David Ricardo's Theory Of Comparative Cost

Comparative cost advantage theory of international trade was developed by the British economics in the early 19th century. In the year 1817 David Ricardo published his ?Political Economy and Taxation‘in which he presented the Law of Comparative cost Advantage. As in the absolute cost advantage theory, this theory also says that international trade is solely due to differences in the productivity of labour in different countries. Absolute cost advantage theory can explain only a very small part of world trade such as trade between tropical zone and temperate zone or between developed countries and developing countries. Most of the world trade is between developed countries that are similar with respect to their resources and development which is not explained by absolute cost advantage. The basis for such trade can be explained by the law of comparative advantage. In the following subsection, assumptions and illustrations of Ricardian Theory is explained.

Assumption of the Ricardian Theory

We can begin the analysis by listing the number of assumptions required to build the theory.

• Each country has a fixed endowment of resources and all units of each particular resource are identical.
• The factors of production are perfectly mobile between alternative productions within a country. This assumption implies that the prices of factors of production are also the same among alternative uses.
• Labour theory of value is employed in the model. The relative value of a commodity is measured solely by its relative labour content.
• Countries use fixed technology though there may be different technologies in different countries.
• The simple model assumes that production is under constant cost conditions regardless of the quantity produced. Hence the supply curve for any goods is horizontal.
• There is full employment in the macro-economy.
• In the basic model, transport costs are zero.
• It is a two-country, two-commodity model.