Boxcars New Vegas, Psalm 23:1 Meaning" Tagalog, Orgain Organic 21g Vegan Plant-based Protein Shake, How To Outline A Text Box In Google Slides, Allianz Global Corporate Specialty Glassdoor, Singapore Gun Club Reopen, " /> comparative theory of international trade

comparative theory of international trade

In view of this he asserted that other factors could be validly ignored and for purpose of comparative costs relative efficiency of labour alone of different countries could be considered. The theory of comparative costs is simply an application of the principle of division of labour to different countries. Since U.S.A. has a comparative advantage in the production of wheat it will specialise in wheat and would produce OB or 60 units of wheat, whereas India has comparative advantage in the production of cloth and will specialise in cloth production. But still he employs a dispenser, and he himself specialises in examining the patients. This theory has subsequently become known as the Heckscher–Ohlin model (H–O model). It will be seen from this figure that slope of the price- ratio line tt indicates higher price for cloth and lower one for wheat as compared to domestic price-ratio line pp’ since according to tt more wheat can be ob­tained for a given amount of cloth. Let us illustrate the theory of comparative cost (or comparative advantage) with a numerical example. However, in case of wheat its efficiency is three times greater and in case of cloth two times greater as compared to India. These merits of the theory have led Professor Samuelson to remark, “If theories, like girls, could win beauty contents, comparative advantage would certainly rate high in that it is an elegantly logical structure.” He further writes, “the theory of comparative advantage has in it a most important glimpse of truth…. It only pinpoints the need for reformulating and refining it so as to make it applicable to the dynamic conditions of the developing countries. Further India will export QR’ of cloth and import QC of wheat. Share Your PPT File, Equalization of Factor Prices in International Trade. The basic contention of the theory that a country will specialise in the production of a commodity and export it for which it has a lower comparative cost and import a commodity which can be produced at a lower comparative cost by others, is based on a sound logic. It was formulated by David Ricardo in 1815. In case of increasing opportunity costs, the production possibility curve instead of being a straight line is concave to the origin, as shown in Figure 23.4. However, a pertinent question is if the U.S.A. can produce both the commodities wheat and cloth more efficiently than India, would she gain from specialisation and trading with India. 3. Modern or Firm-Based Trade Theories In contrast to classical, country-based trade theories, the category of modern, firm-based theories emerged after World War II and was developed in large part by business school professors, not economists. This specialisation is very gainful. 23.3 that U.S.A. would gain from specialisation and trade as point R lies at a higher level than point E. At point R, U.S.A. would be consuming more of both wheat and cloth than at point E which is the position before trade. The principle of comparative advantage in international trade Comparative advantage is typically used with international trade to quantify the benefits of importing and exporting products from particular countries. 23.2 production possibility curve between wheat and cloth of India is CD. Indeed, a country produces a certain commodity and also imports a part of it. The Chinese will pay less for a bicycle an… This indicates as we shift resources from the production of wheat to the production of cloth, marginal opportunity cost of cloth (that is, the amount of wheat forgone for a unit of cloth) goes on increasing and vice versa. Comparative Advantage of International Trade. Therefore, it is the total money costs incurred on labour as well as other factors that should be considered for assessing comparative costs of various commodities. To produce one unit of wheat the U.S.A. requires 3 man-hours, while India requires 12 man-hours. In an economic model, agents have a comparative advantage over others in producing a particular good if they can produce that good at a lower relative opportunity cost or autarky price, i.e. But that’s only a temporary fix. It will be seen From Fig. In fact, it was this question which was raised by David Ricardo, a classical economist, who put forward the theory of comparative costs (advantage) as an explanation of the potential gain from international trade. Now, the question is what will be the source of gain from specialisation in the present case. Comparative cost theory of international trade This theory is developed by a classical economist David Ricardo. Economists use the term comparative advantage when describing the opportunity cost of two producers. In Figure 23.4 suppose the price-ratio line between wheat and cloth, as determined by demand and supply conditions, is pp’. If U.S.A. can trade with another country, say India, at a different price-ratio than this, it will then gain from the trade. Hewlett and Packard started their computer business. According to this theory, the international trade between two countries is possible only if each of them has absolute or comparative cost advantage in the production of at least one commodity. Comparative theory states that the value of pr… 5. We show below in Table 23.4 the gain in wheat output that occurs when U.S.A. shifts its labour resources by reducing the production of cloth by one unit and India shifts its labour to cloth by reducing the production of wheat by one unit (the above data of man-hours cost of wheat and cloth are used). The two differ basically in many respects. Incomplete theory: It is an incomplete theory. The fundamental cause of international specialisation and hence international trade is the difference in costs of production. But the pattern of international trade shows that this is far from reality. Introduction Both comparative and absolute advantage are theories of international trade. On the other hand, if India reduces production of one unit of wheat, 12 hours of labour will be released which on using for cloth production will result in gain of 1.33 units of cloth. It was on the basis of these differences, that the old classical economists propounded a separate theory of international trade, known as classical theory of comparative costs.The theory explains the emergence of international trade. Against the Ricardian doctrine of comparative cost it has also been said that it is based on the constant cost of production in the two trading countries. A country can produce many goods. Thus Heckscher and Ohlin supplemented the comparative costs theory by providing valid reasons for differences in comparative costs in various countries. This assumption of constant costs leads them to conclude that different countries would completely specialise in the production of a single product on the basis of their comparative costs. The theory of comparative advantage A country has a comparative advantage when it can produce a good at a lower opportunity cost than another country; alternatively, when the relative productivities between goods compared with another country are the highest. "The theory of comparative cost as applied to international trade is therefore, that each country tends to produce, not necessarily what it can produce more cheaply than an other country, but those articles which it can produce at the greatest relative advantage, i.e., at the lowest comparative cost. The law of comparative costs when freed from the labour theory of value and expressed in terms of opportunity costs is still believed to be true by the modern economists. In U.S.A. opportunity cost of 60 kg. It is evident from the above table that in U.S.A. opportunity cost of wheat is less than that of India, while in India opportunity cost of cloth is less than that of U.S.A. When production of cloth is expanded productive resources less suited to the production of cloth are drawn into that industry. Mill, another noted classical economist, removed this shortcom­ing of the comparative cost theory by supplementing it with Reciprocal Demand Theory which explains the determination of terms of trade. Theory of Comparative Costs of International Trade! It might appear that the U.S.A. which can produce both wheat and cloth more efficiently than India has nothing to gain by trading with India which is comparatively inefficient in the production of both wheat and cloth. 23.3 that the product possibility curve AB of U.S.A. lies India’s production possibility curve C’D’. The various trading partners are not at the same stage of technological development and therefore the factor proportions used for the production of commodities in different countries are vastly dif­ferent. It may be mentioned here that Ohlin’s criticisms do not invalidate comparative cost theory. Indeed, structural changes are being brought about in these economies. At point R, U.S.A. would be exporting RS amount of wheat and would be getting in return for it SD’ amount of cloth from India. According to him, prices of different goods and their quantities produced and consumed depend on both supply and demand conditions. It is the relative differences in costs which determine the products to be produced by different countries. Considering the differences in costs of producing different goods, every country seems to be better suited for the production of certain goods rather than the others. Political leaders are always under pressure from their local constituents to protect jobs from international competition by raising tariffs. It is alleged that comparative cost theory is static in character as it is based on fixed supplies of factors of production, the given technology, and the fixed and identical production functions in the trading countries. 2. This theory of comparative advantage, also called comparative cost theory, is regarded as the classical theory of international trade. In the early 1900s, a theory of international trade was developed by two Swedish economists, Eli Heckscher and Bertil Ohlin. Suppose the price-ratio line in the foreign market (or what is also called terms of trade line) is given by the price line tt in Figure 23.4. Welcome to EconomicsDiscussion.net! Indeed, according to him, international trade is only a special case of inter-regional trade. The fundamental cause as to why international specialisation occurs is the differences in costs, which result from the differ­ences in the availability of the amount and the quality of resources, the prices of these resources or factors and the method of their use. The challenge to the absolute advantage theory was that some countries may be better at producing both goods and, therefore, have an advantage in many areas. joint output of the two countries) will rise by 1 unit of wheat and 0.33 units of cloth as a result of the above shift of man-hours to the products of their comparative advantage. Voicing this criticism Else-worth remarks, “the comparative costs theorem, the way in which Ricardo set up his illustration, tended to obscure the problem of the terms of trade.”. Ricardo thought comparative costs of producing commodities in various countries differed due to the differences in efficiency of labour. Taussig tried to defend Ricardo by pointing out that even if labour theory of value was defective and even if other factors made important contributions to the production of goods, comparative costs could still be based on labour cost alone, if it is assumed that the trading countries are at the same stage of technological development. Considering climatic conditions, availability of mineral and other resources and differences in costs arising from them, every country seems to be better suited for the production of certain articles rather than for others. According to the classical theory of international trade, every country will produce their commodities for the production of which it is most suited in terms of its natural endowments climate quality of soil, means of transport, capital, etc. The terms of trade which will be settled between the two will lie between the production possibility curve CD’ of India and the production possibility curve AB of U.S.A. This has been shown in Figure 23.3 the product possibility. This theory holds that there are benefits to be gained from importing as well as exporting. Further, labour is not homogeneous and the wages of different non-competing groups do not tend to be equal at least in the short run. Indeed, he only refined and modified it. of wheat in U.S.A. In a two-commodity world when one country can produce both of them at a lower cost than another, it will pay to it to specialise in the production of a commodity which it can produce at comparatively lower cost and import the other commodity for which it has a comparatively higher costs. Even in his theory, popularly known as factor-proportions theory of international trade, comparative costs serve as a basis of international trade. It will be seen from Table 23.4 that total world output (i.e. Share Your Word File If each country now specializes in one producing good then assuming constant returns to scale, the output will double. Success attracted more IT firms to that area. In this dynamic context, a developing economy may have a comparative disadvantage in producing a certain commodity but may attain a comparative advantage after a certain stage of its development. On the other hand, India is less efficient in the production of both wheat and cloth, its inefficiency is comparatively less in cloth. 4. Comparative advantage It can be argued that world output would increase when the principle of comparative advantage is applied by countries to determine what goods and services they should specialise in producing. During the late 18th century, economist Adam Smith developed the theory of absolute advantage, which became the most dominant of the international trade theories of its time. Take the case of a doctor. That is, U.S.A. has an absolute advantage in the production of both the commodities. Therefore, it would be advantageous for India and U.S.A. to specialise in cloth and wheat re­spectively. of wheat, that is, 1 metre of cloth has the opportunity cost of 0.75 kg. 2. at a lower relative marginal cost prior to trade. Resources such as land, villagers trained for the art of agricul­ture, are more suited for the production of wheat. It will be much better if after comparing the costs of the various articles that it can produce, it selects those in which the comparative costs are lower or in which it enjoys relative advantage. Internal trade is not exactly the same as the international trade. Thus opportunity cost measures the ratio of marginal costs of the two commodities. Comparative cost theory explained above is based upon labour theory of value. The domestic price-ratio (that is, the rate of which two goods would be exchanged in the absence of trade) are not determined by the production possibility curve alone. Comparative advantage, economic theory, first developed by 19th-century British economist David Ricardo, that attributed the cause and benefits of international trade to the differences in the relative opportunity costs (costs in terms of other goods given up) of producing the same commodities among countries. Welcome to EconomicsDiscussion.net! 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