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Unit 2: Theories of International Trade

International trade will be beneficial to both the countries, if each of them specializes in the notes
production of that commodity, in which it has comparative cost advantage. India, therefore, will
be prepared to specialize in cotton and export part of it, so long as it can get more than one unit
of jute for 1 unit of cotton. Pakistan, on the other hand, will specialize in jute, provided it can
secure 1 unit of cotton for 2 units of jute. Any rate between 1 to 2 units of jute for 1 unit of cotton,
will benefit both the countries. Under such conditions, international trade is beneficial and hence,
possible between the two countries. The principle of comparative advantage is explained in
Figure 2.2.

figure 2.2: case of comparative cost Difference
Y

PRODUCTION- POSSIBILITY CURVE

A
1

COTTON PAKISTAN

INDIA

B C
0 X
1 2
JUTE

In the figure, the line AB, represents the production-possibility curve for India and is based on
the cost-ratio of 1 unit of cotton = 1 unit of jute. Line AC, explains the production-possibility
curve for Pakistan and is based on the internal cost-ratio of l unit of cotton = 2 unit of jute. BC, is
a pure economic surplus, which is to be shared by the two countries through trade. Any rate of
exchange between B and C will be beneficial to the two countries.

criticisms of the theory

For a very long time, the classical theory of comparative cost, as formulated by Ricardo and
refined by Mill et. al., held an undisputed say. It was considered to be the most appropriate
explanation of the basis of international trade. Prof. Samuelson, expressing the elegance of this
theory writes that, “If theories, like girls, could win beauty contests, the comparative advantage
would certainly rate high in that, it is an elegantly logical structure.” But in spite of its popularity,
the theory has been put to a severe critical examination by some modern economists, like, Bertil
Ohlin and Frank Graham. Ohlin describes the theory as clumsy and dangerous, i.e. unduly
cumbersome and unreal. Moreover, it has been founded on an unrealistic assumption and has,
therefore, been vigorously attacked as under:
1. Assumption of labour cost is no longer valid: The most forthright attack against the theory
is, because of its assumption of labour costs. The assumption of labour theory of value
on which it is based, has been long discarded. In actual practice all costs, nowadays, are
measured in terms of money. Therefore, with the collapse of this major support, the theory
falls flat.
Here, it may be pointed out in support of the theory that it will be unjust to condemn
it, merely on account of this assumption. Ricardo had expressed the theory in terms of

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