Ans.
The concept of classical theory of international trade was
popularized by Prof Adam Smith. He introduced the concept of absolute cost
advantage but his theory failed to explain the situation where foreign trade
was undertaken even without any absolute cost advantage. This theory was
further modified by Prof. David Ricardo. Where he specified that foreign trade
takes place on account of comparative cost advantage however this theory has
been based on various assumptions which are as follows:
There are two countries
a. There are two commodities
b. Existence of perfect competition
c. Free trade
d. Cost of production is expressed in
terms of labour hours required to produce
e. The only productive factor is labour
f. There is full
employment in both the countries.
g. Absence of transport cost
h. Technology should remain the same
i. Labour
is identical
With the help of above assumptions Prof. Ricardo has stated
that if a country is superior in production of both the commodities than it
would be at benefit if a superior country specializes in the production of that
commodity in which it has comparatively more advantage on the other hand
inefficient country should specialize in the production of that commodity in which
it has comparatively less disadvantage. Prof. Ricardo has further illustrated
this theory with the help of following example.
Let us consider two countries i.e. USA and India and two
commodities X and Y. the cost of production of both this product is measured in
the terms of labour hours required and is illustrated as follows.
In the above table we can see that
USA is superior in production of both the products where as India is inferior
in production of both the product. Prof Ricardo has further specified that USA
will get benefited if it get specialized in the production of commodity X in
which t will have more comparative advantage however he stated that India
should get specialized in the production of commodity Y in which it has less
comparative disadvantage thus we can make following comments;
a. USA
has specialized in Commodity X and the domestic exchange rate in USA between X
and Y is 1X = 0.89 Y
b. India
has specialized in commodity Y and the domestic exchange rate in India between
X and Y is 1X = 1.2Y
c. Let
us assume that countries enter in to foreign trade with an exchange rate of 1X
= 1Y
d. As
USA has specialized in the production of X it will export commodity X to India
and in return will get 1 unit of Y from India for which it used to get 0.89
units of Y in domestic economy. Thus we can see that USA has been benefited
with 0.11 Units of commodity Y on account of foreign trade.
e. AS India has specialized in the production of Y it will
export commodity Y yo USA and in return will get 1 unit of X from USA for which
it use to spend 1.2 units of Y in domestic economy. Thus we can see that India
has been benefited with 0.2 units of commodity Y on account of foreign trade.
From the above points we can conclude that both the
participating countries can get benefited from the international trade on the
basis of comparative cost advantage. This theory has been criticized by modern
economists with reference to following points:
1. This theory has limited scope as it has restricted itself to
two countries and two commodities. However in reality there are multiple
countries and numerous product.
2. unreal assumptions are made under this theory like existence
of perfect competition. In reality perfect competition does not exist and thus
we can say that this law does no t have practical significance.
3. this law has assumed that labour is the only productive
factor which is false assumption. Production is not only on account of labour
but also it is a joint effort of land, labour, Capital and entrepreneur.
4. this law has assumed that there must be presence of full
employment however the countries where there is free trade will always suffer
from under employment or unemployment.
5. this theory has assumed that there must be absence of
transport cost however in terms of international trade we cannot analyse the
situation where there will be absence of transport cost.
6. this theory is static in nature as it has assumed that the
level of technology should remain same. In the modern world technology does not
remain constant but it is highly dynamic in nature.
7. this theory has assumed that the labour factor should be
homogeneous in nature and in reality the labour can never ever be identical it
will always be a heterogeneous factor.
8. ignores the demand side of the commodity and has given more
and more importance to the supply side of the commodity.
9. this theory has explained that foreign trade has arises on
account of comparative cost advantage but has not explained the reasons for differences
in cost.
