Ricardian Theory of International Trade

-Sa’ad Shaikh
 Introduction

 First theory on international trade

presented by Adam Smith-
“Wealth of Nations”.
 David Ricardo systematically
represented another in his book
-“Principles of Political Economy
and Taxation”.
 Based on Comparative Cost
Advantage.
 Improvements made to the theory David Ricardo

(Ricardo-Sraffa model)
Comparative Cost Advantage

 Countries will export a product for which it

has a relatively lower cost of
production/higher labour productivity.
 Specialization in the good which has
lowest opportunity cost.
 “Comparative Advantage a meaningful
and non-trivial result from the economics
discipline” - Samuelson
Ricardo’s Comparative Cost Model

 Two country-Two product model. [England-Portugal ;Wine-

Cloth]
Labour cost of Labour cost of
production (hrs)- 1 unit production (hrs)- 1 unit
of wine of cloth

Portugal 80 90
England 120 100
 Portugal- Wine(80/120*100=67%) ;Cloth(90/100*100=90%)
 England- Wine(120/80*100=150%) ;Cloth(100/90*100=111%)
 Gains from Trade

 Cost of Production in isolation

Country Cost of Wine in terms of Cloth
Portugal 1 unit = 0.89 units of cloth
England 1 unit = 1.2 units of cloth

 Terms of Trade= Total quantity of Goods Exported

Total quantity of Goods Imported
 International price of 1 unit of wine = 1 unit of cloth
(assumed)
Total Cost of Production

 Lower total cost of production for the world economy under

comparative cost
In Isolation
Country Labour cost of Labour cost of Total Labour Cost
production (hrs)- 1 production (hrs)- 1 for 1 unit of Wine
unit of Wine unit of Cloth and Cloth
Portugal 80 90 170
England 120 100 220
Total Cost 200 (80+120) 190 (90+100) 390
Under Comparative Cost Theory

Country Labour cost of Labour cost of Total Labour Cost

production (hrs)- 1 production (hrs)- 1 for 1 unit of Wine
unit of Wine unit of Cloth and Cloth
Portugal 80 * 2 = 160 0 160
England 0 100 * 2 = 200 200
Total Cost 160 200 360
Assumptions-Limitations

 Labour Cost
 Wage Rates
 Labour Mobility
 Constant Returns to Scale
 Full Employment
 Barriers to Trade
 Transport Cost
 Country Size
 Basis of Cost Difference
 Conclusion

 Importance of “Comparative Advantage”

as the basis of world trade pattern.
 Limitations of Adam Smith’s theory were
overcome.
 Improvements to the Ricardian Theory
(Ricardo-Sraffa model) overcome
limitations of the original theory.
 Realistic and has practical applicability