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Unit 2: Theories of International Trade

1. Trade between two countries is profitable when a country produces one good at a lower notes
cost than another country and that other country produces another good at a lower cost
than the former country.
2. Trade between two countries is also profitable when one country produces more than one
product efficiently, but when it produces one of these products comparatively at greater
efficiency than the other product.
3. Both the nations can engage in international trade when one country specializes in
production in which it has greater efficiency than the other.

assumption of the theory

The following are the assumptions of the comparative cost advantage theory:
1. There are only two countries.
2. They produce the same two commodities.
3. There are similar tastes in both countries.
4. The only element of cost of production is labour.
5. The supply of labour is unchanged.
6. All units of labour is homogenous.

7. Prices of two commodities are determined by labour cost i.e. the no. of labour units employed
to produce each.
8. Production is the subject to the law of constant returns.
9. Technological knowledge is unchanged.
10. Trade barriers between the two countries takes place on the basis of the barter system.
11. Factors of production are perfectly mobile within each country but are perfectly immobile
between countries.
12. There is free trade between the two countries, there being no trade barriers or restrictions in
the movement of commodities.
13. Trade is free from cost of transportation.
14. All factors of production are fully employed in both the countries.
15. The international market is perfect so that the exchange ration for the two commodities is
the same.

Notes David Ricardo illustrated the Comparative Cost Theory in 1817.

Task Give and explain any example of the above mentioned theory.

explanation of the theory

Suppose the production of a unit of wine in England requires 120 men for a year, while a unit
of cloth requires 100 men for the same period. On the other hand, the production of the same
quantities of wine and cloth in Portugal requires 80 and 90 men respectively. Thus England

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