Page 31 - DMGT545_INTERNATIONAL_BUSINESS

International Business

notes uses more labour than Portugal in producing both wine and cloth. Hence Portugal possesses an
absolute advantage in both wine and cloth. Amongst the two Portugal’s greater advantage is
production of wine and exporting to England. Since the cost of production of wine 80/120 men
is less than the cost of production of cloth 90/100 men. On the other hand, it is England’s interest
to specialize in the production of cloth in which it has least comparative disadvantage. Since the
cost of production of cloth in England is less (100/90 men) as compared with wine (120/80 men).
Thus trade is beneficial for both the countries.

Derivatives of the theory

The advantages desired from this theory are:
1. Efficient allocation of global resources.
2. Maximization of global production at the least possible cost.
3. Product prices become more or less equal among world markets.

4. Demand for resources and products among world nations will be optimized.

case: comparative cost Difference

There may be a second case, where two countries can produce two commodities. The factors of
production may be so distributed that one country may produce both the commodities at a lower
cost than the other country, but the greater advantage lies in the production of any one commodity
instead of two. There is, therefore, a need for specialization. This is explained below.
Suppose:

In India, 10 days of labour can produce 100 units of cotton or
In India, 10 days of labour can produce 100 units of jute.
In Pakistan, 10 days of labour can produce 40 units of cotton or
In Pakistan, 10 days of labour can produce 80 units of jute.
In this example, the internal cost-ratio between cotton and jute in India is 100:100 or 1 unit of
cotton = 1 unit of jute.
Similarly, the internal cost-ratio in Pakistan, between cotton and jute is 40:80 or 1 unit of
cotton = 2 units of jute.
Comparative cost difference implies that, one of the two countries has an absolute advantage in
the production of one commodity, than in the production of the other. In our example, India has
an absolute advantage in the production of both the goods, since it can produce both, cotton and
jute at a lower cost, as compared to Pakistan. But India’s advantage is comparatively greater in
the production of cotton, than in jute:
100 units of cotton in India > 100 units of jute in India
40 units of cotton in Pakistan 80 units of jute in Pakistan

On the other hand, Pakistan has cost disadvantages in the production of both the goods, but its
comparative cost disadvantage is less in the production of jute, than in cotton. To express the
idea differently, Pakistan has a comparative cost advantage in the same production of jute, than
in cotton:
80 units of jute in Pakistan > 40 units of cotton in Pakistan
100 units of jute in India 100 units of cotton in India

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