International Economics >> Theory of Comparative Cost
The pure theories of international trade can be grouped under (a) the Classical Theories of Trade, (b) the Neo-c1assical Theories of Trade, and (c) the Modern Theory of Trade. The first classical theory of international trade was propounded by Adam Smith, the founder of classical economics. His theory is known as the Theory of Absolute Advantage. It was later modified and improved by David Ricardo' and Robert Torrens'. The Ricardian Theory of Trade is known as Comparative Cost Theory of Trade.
RICARDIAN THEORY OF COMPARATIVE ADVANTAGE
It may be inferred from the Smith's theory of absolute advantage that trade between any two countries would be possible only if each country has an absolute advantage in the production of at least one commodity and absolute disadvantage in another. That is, if a country has an absolute advantage in the production of all the commodities and the other has an absolute disadvantage in the production of all the commodities, there is no ground for trade between them.
Ricardo has however shown that gainful trade is possible even if one of the countries has absolute advantage in producing both the goods, but has comparative disadvantage in producing one of the commodities. He demonstrated that there can be a gainful trade between the two countries even if one country enjoys absolute advantage and the other has absolute disadvantage, in the production of both the goods, so long as each has comparative advantage (or (disadvantage) in the production of at least one commodity.
Ricardo's theory is widely known all the theory of comparative advantage. His theory of comparative a vantage provides a powerful evidence to t e effect that so long as each country enjoys comparative advantage in the production of at least one commode specialisation and trade between the countries would always be possible and gainful to both of them. It is this emphasis of Ricardo on comparative advantage and disadvantage that marks his great improvement over Smith's theory of trade. Ricardo has postulated his theory of comparative advantage on the following assumptions.
Assumptions
1. Ricardo assumed labour to be the only factor of production. Other factors of production, such as land and' capital equipments, are assumed to be either insignificant or required in fixed proportion with labour or, alternatively, it may be treated as stored-up labour.
2. Labour all over the world is homogeneous.
3. Supply of labour is constant and labour is fully employed;
4. Labour theory of value is valid in the sense that the rate of exchange between any two goods is determined by their labour cost.
5. Production of commodities is subject to constant costs or constant returns.
6. Production technology is given. This is implicit in assumption (1).
7. Factors of production are fully mobile within the country, but are completely immobile between the countries.
8. Trade between any two nations is free from any kind of trade barrier.
9. There is no cost of transport involved in foreign trade.
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