BITS Pilani

presentation
BITS Pilani
Hyderabad Campus

Tanay Kumar
Fractalink Design studio

BITS Pilani
Hyderabad Campus

Course No. ECON C372- International Trade

and BoP- Lec-4
Date: 15.1.2013

CHAPTER 2
The Law of Comparative Advantage
Learning Objectives

1. What is the basis for trade and what are the gains from
trade?
2. What is the pattern of trade? That is, what commodities are
traded and which commodities are exported and imported by
each nation?

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ILLUSTRATION OF ABSOLUTE ADVANTEAGE

Absolute advantage

Wheat (bushels/man-hour)
Cloth (yards/man-hour)
If US exchanges 6 W = 6C
US gains 2C or man-hour
UK gains 24C or 5 man-hours

U.S
6
4

U.K
1
5

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After trade assuming that US completely specializes in

wheat and UK specializes in cloth

Wheat (bushels/man-hour)
Cloth (yards/man-hour)

U.S
12
0
12

U.K
0
10
10

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LAW OF COMPARATIVE ADVANTAGE- DAVID

RICARDO
David Ricardo, in 1817 published his Principles of Political Economy and
Taxation, in which he presented the law of comparative advantage
theory.
According to the law of comparative advantage, even if one nation is less
efficient than (has an absolute advantage with respect to) to other
nation in the production of both commodities, there is still a basis for
mutually beneficial trade.
The first nation should specialize in the production of and export of the
commodity in which its absolute disadvantage is smaller and import the
commodity in which its absolute disadvantage is greater.

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ASSUMPTIONS OF THE LAW

1.
2.
3.
4.
5.
6.
7.

Only two nations and two commodities,

Free trade,
Perfect mobility of labour within the nation and perfect immobility
between the nations,
Constant cost of production,
No transportation costs,
No technical change,
The labour theory of value.

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ILLUSTRATION OF COMPARATIVE ADVANTEAGE

Comparative advantage
U.S
Wheat (bushels/man-hour)
6
Cloth (yards/man-hour)
4

U.K
1
2

From this table it is evident that U.K has absolute disadvantage in the
production of both the commodities. And U.S has absolute advantage in
the production of both.
But as per law it has to produce that, in which the absolute disadvantage is
lesser than in the other commodity. For U.K absolute disadvantage is
lesser in cloth than in the cotton.

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Whereas for U.S the absolute advantage lies in the production of both the
commodities, but comparatively the absolute advantage is greater in
wheat than in cloth.
Hence as per law, U.K should produce cloth and U.S should produce wheat.
THE GAINS FROM TRADE
U.S would be indifferent to trade if the exchange is only 6W for 4C because it
could have produced at home with this rate.
U.K similarly would not like to trade if it had to give up more than 2C for 1W,
because it would be loss to the economy.

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Now to show the gains from trade

Suppose the exchange equation is 6W = 6C
US gains 2C extra
For UK to produce 6W it should spend 6 hours, instead those 6 hours if it
spends on cloth it can produce 12C and by giving away 6C, still it can be
with (6W,6C).
The exchange equation 6W =6C is not the only combination it could be
exchange, In-fact a range that both countries can benefit is
4C < 6W < 12C
For eg: if it is 6W = 8C it more advantageous to US and disadvantageous to UK

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Exception to the Law of Comparative Advantage

There is only one exception to the law, that is if the comparative disadvantage
is same in the production of both. For example it Uks combination is 3W
and 2C.
Anyhow it is rare to have a combination as such, hence the law of
comparative advantage is highly applicable in all situations.

BITS Pilani, Hyderabad Campus

BITS Pilani, Hyderabad Campus