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

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International Business- Dr. R. Chandran
the least comparative disadvantage in the production of cloth, whose relative
cost (100/90) is less than relative cost of wine (120/80). Thus Portugal
should concentrate more on the production of wine whereas England should
concentrate on cloth, thus benefiting both countries.
Ricardo explained the principle of comparative cost in international trade,
but did not explain the determination of the terms of trade i.e. the rate at
which one commodity will be exchanged for the other. Since the ration of
exchange, say wine for cloth would be the same for both the countries after
they enter into trade, it must be somewhere between domestic exchange
ratios of the two goods within each country. Since wine is costlier in
England than cloth, as it takes more Labour to produce wine than cloth, the
exchange ratio in England would be 1 unit of wine = 120/100 = 1.2 units of
cloth. On the other hand, cloth is costlier in Portugal as it takes more labour
to produce cloth than wine. The exchange ratio would be 1 unit wine =
80/90 = 0.89 units of cloth. So the international rate of exchange of wine for
cloth would thus be settled somewhere between 1 unit of wine = 1.2 units
and 0.89 units of cloth. Assuming that the rate is established at 1 unit of
cloth = 1 unit of wine, England would gain because at home the ratio was
1.2 units of cloth for 1 unit of wine. Portugal would also gain because at
home it could produce only 0.89 units of cloth for 1 unit of wine. Thus, with
international trade both the countries will benefit.
On the same lines Spain produces chicken and Chile produces wine at
lower cost; Australia produces wool made ups and Singapore produces
edible oil at relatively low cost; Malaysia produces rubber products at a low
cost compared to knit wear, which Indonesia produces at a lower cost
compared to rubber. In the latter case both countries are situated close to
each other and hence it would be a distinct advantage for Malaysia to focus
on rubber and supply it to Indonesia and for Indonesia to focus on knit wear
and export it to Malaysia.
An important implication of theory of comparative cost is based on the
principle of complete specialization. According to above example, England
should specialize in the production of cloth and Portugal in the production of
wine. Each country would produce only goods in which it has a comparative
advantage and trade the surplus of production with other countries. The
underlying basis of complete specialization is that the comparative
advantage is permanent, irrespective of the scale of production in both
countries- Ricardo assumes the production is subject to the law of constant
returns i.e. the cost per unit of output would remain the same whatever be
the scale of production. He also assumes that a permanent supply of raw
material and other consumables associated with the product are available,
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