Comparative Cost Advantage Theory of International Trade
- David Ricardo explained this theory in his book “Principles of Political Economy and Taxation” in 1817.
- According to him both country can produce two commodities at lower cost.
He imposed the question, what would happen if one country produces both the commodities more cheaply than the other countries i.e., one country has cost advantage in the production of both the goods and other country has cost advantage in the production of both the goods.
He gave the answer that, here in this case a country would specialize in the production of one good in which it has comparatively greater cost advantage and relatively lower cost disadvantage.
This can be explained with the help of following table:
| Country A | Country B | |
|---|---|---|
| Wheat | 20 | 15 |
| Rice | 40 | 10 |
Suppose there are two countries A and B, producing two commodities wheat and rise with labour as the only factor of production. Now assume that both the countries have 200 labourers and they use 100 labourers to produce wheat and 100 labourers to produce rice.
Table above shows that country A can produce 20 units; whereas, country B can produce 15 units of wheat by employing same number (100) of labourers. In addition, country A can produce 40 units; whereas, country B can produce 10 units of rice by employing 100 labourers.
Country A has absolute advantage in producing both the items. Country A employs same number of labourers (100 labourers in production of each item) in producing rice and wheat; however, the production of rice is higher than the production of wheat. This reveals that country A has comparative advantage in producing rice. Similarly, country B also employs same number of labourers (100 labourers in production of each good) in manufacturing wheat and rice; but, its production of wheat is more than the rice. It indicates that country B has comparative advantage in produing wheat.
For example, country A has decided to produce 60 units of rice by employing 150 labourers. It uses 50 labourers to produce 10 units of wheat. On the other hand, country B has decided to use all the 200 lanourers to produce 30 units of wheat and stop the production of rice.
| Country A | Country B | |
|---|---|---|
| Wheat | 10 | 30 |
| Rice | 60 | 0 |
In this situation country A exchanges 14 units of wheat produced by country B.
| Country A | Country B | |
|---|---|---|
| Wheat | 24 | 16 |
| Rice | 46 | 14 |
It can be seen from the table that both the countries have been benefitted or gained from trade. Before specialisation in trade, country A has only 20 units of wheat and 40 units of rice; while, after trade, country has 24 units of wheat and 46 units of rice.
At the same time country B has 15 units of wheat and 10 units of rice before trade, has 16 units of wheat and 14 units of rice after trade. Therefore, comparative advantage theory clarifies that trade can create benefit for both the participating countries even if one country has absolute advantage in both the commodities.