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Ricardian Comparative cost theory of International Trade

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Ricardian Comparative cost theory of international trade

Ricardian Comparative cost theory of international trade:

The Comparative Cost Theory of International Trade was propounded by the classical economist, David Ricardo in 1817. As he has explained the international trade on the basis of the comparative cost, this theory is famous as the comparative cost theory of international trade. This principle is based on the difference in the cost of production of similar goods in different countries. The cost of production of a commodity may differ from country to country because of various reasons like climate, natural resources, geographical situation, the efficiency of labor, etc. 

Thus, each country is specialized to produce such goods in which the comparative cost of production is the least. A country is specialized in the production of such goods in which it has a greater comparative advantage or the least comparative disadvantage with other countries on the basis of the cost of production. If a country produces all the commodities at a higher cost than others, it is specialized to produce that commodity in which it has the least disadvantage of cost in comparison to other countries.

Assumptions of the Comparative Cost Theory of International Trade

  • This theory is based on the following assumptions:
  • There are only two countries and two commodities.
  • Both countries produce similar goods.
  • The tastes of the people are the same in both countries.
  • Labour is only the factor of production.
  • The labor units are homogenous.
  • The goods are produced under constant returns to scale.
  • Production technology remains constant.
  • The resources are perfectly mobile within the country but perfectly immobile between the countries.
  • Cost of production is measured in terms of labor.
  • There is perfect competition in both product and factor markets.
  • There is free trade among the countries.

The concept of comparative cost theory can be explained by the help of the following schedule:

   Countries
                  Cotton (C)
                     Jute (J)

Cost of production per kg in labor hours
Opportunity cost
Cost of production per kg in labor hours
Opportunity cost
       India
              4
1C = 2 J
             2
1 J = ½ C
       Nepal
             15
1C = 3 J
             5
1 J =  1/3 C

According to the above table, India needs 4 labor hours to produce 1 kg of cotton and 2 labor hours to produce 1 kg jute. On the other hand, Nepal needs 15 labor hours to produce 1 kg of cotton and 5 labor hours to produce 1 kg jute. Thus, India has an absolute advantage in the production of both goods: cotton and jute. Now, according to the Ricardian Comparative Cost Theory of International Trade, both countries will gain it they produce according to comparative cost advantage.
In this situation, if Nepal specializes in the production of jute and India specializes in the production of cotton, both countries will gain from international trade. In other words, Nepal should export jute to India and import cotton from India and India should import jute from Nepal and export cotton to Nepal to gain from the international trade.

Criticisms of Ricardian comparative cost theory of international trade:

1. The model of two countries and two commodities is unrealistic:
Comparative Cost Theory of International Trade is based on the concept of two countries exchanging only two goods. In reality, international trade takes place between many countries and many commodities.

2. Limitation of labor cost:
This theory assumes that labor is the only factor of production and all the other factors of production are neglected. But the limitation of labor cost does not represent the Whole value of goods in relation to international trade.

3. No similar tastes:
The tastes of the people in different countries are not similar and constant. It depends upon the income level of the people and the economic situation of the country.

4. Returns to scale do not remain constant:
This theory assumes that specialization is followed by constant returns to scale. But in reality, the cost of production does not remain constant with the increasing level of output. The marginal product varies with every increase in the input.

5. Transportation cost is ignored:
In this theory, transportation cost is ignored for the determination of comparative advantage. This is highly unrealistic because it plays an important role in the development of international trade.

6. Assumption of homogeneous labor is wrong:
The theory assumes that all the workers are homogeneous. But in reality, workers differ in efficiency and productivity.

7. Mobility of factors of production:
This theory assumes that the factors of production are perfectly mobile within the country. But in reality, when there is more specialization, there is less mobility of factors. When there is a difficulty in the transfer of factors, the cost of production is affected.

8. Free trade:
This theory is applicable only in the situation of a free and perfect trade. But in the real world, international trade is not free and perfect. Every country is applying restriction on the free movements of goods.

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