Page 29 - DMGT545_INTERNATIONAL_BUSINESS

International Business

notes Now, if both India and Pakistan, form a part of only one country, each part will specialize in only
one commodity, viz., India in the production of cotton and Pakistan in the production of jute.
Division of labour between the two regions must lead to an increase in the total output. This is
what exactly happens, when international trade takes place between these two countries. India
will specialize in the production of cotton, export part of its output to Pakistan, as against import
of jute. India will be prepared to enter into trade, so long, as it can secure more than 1/2 unit of
jute for one unit of cotton (this is the cost ratio within India). Pakistan on the other hand, will
be prepared to give, as much as 2 units of jute, for one unit of cotton. Hence, trade between the
two countries will be very beneficial at any rate between 1/2 to 2 units of jute, for one unit of
cotton. International trade will, therefore, definitely take place under conditions of an absolute
difference in cost. But the trade between the two countries will not be for a long period or on a
permanent basis.
Nowadays, there is a very small trade on this basis. This situation is explained in Figure 2.1.

figure 2.1: case of absolute cost Difference

Y

PRODUCTION- POSSIBILITY CURVE

A
1.0
COTTON

0.5 PAKISTAN
INDIA

B C
0 X
0.5 1.0 1.5 2.0
JUTE

In Figure 2.1, the production-possibility curves for India and Pakistan are prepared on the basis
of 1 unit of cotton = 1/2 unit of jute and 1 unit of cotton = 2 units of jute, respectively. The line
AB explains the position of India, where the distance along Y-axis i.e., OA (cotton) is double the
distance along X axis, i.e., OB (jute). Similarly, line AC indicates the position of Pakistan, where
the distance along Y-axis i.e., OA (cotton) is half the distance along X-axis i.e., OC (jute). BC is the
amount of pure surplus, which can be distributed between the two countries, in case trade takes
place. Any rate of exchange between B and C, will be beneficial to both the countries.

2.3 comparative cost advantage theory

According to the Comparative Cost Theory, countries in the long run will tend to specialize in the
business (production and marketing) of those goods in whose business they enjoy comparative
low cost advantage and import other goods in which the countries have comparative cost
disadvantage, if free trade is allowed. This specialization helps in the mutual advantage of the
countries participating in international business.
David Ricardo illustrated the Comparative Cost Theory in 1817. He used two countries,
two-commodity model. The conclusions of his model are:

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