QUESTION 19 . Define the theory of comparative advantage.
ANSWER 19. DAVID RICARDO explained comparative advantages theory in his book "ON THE PRINCIPLE OF POLITICAL ECONOMY AND TAXATION " in 1817. According to the law of comparative Advantages propounded by David Ricardo two countries will gain from trade if they have different relative cost for producing the same goods. Even if one country i.e absolute advantage than the other, both countries will still gain by trading with each other , as long as they have different relative efficiencies in terms of cost.
This theory is based on two country and two commodity model. Comparatively difference in cost means that one country is capable of producing both commodities but will able to produce one commodity more efficiently than the other commodity because the country will produce both the goods at absolutely lower cost than the other country.
According to this theory , a country will specialize in the production of those commodities in which it has a comparative advantages availability of natural resources, skill of the people , geographical environmental condition etc . A country will concentrate on a production of those goods and services in which it has cost advantages and exchange them with other sets of goods and services which is produced by other countries at less cost.
ASSUMPTION :
1. Labour is considered as the only factor of production.
2. Homogeneous nature of labour.
3. Labour is mobile in a country but immobile between the countries.
4. No transportation cost.
5. Perfect competition both in goods and factors market.
CRITICISM:
This theory is also criticised because that is assumed that there are no transportation cost. This is wrong and unrealistic assumption. RICARDO's theory assumed employment. But in real world, there exist unemployment . Another drawback of the classical theory of comparative cost is that it assumed that internally factored production are completely mobile but internationally they are immobile.