Within the limits set by the
model, we take three possibilities and examine wheel trade is profitable
i.
Countries with absolute difference in cost of producing
goods
ii. Countries
with equal difference in cost of producing goods
iii. Countries
with comparative difference in cost of producing goods, international trade is
profitable only under 1 and 3 countries but not under 2 as a explained below
1. ABSOLUTE DIFFERENCE IN COST
Let us assume
there are two countries, Pakistan and India Pakistan specializes in the
production of sugar and India in wheat. Pakistan with X Labor cost produces 60
quintals of wheat or 30 quintals of sugar in a season, as is shown in the table below.
Case 1 :
absolute cost differences:
|
Commodities
|
Wheat
|
Sugar
|
Cost ratio |
|
Pakistan with x resources
productions
|
30 quintals
|
60 quintals
|
1:2
|
|
India with x resources produces
|
60 Quintals
|
30 quintals
|
1:1/2
|
This table shows that in Pakistan 30 quintals of wheat is equal in its
exchange value of 2
quintals of sugar, the
substitution ratio of the opportunity cost relation between wheat and sugar is
1:2 in India, the substitution
ratio between wheat and sugar in
1:1/2 (on quintal of wheat is
equal to ½ quintal of sugar). From this table it is clear that Pakistan has an absolute
advantage in the production of sugar and
India in the production of wheat, if
Pakistan specializes in the production
of sugar and India in wheat, there will
be increase in total output and both the countries will gain from mutual trade.
Pakistan will
gain so long as it can receive more than one quintal of wheat by giving two
quintals of sugar. India will benefit
from trade if she gets more than ½ quintal of sugar in exchange for one quintal
of wheat.
2. TRADE UNDER EQUAL DIFFERENCE COST RATIO
If the
opportunity cost ratio between two countries is equal, trade will not be
advantageous to any of them for example, if Pakistan with X labour cost produces 30
quintals of wheat or 60 quintals of sugar and India will
the same given resources produces
26 quintals of wheat or 52
quintals of sugar, international
trade will not take place
between them.
CASE II: EQUAL COST DIFFERENCES:
|
Commodities
|
Wheat
|
Sugar
|
Cost ratio
|
|
Pakistan with x Resources
|
30 quintals
|
60 quintals
|
1:2
|
|
India with x Resources
|
28 quintals
|
52 quintals
|
1:2
|
Trade
is not gainful in both the countries because of the fact that in both Pakistan
and India, one quintal of wheat can be exchanged for 2
quintals of sugar, Pakistan can benefit only if it gets more than 2
quintals of sugar in exchange for one quintal of wheat- India wilt not
agree to this bargain because she herself can exchange that much quantity in her own country.
3. COMPARATIVE DIFFERENCE IN COST RATIO
According to
Ricardo, if one country is more efficient than the other in the production of
both the commodities, international
trade will be mutually profitable to them. The basic statement involves the
principal of comparative cost which is explained with the help of an example.
Let us suppose, Pakistan with x resources (labour) produces 10 quintals of wheat or 100
quintals of sugar and India with
the same x resources (labor) produces
5 quintals of wheat or 75
quintals of sugar.
CASE III: COMPARATIVE COST DIFFERENCES:
Commodities |
Wheat
|
Sugar
|
Cost ratio
|
|
With x resources Pakistan
produces
|
10 quintals
|
100 quintals
|
1:10
|
|
With x resource India produces
|
5 quintals
|
75 quintals
|
1:15
|
It is clear from
the table, above that Pakistan has comparative cost advantage in the production
of both commodities, ie wheat and sugar . But
when we examine opportunity costs of
producing both the commodities
in two countries, the picture is then different. In picture is then different. In Pakistani the cost of one quintal of wheat is equal to 10
quintals of sugar; whereas in
India the cost of one quintal of wheat is equal to 15 quintals of
sugar. Pakistan, thus, has a comparative advantage in the production of
wheat and India in sugar, so if Pakistan
specializes in the production of whet and India in sugar, there will be greater
output of both the commodities,
trade will be beneficial to the trading
countries.
As regards the
rate of exchange, it is determined by the relative elasticity’s of demand of
two countries for the , goods of the other, if Pakistanis demand for sugar in
more intense than that of India for wheat, the
terms of trade will be more favorable to India and vice versa.