VIEWS ON

INTERNATIONAL
TRADE BY
DAVID RICARDO
P R E S E N T E D B Y:
PRACHI JAIN
TA N M AY S I N G H A L
YA S H B I D H U R I
WHO IS DAVID
RICARDO ?
• Stock trader turned British political economist
• Systematized economics and one of the most
influential classical economist
• Contributions to a number of areas of economic
theory like labor theories of value, international
trade, comparative advantage, public finance,
diminishing returns and rent, etc.
• Ricardo’s Book: Principles of Political Economy
and Taxation in 1817
THEORY OF COMPARATIVE COST
• From 1500-1750, Mercantilism prevailed
• Ricardo challenged the purpose of trade in mercantilism
• With "comparative advantage" Ricardo argued in favour of industry
specialisation and free trade. He suggested that industry specialization
combined with free international trade always produces positive results.
• 2 assumptions for the theory of international trade:
(a) F.O.P are perfectly mobile within the country but immobile among the
countries
(b) goods are perfectly mobile both within and among countries i.e.
transportation costs are also zero
• Problem was the determination of the direction of trade i.e. which
commodity is to be exported and which to be imported, so this problem was
dealt by Ricardo’s theory of Comparative
• Comparative advantage is an economy's ability to produce a particular good
or service at a lower opportunity cost than its trading partners. Comparative
advantage is used to explain why companies, countries, or individuals can
benefit from trade.
• DEFINITION
The theory of Comparative Cost states that a country, in the long run will
tend to specialize in the production and export of that commodity in whose
production it experiences Comparative Cost Advantage and import that
commodity in whose production it experiences Comparative Cost
Disadvantage.
• 3 Types of Cost Differences
• Equal Cost Difference
Equal differences in cost arise when two commodities are produced in both
countries at the same cost difference. When cost differences are equal, no country
stands to gain from trade. Hence international trade is not possible.
• Absolute Cost Difference
There may be absolute differences in costs when one country produces a commodity
at an absolute lower cost of production than the other. The absolute cost differences
are illustrated in Table
Country Commodity- X Commodity- Y
A 10 5
B 5 10

The table reveals that country A can produce 10X or 5Y with one unit of labour and
country В can produce 5X or 10Y with one unit of labour. In this case, country A has
an absolute advantage in the production of X (for 10X is greater than 5Y), and
country В has an absolute advantage in the production of Y (for 10Y is greater than
5X).
• Comparative Cost Difference
Comparative differences in cost occur when one country has an absolute advantage in the
production of both commodities, but a comparative advantage in the production of one
commodity than in the other.
Country Commodity- X Commodity- Y
A 10 10
B 6 8

The table reveals that country A can produce 10X or 10Y, and country В can produce 6X or 8X. In
this case, country A has an absolute advantage in the production of both X and Y, but a
comparative advantage in the production of X. Country В is at an absolute disadvantage in the
production of both commodities but its least comparative disadvantage is in the production of Y.
This can be seen from the fact that before trade the domestic cost ratio of X and Y in country A is
10: 10 (or 1:1), while in country B, it is 6:8 (or 3:4). If they were to enter into trade, country A’s
advantage over country В in the production of commodity X is 10X of A / 6X of B or 5/3, and in
the production of Y, it is 10Y of A/8Y of B or 5/4. Since 5/3 is greater than 5/4, A’s advantage is
greater in the production of commodity X, A will find cheaper to import commodity Y from
country В in exchange for its X.
ASSUMPTIONS OF THE THEORY
1. Labour is the only factor of production and the value of a commodity is
directly proportional to the quantity of labour required in its production
2. since there is a single factor of production, commodities are produced at
constant costs
3. under the constant cost conditions, prices are determined by supply and the
changes in demand have no effect on it.
Later economists were able to discard these unrealistic assumptions without
doing any harm to the basic argument. Important modification in the theory of
comparative cost were made by Mill, Haberler and Ohlin.
FURTHER MODIFICATIONS
• The value of a commodity is determined not by the physical cost of resources required
to produce it, but by the opportunities of production of other commodities. which have
to be foregone in order to obtain this commodity.
• The theory of comparative cost now states that a country will specialise in the
production of those commodities which have comparatively low opportunity costs.
Thus, the opportunity cost theory provides a broader and more realistic basis for
international trade
• The theory of comparative cost can be extended to cover more realistic conditions of
increasing costs. Increasing cost conditions prevail when (a) there are diminishing
returns to scale, and (b) all resources are not equally adaptable for the production of all
the commodities
• Therefore the differences in comparative costs provide the foundation for which the
international trade is possible but the question arises why do the costs differ ?
THEORY OF COMPARATIVE COST AND
THE UNDERDEVELOPED COUNTRIES
• Comparative cost difference between the nations not only directs them to trade freely
with each other, but also ensures them gainful effects from such trade, example of a
rich and a poor country.
• But the impact of trade on growth is indeterminate and cannot be generalized.
• Kindleberger has constructed 3 models in this regard
1) There are countries like England, Sweden, Denmark, Switzerland, Canada, U.S.A.,
where trade has stimulated growth
2) In the countries like Japan trade acted as a balancing sector
3) in many countries, generally the underdeveloped countries, trade has been considered
as a lagging sector
In the end he concluded “Trade can stimulate growth when the demand is right abroad
and supply is right at home
CRITICISM OF THE THEORY
• The underdeveloped country majorly export primary products but the world
demand for these products in rich countries is unstable and declining in long run.
• The theory ignores the effects of transport costs. However, once transport costs
are added any comparative advantage may be lost.
• The theory applied their principle in case of trade with two countries only and
with two commodities only. So, the principle has a limited scope of application
in practice. It cannot explain multi-lateral trade
• 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.
THANK YOU