THE THEORY OF COMPARATIVE COST

Ricardo agreed with the analysis of Smith thaI international trade would be of mutual advantage if one country has absolute advantage over another in one line of production and the other country ha, all absolute advantage over the first country in another linc of production. But Ricardo went unhcr and argued that any two countries can very well gain hy trading even if one of thc countries is having all absolute advantage ill both thc goods over another, comparative advantage  greater in good than  ill that, when there arccutnparativc differences ill costs Let  lake a numerical example. Size nf the (;:till. The total gain from international trade depends upon the differences in the cost ratios in the two countries. The larger the range  between the comparative costs the greater the total gain. In the words of Harrod:- “A country gains by foreign trade if and when the traders find that there exists abroad a ratio of prices very different from that to which they arc accustomed
at horne. Thcy buy what to then] seems cheap and sell what to them seems dcar. The bigger the gap between what to them seems low points and high points. and thc more important the articles affected, the greater will the gain from trade be.”  Sharing the (;aill. As regards the share of this gain accruing to thc parties, this will depend also upon  the terms of trade. i.e.. the ratio .i.n which wheat exchanges for colton in our example for instance. This ratio, as we have explained, depends upon the elasticity of the demand of one country for the goods of the other, or the intensity of reciprocal demands. Whoever is more keen to purchase or sell will be the loser in the bargain. what will Ill’ the terms flf trade? B will gain as long as she can get a quintal of wheat by parting with less taIl .71 quintals of cotton. A will gain as long as she gd more than .50 quintessential of colon hyhy parting with a quintal of  wheat. The rate of exchange will lie between.

If the demand of A for cotton is more classic than the demand of B for wheat, the rate of exchange will be more favourable to A. This is so because A will be less anxious for colton than B is for wheat. In thc opposite case, the rate of exchange will be 11\0re favourable to B.  When the rate of exchange is favourable to A. itis nearer the Quintal of wheat = 71 quiutal of cotton limit. When the rate is favourable to 13, it is nearer  the I quintal of wheat = .50 quintal of colton limit.The margin of gain in this example is quite narrow. In actual practice, trade will arise if the margin is fairly wide to counterbalance any inconvenience  involved in such a trade.The argument here relates to two countries and two commodities but it can be extended to cover 1\10re than two commodities and to more than two countries  without invalidating the cs .cntial principle.We may sum up the thc ry of comparative cost in general terms, An individu I IS able to perform many tasks but he docs not perf nn them all. He selects this work which pays him the mo. t. A doctor can also do the dispensing but he not do it: a lawyer can perhaps type. but he does not do it: a professor can teach his son reading in a school but he doe not do it. All these people find it (0 their advantage. :u d it i~ also to the advantage of the community, tile  work is left to inferior  persons. In that ca . lime and energy arc more profitably employed. The same principle works in international trade.Considering climatic conditions, distribution of mineral and other natural resources, geographical position and physical configuration. every country seems to be better suited for the production of certain articles rather than for others. It will bc to the advantage of each country. as well as to the advantage of the world as a whole. that each country spccialiscs in the production of those commodities for which it has greater relative advantage.  In that case. the productive resourceresource of the countries concerned wi II be 1110rethat  remuneratively employed.Among the factors that determine the commodities in which a country should specialisc, we may mention the rate of exchange, the monopoly element, transfer emts. pnccs of thc factors and their relative efficiency. A country would lend to spccialisc ill the production of thusc commodities in which transfer  costs and factor prices arc low.