a.
Definition
b.
Assumption
c.
Importance
d.
Disadvantages
Theory of comparative cost is a process by which a
nation should not waste their scarce
resources on producing the
commodities which they can obtain from aboard at a
lesser cost, a nation should divert its resources only to the production[n
of commodities in which they have
greatest relative efficiency and trade
for products which they can not
produce efficiently.
For example, with the help of his comparative cost theory tired to illustrate that
even if Portugal could produce wine
and cloth more cheapy (in gterms
of labour hours) them England, it will be beneficial for Portugal
to specialize in the production of wine,
because she is comparatively more
efficient in its production them cloth,
so if Portugal concentrate in the production of
wine and England specializes in
the production of cloth, trade will; be mutually profitable to them because the have now a larger supply
of wine and cloth. The principle of
comparative cost can be make clear by taking a simple example from
our every day life. Let us suppose,
there is
a very successful barrister who at the very same times is a very good
typist will it be advantageous for the barrister to type all
his legal documents himself? The answer
is no. the time which he spends in typing his papers can be more profitable utilized in
the preparation and preaching of his
cases in courts.
For instance,
if the types all his legal document himself, he can scare N2000 per month, if he engages a typist and spends that time in the preparation of cases
he can earn N4000 per month. It will
thus be profitable for the barrister to derot his time in the preparation of
case and pleading them in court than doing any other work..
In economic technology, we can say, that through the
barrister has an advantage in the both
preaching his cases and typing of document , got he can earn more if he devot
himself exclusively to the
occupation in which he has the
greater comparative advantage ie, in the legal work, we can take many other example like this to clear the concept
of comparative cost. For instance, it is advantageous for a doctor to employ a dispenser them to do the work of dispensary himself,
though be himself is a better dispense
Theory of comparative cost as applied to international
trade is therefore, that each country
tends to produce, not necessarily
what it can produce more cheapy
than an other country, but those articles which it can produce at the greatest relative advantage, ie at
the lowest comparative
cost. Each country will
produce that article in the production of which its superiority is more marked or its inferiority least marked .
It may be remembered have that when the
products of one country exchange for that of another its is not the cost of production
which we compare of the production of the commodities concerned.
ASSUMPTION OF
THEORY OF COMPARATIVE COST:
a.
The two commodities two commodities
and all the countries . each country then will specializes in the
production of those commodities in which enjoys comparative advantage and export them to others and
import the required goods from others
where they are available at a lower price than
at home.
b. The theory which was explained in terms of labour can also be
expressed in terms of money
specialization would take place on the basis of comparative advantage in terms
of money cost.
c.
The assumption of constant return to
scale and no charge in technology and production being subject to laws of returns, specialization will still take place
on the basis of cost advantage under increasing
and decreasing cost.
d. Assumption of no transport cost makes the
comparative advantage theory, it is argued very
unrealistic. It pointed out that
adding transport cost to the cost of production, each country
will produce those goods I which it will have cost advantages after adding transport cost, for
example India may no enjoy the cost
advantage for selling them in the nieghbouring countries.
e.
It is suggested that cost would not under go a
charge as the countries operate
with assumptions like full employment, perfect competition, static nature of the economy,
true trade and many other restrictive assumption
IMPORTANCE OF THEORY OF COMPARATIVE COST
Assumption Of Labour Cost: The most
important criticism of the theory
of comparative cost is that it is
stated in labour or real terms. It
assumes that labour is the only factor of production consist of labour
cost alone. The theory igriores the
basic fact that labour is not the only facto[r of production and the production
costs include non- labour cost too
Defects of labour theory of value: the labour theory of value on which the
comparative cost theory is based has
long been discarded because of the following defects:
a. The labour theory is based on the unfounded assumption
that labour is the only factor used in
the production of commodities,
b. The labour theory assumes homgenous labour, while in
reality labour differs in inefficiency and skill,
c. Labour theory of value assumes that if other factors
are used along with labour, they are combined in fixed proportions. But, reality,
capital labour ratio varies from industry to industry,
d. The labour
theory of value is also based on the
unrealistic assumption of perfect competition and perfect competition
and perfect mobility of labour.
e. The labour theory of value was discarded by the neo –
classical economists since it ignored
the role of utility in the determination of value
Assumption of
constant cost: the theory of comparative
cost assures the existence of constant
cost conditions. It maintains that the additional units of the same
commodities, can be produced at the constant
average cost . The reality on the other hand, is that there are either
increasing costs or decreasing costs
because of the operation of the laws of
diminishing returns respectively constant costs are
the exception rather than the rule assumption of factor mobility: the classical theory of informational trade is based on another unrealistic assumption that factors of
production are perfectly mobile within
the country and perfectly immbile
between the countries. The
reality is quite different?
a. Within a country, factors of production do not more freely from one industry
to another and form one region to another. This is evident from the existence of different wage
rates and interest rates in different industries and regions.
b.
Factors are not perfectly immobile internationally there
have been movement of factor
surplus to factor –scarce countries.
Assumption of two commodities and two countries : another unrealistic
assumption of the theory of comparative
cost is that its operation is
restricted to two commodities and two
countries the theory breaks down when it is applied to the nominal and more realistic situation of
international trade among more than
two countries
Neglect of transport costs: the theory of
comparative cost does not take into
consideration the transport
costs . neglect of transport
cost is highly unrealistic because in production transport cost play an important role in influencing the
pattern of world trade . Infact, international trade occurs only when the comparative cost advantage exceeds transport costs
Static theory : The unrealistic
assumption liked the existence of full
employment fixed and constant supply of
factors of production etc, make the
theory of comparative cost a static theory
and render it unfit for the changing and dynamic world.
One sided theory: the comparative cost theory of international trade has been regarded as one sided theory because it takes into account only the supply
or cost side and ignores the demand
side, the neglect of demand conditions
is responsible for the theory’s
inadequate explanation for the determination of terms of trade.
In the words of line the comparative
cost reasoning alone explains
very little about international trade . it is, indeed nothing more than an
abbreviated account of the condition
of supply
Growing emphasis on self sufficiency : in
modern times, because of defence and other strategic reasons,
almost every country tries to achieve the objective of self sufficiency and may decide to produce certain good
even though they can be cheaply
imported form other countries. For
instance, all countries prefer to produce
military equipment at home even if it can be imported from aboard at
cheaper rates this the theory of comparative cost is unrealistic and has little relevance in the
actual world.
Improssiblity
of complete specialization: even if the
various assumption of the theory are accepted, the existence of
comparative advantage may not head
to complete specialization on the part
of two countries which enter
into international trade. as pointed out by frank gratin, this may happen when one trading country is big and the other is small. The small country will be in a position to
special usefully as it can dispose of its surphs in the big country. But the big country cannot have
complete speicalisation of because of
the two reason:
a. The small country will not be able to meet all the
requirement of the big country
b. The surplus of the big
country will not be articly absorbed by
the small country.
DISADVANTAGE THEORY OF COMPARATIVE COST:
a.
Intro classical Theory of
international tendering English
political economist contributed theory
of comparative advantage his book princes of poltical economy and taxation.
This theory of comparative advantage
also called comparative cost theory, is regarded as the classical theory of international trade
c. Types of difference in production” economists speak about three types of cost difference in production, there are
:
1. Absolute cost
difference
2. Equal cost difference
and
3. Comparative cost
difference
Cost
ratios a producing wine and cloth:
portaged has advangage of lower cost of production both in
wine and cloth. However the
difference in cost, that is the
comparative advantage is greater in the production of wine than
in cloth. Even if the terms of absolute
number of days of labour Portugal has a large comparative advantage in wine,
that is, 40 labourers less than England as compared
to cloth where the difference is only
10, (40710|) accordingly Portugal specializes in the
production of wine where its comparative
advantage is larger . England specializes in the production of cloth where its comparative disadvantage is lesser than in wine.
Comparative
cost benefits both participants: let us explain receding contention that comparative cost
benefits both the participants, though
one of them had clear cost advantage in both commodities to prove it, let us work out, their internal exchange ratio let us assumes the two country enter into trade at an
international exchange rate (terms of
trade) I:1
At this rate, England specializing I cloth and
exporting are unit of cloth gets are
unit of wine. At home it is
required to give 1.2
units of loath for one unit of
wine. England thus gains 0.2 of cloth
ie wine in cheper form Portugal
by 0.2
unit of cloth
Similarly
Portugal get are unit of cloth
against 0.59 of cloth at home
thus gaining extra cloth to get one unit of wine and Portugal gets 0.11 more of cloth for one unit of wine. Thus comparative cost theory states that each country produce and exports
those goods in which they enjoy
cost advantage and imports those good suffering cost disadvantage.