International-Business-Dr-R-Chandran-E-book

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International Business- Dr. R. Chandran
commodities and import those commodities that it produces at a higher
comparative cost. The theory of comparative advantage is based on certain
underlined assumptions given below:
a) There should be two countries that produce the same two
commodities.
b) Labour is the only factor applied in production. It is assumed that the
supply of labour is given and fixed. Also, the labour force is assumed
to be homogeneous.
c) Cost of labour, i.e, wages determine the price.
d) Production is subject to the law of constant returns.
e) There is no change in taste and preference of the people.
f) No change in technology in expected.
g) Factors of production are perfectly mobile within two countries but
are not freely mobile between the countries.
h) There is no transportation cost.
i) There is full employment of factors in both the countries.
j) There is homogeneity in consumption, buying behaviour and
affordability.
Based on the above assumption, Ricardo showed that two countries could
indulge in trade even when one of them has an absolute advantage in
production of one of the two commodities vis-à-vis the other country.
Ricardo explained the theory of comparative advantage with the help of the
example given below.
Suppose the two countries viz. England and Portugal produce two
different types of goods say wine and cloth, whose labour costs in terms of
man hours required for unit of production are as follows:
Country Wine Cloth
England 120 100
Portugal 80 90
It is very clear from the table that Portugal has to expand less labour as
compared to England in the production of both the commodities. Thus
Portugal has an absolute cost advantage in both the goods while England has
an absolute cost disadvantage in both of them. But Portugal would benefit by
producing wine and exporting it to England in return for cloth as it has a
comparative advantage in the production of wine. This is due to the fact that
the relative cost of producing a unit of wine (80/120), is less than the relative
cost of producing a unit of cloth (90/100). On the other hand, England has
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