Theory of Comparative Advantage

Q.35. What are the assumptions and criticism relating to the theory of comparative advantage? ASSUMPTIONS OF THE THEORY
The comparative cost theory is based on the following assumptions:
i. labour is regarded as the sole factor of production and the cost of production only consists of labour cost.
ii. Production is subject to the law of constant returns.
iii. Factors of production are assumed to the perfectly modile within a country but immobile between countries.
CRITICISM
The theory of comparative cost is criticized on the following grounds.
Assumption of Constant Cost
The classical economists were of the opinion that additional quantities & a commodity could be obtained with the same expenditure of cost per unit us previously But this is not valid assumptions lost ratios are subject to change where specialization between the two countries has gone a pace.
Some Static Assumptions
The comparative cost theory in a number of static assumptions of fixed costs industrial production functions between trading countries and fixed supply of land, labour, capital etc. It cannot be applied 100% to the real world.
Assumption of perfect mobility inside and immobility outside a country
This assumptions seems to be un-applicable to todays modern world of communication and technology the development of cheap quick and safe means of transport and communication has broken down this immobility to a great extent.

Theory of Comparative Costs

Q.34. Explain in detail the theory of Comparative Costs. INTRODUCTION
The classical theory of International trade commonly known as the principle of comparative cost was first enunciated by David Ricardo. The theory went through many additions improvements and refinements at the hands of economists like Mill, Cairns & Bastable.
An individual is able to perform many tasks but he does not perform them all. He selects that work which pays him the most. A doctor can also do the work of a dispenser but he does not do it. The same principle works in international trade. Considering the climatic conditions, distribution of material resources, geographical concern etc. Every country seems to be better suited for the production of certain articles rather than for others to employ its resources more remuneratively it will be to the advantages of each country as well as to the world.
THEORY
In its simplest form the theory may be stated as, ‘’It pays countries to specialize in the production of those goods in which they possess the greatest comparitve disadvantage.’’
EXPLANATION
Ricardo argued that two countries can gain very well by trading even if one the countries is having an absolute advantage in the production of both the commodities over the country. The condition is ‘’Provided the extent of absolute advantage is different in the two commodities in question’’ i.e. the comparative advantage is greater or comparative is lesses in respect of one good than in that of the other. In this connection we compare not the cost of production of one commodity with the other rather we compare the ratio between the cost of production of the two commodities concerned in one country with the ratio of their cost of production in the other country.
EXAMPLE
Suppose there are two countries A and B and there are two commodities wheat and rice. Suppose a unit of labour produces 10 tons of wheat or 20 tons of rice in country A. The same unit can produce 6 tons of wheat and 18 tons of rice in country B. According to this situation country A is having an absolute advantage in the production of both commodities over B. But she is at a greater comparative advantage in the production of wheat country B is at a disadvantage in both. Commodities the comparative disadvantage is less than case of rice. Hence the ratio would be
In A it is 10 : 20 i.e. 1 : 2
In B it is 06 : 18 i.e. 1 : 3
Therefore, A will specialize in wheat and B in rice and international trade will become possible and profitable. This is the law of comparative advantage or costs.

Advantages and Disadvantages of International Trade

Q.33. What are the advantages of International trade? Also discuss its disadvantages. ADVANTAGES OF INTERNATIONAL TRADE
Various advantages are named for the countries entering into trade relations on a international scale such as:
A country may import things which it cannot produce
International trade enables a country to consume things which either cannot be produced within its borders or production may cost very high. Therefore it becomes cost cheaper to import from other countries through foreign trade.
Maximum utilization of resources
International trade helps a country to utilize its resources to the maximum limit. If a country does not takes up imports and exports then its resources remain unexplorted. Thus it helps to eliminate the wastage of resources.
Benefit to consumer
Imports and exports of different countries provide opportunities to the consumer to buy and consume those goods which cannot be produced in their own country. They therefore get a diversity in choices.
Reduces trade fluctuations
By making the size of the market large with large supplies and extensive demand international trade reduces trade fluctuations. The prices of goods tend to remain more stable.
Utilization of Surplus produce
International trade enables different countries to sell their surplus products to other countries and earn foreign exchange.
Fosters International trade
International trade fosters peace, goodwill and mutual understanding among nations. Economic interdependence of countries often leads to close cultural relationship and thus avoid war between them.
DISADVANTAGES OF INTERNATIONAL TRADE
International trade does not always amount to blessings. It has certain drawbacks also such as:
Import of harmful goods
Foreign trade may lead to import of harmful goods like cigarettes, drugs etc. Which may run the health of the residents of the country. E.g. the people of China suffered greatly through opium imports.
It may exhaust resources
Internation trade leads to intensive cultivation of land. Thus it has the operations of law of diminishing returns in agricultural countries. It also makes a nation poor by giving too much burden over the resources.
Over Specialization
Over Specialization may be disasterous for a country. A substitute may appear and ruin the economic lives of millions.
Danger of Starvation
A country might depend for her food mainly on foreign countries. In times of war there is a serious danger of starvation for such countries.
One country may gain at the expensive of Another
One of the serious drawbacks of foreign trade is that one country may gain at the expense of other due to certain accidental advantages. The Industrial revolution is Great Britain ruined Indian handicrafts during the nineteenth century.
It may lead to war
Foreign trade may lead to war different countries compete with each other in finding out new markets and sources of raw material for their industries and frequently come into clash. This was one of the causes of first and second world war.

International Trade

Q.32. Why do International trade take place? OR
What are the bases for international trade?
Some of the reasons that why do trade between different countries occur are discussed under the following heads.
NATURAL ENDOWMENTS
Differences in advantages of trade to different countries may arise because of natural reasons like geographical and climatic conditions. This lead to territorial division of labour and localization of industry. This different countries specialize in the production of different things.
HUMAN CAPABILITIES
People in some countries are physically more sturdy where as in others they are intellectually superior. Some have greater skill and dexterity thus the countries. Which do not possess these qualities try to share with them.
STOCK OF CAPITAL
Some countries have large stock of capital goods like U.K, U.S.A, etc. These gives an opportunity to the underdeveloped countries or those which lack these capital goods to exchange or trade them through the channel of distribution internationally.
SPECIALIZATION IN PRODUCTION
A country may have a comparative cost advantage in production in more than one commodity over other countries but produces only one commodity for the sake of specialization. It helps in improving the quality of production to a great extent.

Short Notes

Q.31. Define the following terms INTERNATIONAL TRADE
International trade refers to that trade that take place between a country and a number of countries of the world. In other words we can say that all the trading activities that take place across the national boundaries is called International or Foreign trade. It is effect is called balance of payments.
INTERNAL TRADE
Internal or Domestic or inter-regional trade is the trade between different regions in the same country. We can also say that all the trading activities that take place within a country is called Internal trade.
ABSOLUTE ADVANTAGE
A country due to its most favourable geographical conditions may have an advantage in the production of a particular commodity over other countries. This advantage is known as absolute advantage for that country over rest of the world. The absolute advantage results in a regular inflow and outflow of goods which gives rise to International Trade.
COMPARATIVE ADVANTAGE
When a country has an advantage of production and move than one commodity it prefers to produce only one commodity that is more advantageous for other. This advantage is calculated by comparing the different commodities that how much they paying commodity is selected and the country goes for specializing. This is known as comparative advantage.

Adverse Balance of Payments

Q.30. Explain in detail that how are adverse balance of payments can be corrected? METHODS OF CORRECTING AN ADVERSE BALANCE OF PAYMENTS
Following are same of the methods adopted for correcting and adverse balance of payments.
Improving the balance of trade through import restrictions & measures of export promotions
Since balance of payments becomes adverse because of excess imports over exports, so a country having such a problem must try to check imports either by total prohibition or by levying import duties so by a quota system. Another method may be import substitution i.e. trying to produce in the country what it currently imports. Exports can be stimulated by measures of export promotion granting subsidies or other concessions to industrialists and exports.
Depreciation of the currency
If a country depreciates its currency it proves very helpful in increasing the exports of goods. The value of the home currency fall relatively to foreign currency hence the foreigners are able to buy move goods with the same amount of their own currency or for the same amount of goods they have to pay less in terms of their own currency than before.
Devaluation
A country can turn the balance of payments in its favour by devaluating her currency. In this case also the devalued currency will become cheaper in terms of the foreign currency and the foreigners will be able to buy move goods by paying the same amount of their own currency. The effect is the same as in the case of depreciation.
Deflation
Deflation means construction of currency. If currency is contracted then according to the quantity theory of money the value of the currency will rise or the prices will fall. When prices fall the country becomes a good country to buy in and not a good country to sell into Exports will also thus increase and imports will be checked and hence the balance of trade will become favourable.
Exchange Control
Under a system of exchange control, all exporters are asked to surrender their claims or foreign currencies to the central bank which pays in return the home currency, which the exporters really want. This available foreign exchange is rationed by the central bank among the licenced importers. Thus imports are restricted to the foreign exchange available. There is no danger of more goods being imported than exported

Balance of Payment

Q.29. Write a detailed note on Balance of Payments. BALANCE OF PAYMENTS
Each nation periodically publishes a set of statistics that summarize for a given period all economic transactions between its residents and the outside world. This statistical statement is referred to as balance of payments. The accounts show how a nation has financed its internation activities during the reporting period. They also show that what changes have taken place in the nations financial claims and obligations with the rest of the world.
STANDARD PRESENTATION
The IMF has significantly worked with success to standardize the system and the form of presentation.
B.O.P – DOUBLE ENTRY ACCOUNT
The B.O.P used double entry accounting. Transactions are recorded as credits of the yield receipts from or claims against foreign owners. Credits are received for example by exports of merchandise, sale of securities overseas and rendering services to foreigners. Similarly, debits are recorded of transactions cause payments to foreigners e.g. importing goods, tourist expenses abroad, purchase of foreign bonds.
B.O.P – CURRENT ACCOUNT
The Current Account uncludes merchandise trade in good and International Services are termed as Invisible trade. There are four basic service components. Tourism, Investment, Private Sector, Services such as royalties, rent, consulting and engineering fees etc and Government services such as diplomatic and buildings and membership fees in international organizations.
B.O.P – CAPITAL ACCOUNT
The capital account has a long term and a short term sector. The long term amount shows the inflow and outflow of capital commitments which have a maturity longer than a year. Short term capital movement frequently have a maturity date from 30-90 days. Long term capital items generally include loans to and from other governments, financial support for development. Projects abroad and export financing. Short term capital include paying for international services, selling accounts etc.