Considering Ricardo's Comparative Advantage theory, explain why is trade always possible between two countries, even when one is absolutely inefficient compared to the other?
CS Professional · International Business – Laws and Practices · PYQS · June 2017
Considering Ricardo's Comparative Advantage theory, explain why is trade always possible between two countries, even when one is absolutely inefficient compared to the other?
Answer & Explanation:
The theory of comparative advantage suggests that a country should export goods in the country in which its relative cost advantage, and not the absolute cost advantage, is greatest in comparison to other countries. According to Smith, if one country has an absolute advantage over the other country in one line of production and the other country has an absolute advantage over the first country in a second line of production; both countries can gain by trading. But what if one country is more productive than another country in all lines of production? Ricardo claimed that if country I can produce all goods with less labour cost than country II then also it will benefit the countries to trade so long as long as country II is not equally less productive in all lines of production. A country has a comparative advantage in producing a good if the opportunity cost for producing the good is lower at home than in the other country. We should now further clarify the meaning of the term 'comparative advantage'. In order to speak about comparative advantage there must be at least two countries and two goods. We compare the opportunity costs of production of each good in both countries. As long as the two countries' opportunity costs for one good differ, one country has a comparative advantage in the production of one of the two goods, while the other country has a comparative advantage to the production of the other good. As long as this is the case, both countries will gain from trade, regardless of the fact that one of the countries might have an absolute disadvantage in both lines of production. The comparative advantage proposition states that a less developed country that lacks an absolute advantage in any goods can still engage in mutually beneficial trade, and that an advanced country whose domestic industries are more efficient than those in any other country can still benefit from trade even as some of its industries face intense import competition.
Topics: International Trade Theories
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