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International Trade and Finance

Notes cost ratios of the two countries, so that both the countries gain from trade in terms of production (or
GNP) as well as consumption (or economic welfare) Government non-intervention is a condition,
and free trade must be guaranteed.
3.2 Comparative Advantage Model of David Ricardo

Ricardo went even further, and he argued that even if the countries did not have absolute advantage
in any line of production over the others, international trade would be beneficial, bringing gains
from trade to all the participating countries. Ricardian model is termed as comparative advantage model,
as opposed to Smith’s model of absolute advantage. Ricardo’s model is a further refinement of Smith’s
model. Let us now discuss Ricardo’s model.

What is absolute advantage?

Once again, let us assume a world of two countries and two commodities. Malaysia and India are the
two countries, rubber and textiles are the two commodities. The production possibilities in the two
countries are such that both countries can produce both the goods if they wanted; this means that
dependence on each other is not inevitable, because the two countries can produce and consume
some combination of the two goods, working in isolation (closed economy). Thus far Ricardian model
is similar to Smith’s model, but the differences arise from here on. In the Ricardian model we assume
that one country has the absolute advantage over the other country in both the lines of production,
and the other country has the absolute disadvantage in both the lines of production (contrast this with
Smith’s model, where one country has absolute advantage in one line, and the other country in the
other line). This is in terms of absolute advantage. In terms of relative or comparative advantage,
Ricardo assumes that the first country (which has absolute advantage in either line of production)
has a greater comparative advantage in one line compared with the other line, in which its comparative
advantage is smaller; and the other country’s (i.e., the one which has no absolute advantage in either
line of production) comparative disadvantage is smaller in the second line compared with the first
line of production, where its comparative disadvantage is greater. In brief, one country’s comparative
advantage is greater in one line of production, and the other country’s comparative disadvantage is
smaller in the other line of production. International trade would bring production and consumption
gains, when these two countries enter into trade with each other. Let us see, with the help of a numerical
model, how that happens.
The following table shows the production possibilities in the two countries.
Table 6 : Production Possibilities in India and Malaysia
Commodities International
Countries Textiles Rubber Opportunity
(units) (units) (Cost Ratios)

India 120 or 120 1:1
Malaysia 40 or 80 1:2

With “x” factors of production, India can produce 120 units of textiles or 120 units of rubber, or any
combination of textiles and rubber at the constant opportunity cost ratio of 1:1 i.e. India can produce
1 unit of rubber (or textiles) by giving up the opportunity of producing 1 unit of textiles (or rubber).
India is equally efficient in the production of the two commodities.
Malaysia, on the other hand, is equally inefficient in either line of production compared with India;
because, with “x” factors of production Malaysia can produce either 40 units of textiles (compared
with India’s 120 units) or 80 units of rubber (compared with India’s 20 units), or any combination of

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