Question

Explain the main lessons of Ricardo's Comparative Advantage Theorem, and elaborate upon the important extensions made of this theorem in economics.

Answer 1

Answer : Recardian comparative advantage theorem is based on the following assumptions :

i) Two countries : 1 and 2 producing two commodities A and B.

ii) Both countries has 100 units labour endowment and the factor of production is labour only.

iii) In both countries constant returns to scale exist.

iv) There exist free trade situation.

v) In both countries commodity A is produced by using 1 unit labour endowment.

vi) Commodity B requires one unit labour endowment in production process for country 1 and two units labour endowment for country 2.

The comparative advantage theorem explains that the county 1 use only one unit of labour endowment in production process for both commodities and country 2 use one unit labour endowment in producing commodity A but use two units of labour endowment in producting commodity B. This means the country 1 has comparative cost advantage on producing commodity B in comparison to country 2. And hence in trade the country 1 will export commodity B and import commodity A . Similarly, country 2 will import commodity B and export commodity A.