Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

Recardo’s Theory of International Trade: Comparative Cost Advantage
theory

Comparative Cost Advantage Theory
The Comparative Cost Advantage Theory of Trade was developed by British political
economist, David Ricardo in his book “ The Principles of Political Economy and Taxation”
published in 1817
...
A lower opportunity cost
means it has to forego less of other goods in order to produce it
...

(b) They are trading with only two commodities, say, Cloth and Wine
...

(d) The production of these two goods in both the countries taken place at constant costs
...

Given the above assumptions, the theory of comparative Cost Advantage can be
explained with the following table as below:

The above Table showsthat the US has an absolute advantage in producing clothing (5>4)
and also aeroplanes(12>1)
...
However,
that doesn’t mean the US should be the only producer
...


Opportunity Cost Table

The above opportunity cost table shows that, the US has a comparative advantage in
producing aeroplanes
...
41)
is lower than that of Cloth (12/5=2
...
Therefore, US should specialise in producing
aeroplanes even though it has absolute advantage in both cloth and aeroplanes
...
Brazil produces
clothing, the opportunity cost is 1/5 = 0
...
This is
because the opportunity cost of producing cloth (¼=0
...
Therefore, Brazil should specialise in producing clothing even though it
doesn’t have an absolute advantage
...

Criticisms of the Theory
As with many other economic ideas there are criticisms to be levelled at comparative cost
advantage theory:
(i) It is much more complicated in the real world in deciding in which goods countries have a
comparative cost advantage
...

(ii) The theory ignores the effects of transport costs
...

(iii) Modern theories, no longer based on Ricardo’s labour theory, have established that the only
necessary condition for the possibility of gains from trade is that price ratios should differ
between countries
...

(v) Ricardo’s analysis is based on the labour theory of value as costs are expressed in terms of
labour hours
...

(vi) The theory applied their principle in case of trade with two countries only and with two
commodities only
...
It cannot
explain multi-lateral trade

---