Ricardo's Theory

Ricardo's Theory of Comparative Advantage ↓

David Ricardo stated a theory that other things being equal a country tends to specialise in and exports those commodities in the production of which it has maximum comparative cost advantage or minimum comparative disadvantage. Similarly the country's imports will be of goods having relatively less comparative cost advantage or greater disadvantage.

1. Ricardo's Assumptions :-

Ricardo explains his theory with the help of following assumptions :-

There are two countries and two commodities.

There is a perfect competition both in commodity and factor market.

Cost of production is expressed in terms of labour i.e. value of a commodity is measured in terms of labour hours/days required to produce it. Commodities are also exchanged on the basis of labour content of each good.

Labour is the only factor of production other than natural resources.

Labour is homogeneous i.e. identical in efficiency, in a particular country.

Labour is perfectly mobile within a country but perfectly immobile between countries.

There is free trade i.e. the movement of goods between countries is not hindered by any restrictions.

Production is subject to constant returns to scale.

There is no technological change.

Trade between two countries takes place on barter system.

Full employment exists in both countries.

There is no transport cost.

2.

The principle of comparative advantage explains how trade can benefit all parties involved (countries, regions, individuals and so on), as long as they produce goods with different relative costs. The net benefits of such an outcome are called gains from trade. Usually attributed to the classical economist David Ricardo, comparative advantage is a key economic concept in the study of trade.

Adam Smith had used the principle of absolute advantage to show how a country can benefit from trade if the country has the lowest absolute cost of production in a good (ie. it can produce more output...