International Trade

On the basis of cost of production explain the international trade focusing more on David Ricardo's' Comparative cost advantage theory?

Comparative cost advantage theory was propounded by 18th Century economist David Ricardo which is attributed in his work "Principles of Political economy and Taxation" published in 1817 AD. Latter J. S. Mill, Cairns and Bastable developed the concept. American economist Prof. Taussing and German Prof. Haberier sophisticated and refined it. 

Comparative cost advantage theory is more than absolute cost advantage theory. Hence, it is revised and improved version of Adam smiths' absolute cost advantage theory. According to this theory, the cost of production of same good varies in different nation as a result of peculiar environment, way of living, culture and tradition, topography and human specialization than in other nation.

Due to difference in cost of production of same goods in different country, a country will produce the good in which it experiences least comparative cost disadvantage of production. In other words, country will import only that goods in which it observes high comparative gain. 

(source of image is internet)

Hence, due to difference in cost of production the international trade happens.

Assumptions of Ricardo's' concept

i. Two countries and two goods

ii. Labour is only homogeneous factors of production.

iii. Given wage rate.

iv. There is no restriction on import and export

v. Given technology

vi. Barter exchange

vii. Labour is not mobile outside the two country

viii. There is no transaction cost

ix. There is no government intervention.

According to differences in production cost in two countries, the international trade can be understood in three ways.

a) Equal cost differences: The equal cost differences is a condition in which the cost of production of two good in one country is less whereas the ratio of cost of production of two goods in both countries is same.

This concept is further more cleared by table below:

                                                                 Table

                                                   (Equal cost differences)

Country	Cost of Production	Good		Ratio of cost between jute and wheat
		Jute (In unit)	Wheat (In unit)
Nepal	10 day labour	30	60	1:2
India	10 day Labour	15	30	1:2

According to the table above, the cost of production of Nepal in both good; jute and wheat is comparatively low than in India. But, the ratio of cost differences in both countries is same, i.e. 1:2.

In this condition, there will be no international tade exist.

b) Absolute differences in cost: If cost of production in each country among two country in production of one good is absolute low than another then, difference in cost of production of two product is known as absolute differences in cost.

This concept is further more cleared by table below:

                                                                    Table

                                                    (Absolute differences in cost)

Country	Cost of Production	Good		Ratio of cost between jute and wheat
		Jute (In unit)	Wheat (In unit)
Nepal	10 day labour	30	60	1:2
India	10 day Labour	60	30	2:1

According to above table, Nepals' 10 day labour resulted in 30 unit of jute and 60 unit of wheat. As a result, the domestic exchange rate of 1 unit of jute is equal to 2 unit of wheat.

While, Indias' 20 day labour resulted 60 unit of jute and 30 unit of wheat. As a result, the domestic exchange rate in India is  2unit of jute = 1 unit of wheat.

Hence, there is absolute cost advantage in production of wheat to Nepal and in production of Jute to India. In this pretext of low cost of opportunity, Nepal should specialize in production of wheat whereas India should more focus on Jute production. By this exchange of goods both Nepal and India can be benefited.

Adam Smith's international trade theory is based on absolute cost advantage. But, this reason of international trade on the basis of absolute cost advantage is in complete.

For e.g.: Due to many obstacles and obligations least developed/developing nation experiences high cost in production in all of their goods and no good remains for absolute cost difference.

In comparative cost differences David Ricardo addressed this shortcomings. 

c) Comparative differences in cost: Among two countries, one country is efficient in production in both goods while other is inefficient then is called comparative differences in cost.

The cost of production of efficient nation is less in both good than least efficient country. 

In another word, efficient country experiences cost advantage in both good production whereas inefficient country experiences least comparative cost dis-advantage in one good whereas high comparative cost disadvantage in next good.

Hence, on the basis of comparative maximum benefit efficient country will specialize in particular product. Similarly, on the basis of comparative least cost disadvantage inefficient country will specialize in production of particular good.

This concept can be more cleared by the table following:

                                                                         Table

                                                     (Comparative differences in cost)

Country	Cost of Production	Good		Ratio of cost between jute and wheat
		Jute (In unit)	Wheat (In unit)
Nepal	10 day labour	90	90	1:1
India	10 day Labour	30	10	3:1

From the above table, Nepal in 10 day labour produced 90 unit of jute and wheat. As a result, the domestic cost ratio is 1 unit of jute = 1 unit of wheat.

For India in 10 day labour produced 30 unit of jute and 10 unit of wheat. As a result, the domestic cost ratio is 3 unit of jute = 1 unit of wheat.

Nepal is cost efficient whereas, India is cost inefficient country. Nepal is efficient in production of both goods whereas, India is inefficient in both goods.

Nepal can be benefited by export of both jute and wheat, hence trade to Nepal is on the basis of maximum benefit. But, in export of wheat Nepal observed 9 times gain in India and only 3 time gain with hute. Hence, Nepal should produce more wheat. To India comparative least cost dis-advantage is found in relation with jute. Hence, India should specialize jute production for minimization of trade loss.

In this case, both nation can be better off as pointed by Mankiw in International trade. In this way Ricardo established comparative cost advantage as a basis for international trade.

Happy Reading!