Comparative cost advanatge theory

For College students

1. B.COM SEM-V UNIT-I International Economics

2. Prof. David Ricardo Comparative Cost Advantage theory of international trade

3. COMPARATIVE COST ADVANTAGE THEORY: ORIGIN The economist David Ricardo in his book “Principles of political economy and taxation” systemically represented the theory of comparative cost advantage theory. According to comparative cost advantage theory of international trade, each country exports the commodity in which it has cost advantage and imports the commodity in which it has cost disadvantage

4. COMPARATIVE COST ADVANTAGE THEORY : ASSUMPTIONS There are only two countries and two commodities There is no governmental intervention in export and import Only labour is factor of production. Quantity of labour used gives cost of production There is perfect mobility of labour within the country but not between the countries There is no cost of transportation between the countries The law of constant returns to scale operates in production. The units of labour are homogeneous The units of each commodity in both countries are homogeneous

5. COMPARATIVE COST A D V A N T A G E THEORY GAINS OF TRADE NUMERICAL EXAMPLE

6. Countries Goods (Units) Exchange rate Wine Cloth England 100 50 2 : 1 2 wine = 1 Cloth Portugal 40 40 1 : 1 1 wine = 1 Cloth Total 140 90 230 Production before specialization Production after specialization Countries Goods (Units) Exchange rate Wine Cloth England 200 -- 4 : 1 4 wine = 1 Cloth Portugal -- 80 1 : 2 1 wine = 2 Cloth Total 200 80 280

7. COMPARATIVE COST ADVANTAGE OF COUNTRIES Cost Ratio of Wine = In England 100 units of Wine In Portugal 40 units of Wine = 100 40 = 2.5 Cost Ratio of Cloth = In England 50 units of Cloth In Portugal 40 units of Cloth = 5 40 = 1.5 Countries Goods (Units) Exchange rate Wine Cloth England 100 50 2 : 1 2 wine = 1 Cloth Portugal 40 40 1 : 1 1 wine = 1 Cloth Total 140 90 230 Cost Ratio of England

8. COMPARATIVE COST ADVANTAGE OF COUNTRIES Cost Ratio of Wine = In Portugal 40 units of Wine In England 100 units of Wine = 40 100 = 0.4 Cost Ratio of Cloth = In Portugal 40 units of Cloth In England 50 units of Cloth = 40 50 = 0.8 Countries Goods (Units) Exchange rate Wine Cloth England 100 50 2 : 1 2 wine = 1 Cloth Portugal 40 40 1 : 1 1 wine = 1 Cloth Total 140 90 230 Cost Ratio of Portugal

9. COMPARATIVE COST ADVANTAGE THEORY : LIMITATIONS Factor mobility is untenable Existence of transport cost Complete specialization is not possible Problem of inadequate production The theory is one sided The theory is static Unrealistic assumption of labour value This theory is not applicable on the basic goods Unrealistic assumption of free trade

10. Thank You Prepared by Dr.Jagdish Maheshwari Assistant Professor, Tolani Institute of Commerce,Adipur