Question

Let’s take a simple example of two countries and two goods. France produces 10 units of Wine in 1 hour and 5 units of cloth in 1 hour. England produces 4 units of wine in 1 hour and 1 unit of cloth in 1 hour. Based on Ricardo’s theory, who has absolute advantage and who has comparative advantage in Wine and Cloth respectively? Who will export /import which good to/from the other country? Explain your answer adequately.

Answer 1

Adams Smith has proposed the theory of absolute advantage .The absolute advantage theory points out that a country will specialize in the production and export of a commodity in which it has absolute cost advantage. Mutually gainful trade is possible only when one country has absolute advantage and the other has absolute disadvantage im the production of atleast one commodity.

So in the question,France has the absolute advantage in producing both wine and cloth.

David Ricardo in the year 1817, developed the classical theory of Comparative Advantage. The law of Comparative advantage states that even if one nation is less efficient than the other nation in the production of commodities,there is still a scope of mutually beneficial trade.

	Wine	Cloth
France	10	5
England	4	1

In the given question, France has an absolute advantage in the production of both the commodities. So as far as the theory of absolute advantage is considered, no trade is possible. But Ricardo considers the internal position in each country.

If France produces wine , the opportunity cost is

5/10 =0.5 cloth foregone.

If England produces wine, the opportunity cost is

1/4= 0.25 clothes foregone.

So it can be concluded that England has comparative advantage in producing wine and France has the comparative advantage in producing cloth.

England has produce to produce more wine and it can export it to other countries even to France and import clothes.France has to produce more clothes and inport wine.