratios of producing wine and cloth can be expressed as :
Portugal has advantage of lower cost of production both in wine and cloth. However the difference in cost, that is the comparative advantage is greater in the production of wine (1.5 - 0.66 = 0.84) than in cloth (1.11 - 0.9 = 0.21).
In the above diagram, PL and EG are the production possibility curves of Portugal and England respectively. Portugal has absolute advantage in the production of both the commodities as OP > OE and
OL > OG. ET line which is parallel to PL tells us that Portugal has greater comparative advantage in the production of wine, as it can produce OT of wine which is greater than OG, which England can produce (OT > OG). England will specialise in cloth where its comparative disadvantage is less than what it is in the production of wine.
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