It is a presentation about international trade. It will improve the knowledge about international trade.

1. Theories of International Trade
Trade
National/ International/
Internal/ External/
Intra-regional/ Inter-regional/
Domestic
 National Trade –
‘Trade within the geographical
boundaries of a nation or a region’.

2.  International Trade –
‘Trade among different countries or
trade across the political boundaries’
Reasons of International Trade
1. Unlimited Wants
2. Factor Endowments
3. Division of Labour & Specialization

3. 4. Technological Advancement
5. Skilled Labour
6. Immobility of Factors
7. Natural Resources
Comparative Cost Theory
*Presented by Classical Economist David
Ricardo
*Classical Theory of International Trade
*Basis of the international trade are-
 Specialization
 Division of labour

4.  Natural resources
*It is the result of advantages a country
possesses in producing a particular
commodity at a lower cost
Assumptions –
1. Two Countries &Two Commodities
2. Labour is the only productive factor
3. Prices of commodities are expressed in
terms of labour hours used in
production
4. All units of Labour are Homogeneous

5. 5.Labour is perfectly mobile within a
country but immobile internationally
6. Free Trade & Full Employment
7. Perfect Competition
8. Constant Technology
9. No Transport Cost
10.There are constant returns to scale
11.Trade between two countries takes
Place on barter system

6. *On the basis of the above assumptions,
David Ricardo explained his comparative
Cost difference theory

7. Cost Differences
1) Absolute Cost Difference
2) Equal Cost Difference
3) Comparative Cost Difference
1.Absolute Cost Difference –
*Adam Smith introduced this Principle in
his book, ‘Wealth of Nations’
*According to him, trade occurs between
two countries if one of them has an
absolute advantage in producing one
commodity & the other country having

8. Absolute advantage in producing some
other commodity
*A country will specialise in the
production of that commodity in
which it has an absolute cost
advantage

9. Example-
Absolute Cost Difference
Cost of Production in Labour Units
Country Cloth
(Units)
Wheat
(Units)
Domestic Exchange
Rate
A 10 5 1 C = 1/2W
B 5 10 1/2 C = 1W
Comparati
ve Cost
Ratio
10/5 =
2
5/10 =
0.5

10.  In country A -
*One unit of labour per day produces 10
units of cloth or 5 units of wheat
*At domestic level the rate of exchange is
1C = 1/2 W
 In country B –
*One unit of labour per day produces 5
units of cloth or 10 units of wheat
*At domestic level the rate of exchange is
1/2C =1 W
 Country A has absolute advantage in

11. The production of cloth over country B
 Country B has absolute advantage in
the production of wheat over country A
 In the international trade country A will
specialise in the production of cloth &
export its surplus to country B
 Country B will specialise in production
of wheat & exports its surplus to
country A
 Thus after specialization, both
countries gain from international trade

12. 2) Equal Cost Difference –
Cost in Labour Units
Country/
Commodity
X Y Domestic
Exchange
Rate
Country A 10 20 1X = 2Y
Country B 15 30 1X = 2Y
Comparative
Cost Ratio
10/15 =
0.66
20/30 =
0.66

13.  If there is equal cost difference,
international specialisation & trade
cannot be a gainful proposition. By
equal cost difference, is meant that two
commodities are produced in both
countries at the same cost difference
 On account of equal cost difference,
the comparative cost ratio is the same
for both countries, so there is no
reason for undertaking specialisation
 When the internal rate of exchange is

14. Identical in both countries, international
trade is not possible
3)Comparative Cost Advantage –
 David Ricardo introduced a wider &
more realistic of comparative cost
advantage to the theory of
international trade
 According to him only comparative &
not the absolute advantage is
necessary for a gainful international
trade

15. Ricardo's Theorem
*Ricardo stated a theorem that, other
things being equal, a country tends to
specialise in & export those commodities
in the production of which it has
maximum comparative cost advantage
or minimum comparative disadvantage
*The country’s imports will be of goods
having relatively less comparative cost
advantage or greater disadvantage
*In the following example David Ricardo

16. Considered two countries Portugal &
England producing two commodities
wine & cloth in both the countries is
expressed in the form of table as follows:

17. 3) Comparative Cost Difference –
Portugal get(1-0.89)=0.11 more cloth per unit
of wine
England saves(1.2-1)=0.2 cloth per unit of wine
Cost in Labour Units
Country/
Commodity
Wine Cloth Domestic
Exchange Rate
Portugal 80 90 1 Wine = 0.89 Cloth
England 120 100 1Wine = 1.2 Cloth
Comparative
Cost Ratio
80/120 = 0.67 90/100 = 0.9

18.  It is clear from the above table –
*In Portugal a unit of wine costs 80 hours
of labour & a unit of cloth 90 hours of
labour
*In England a unit of wine costs 120 hours
of labour & a unit of cloth 100 hours of
labour
*If we compare the cost of production in
both the countries, for international
trade to take place, we observe that
costs of producing both commodities

19. are lower in Portugal as compared to
England
*Portugal has an absolute advantage in
producing both the goods
*Portugal is superior in producing of both
commodities – wine & cloth whereas
England is inferior in production of both
commodities
*But on the basis of comparative cost
advantage, Portugal has a comparative
advantage over England in the

20. Production of wine relatively to cloth
because in the production of wine it
requires only 80 hours of labour
compared to 90 hours of labour for cloth
*Means here, Portugal is comparatively
more efficient in wine making than in
cloth weaving
*The disadvantage of England is greater in
wine than in cloth. England, in fact, has
an absolute disadvantage in producing
both the goods

21. *It has, however, lesser disadvantage in
producing cloth than wine in comparison
to Portugal, for in wine production it
involves 120 hours of labour & in cloth it
is 100 hour of labour
*Hence, England will specialise in the
production of cloth. Evidently, Portugal
has a comparative disadvantage of costs
in producing cloth
*Here, Portugal has a comparative cost
advantage in wine & has a comparative

22. Disadvantage in cloth
*When England specialises in cloth &
exports the surplus to Portugal in
exchange for wine, England gains 0.2 of
cloth for 1 unit of wine
*Likewise Portugal should specialise in
wine & export the surplus to England to
import cloth. Portugal will gain 0.11
more of cloth for 1 unit of wine
*Thus, both England & Portugal will gain
from specialisation & trade: England

23. Exports 1 unit of cloth & thereby saves
0.2 cloth to get 1 unit of wine from
Portugal. Likewise, Portugal gets 0.11
more of cloth for 1 unit of wine
*As international trade takes place on the
basis of comparative cost differences,
there will be complete specialisation
after trade

24. Drawbacks/Critical Evaluation
1. Unrealistic Assumptions -
i. Two Countries
ii. Two Commodities
iii. Only Labour Cost
iv. Homogeneity of Labour
v. Full Employment
In reality international trade take place
between number of countries, they are
importing & exporting number of
commodities, Production is not possible
with the help of single factor & full

25. Employment is unrealistic
2.Neglect of Transport Cost -
No country will export or import unless
the production cost exceeds transport
cost
3. One – Sided Approach –
The Ricardian theory considers only the
supply side of international trade, but
takes no account of the demand aspect
5.Limitation of perfect mobility of factors
This is highly unrealistic, because it is

26. Equally found in the domestic trade as
factors do not move freely from one
industry to another or from one region
to another
4. Ohlin’s Criticisms –
The comparative cost principle was
applicable to all trade & that
international trade was no exception
to it
Conclusion –
The theory of comparative advantage

27. despite its limitations, till continues to be
the basic principle of international trade
& specialization.