Therefore, India should specialize in the production of wheat and import cloth from China. China should specialize in the production Wheat y x Cloth Figure . India China - - International Economics of cloth and import wheat from India. This kind of trade would be mutually beneficial to both India and China.
. . . Ricardo’s Theory of Comparative Cost Advantage David Ricardo , the British economist in his ‘Principles of Political Economy and Taxation’ published in , formulated a systematic theory called ‘Comparative Cost Theory’.
Later it was refined by J.S Mill, Marshall, Taussig and others. Ricardo demonstrates that the basis of trade is the comparative cost difference. In other words, trade can take place even if the absolute cost difference is absent but there is comparative cost difference. According to Ricardo, a country can gain from trade when it produces at relatively lower costs.
Even when a country enjoys absolute advantage in both goods, the country would specialize in the production and export of those goods which are relatively more advantageous. Similarly, even when a country has absolute disadvantage in production of both goods, the country would specialize in production and export of the commodity in which it is relatively less disadvantageous. Assumptions . There are only two nations and two commodities (2x2 model) .
Labour is the only element of cost of production. . All labourers are of equal efficiency. .
Labour is perfectly mobile within the country but perfectly immobile between countries. . Production is subject to the law of constant returns. .
Foreign trade is free from all barriers. . No change in technology. .
No transport cost. . Perfect competition. .
Full employment. . No government intervention. Illustration Ricardo’s theory of comparative cost can be explained with a hypothetical example of production costs of cloth and wheat in America and India.
Comparative Cost Advantage (Units of labour required to produce one unit) Country Cloth Wheat Domestic Exchange Ratios America wheat = . cloth India wheat= . cloth It is evident from the example that