Theory Of Comparative Cost Or Riparian Theory of comparative cost
Theory Of Comparative Cost Or Riparian Theory of comparative cost
Friday, January 3, 2020
Classical economists were of the opinion that fundamental cause of international specialization and hence international trade is the difference in costs, which determine the products to be produced and mutually traded by different countries. Difference in the costs of production depends upon difference in climatic conditions, availability for minerals and other resources. A country tends to specialize in the production of those goods for which it has got greater comparative advantage.
To understand the working of total or absolute difference in costs theory, suppose with the certain cost of one unit of labor.
It is evident that Pakistan with the cost of one unit of labor either can produce 12 bales of cotton or 6 bales of jute; whereas Bangladesh can produce with the same cost either r6 bales of cotton or 12 bales of jute. Obviously, Pakistan enjoys absolute advantage in production of cotton over Bangladesh, whereas Bangladesh has absolute advantage in production of jute. This way there will be not gain from international specialization and trading with each other.
Now, suppose, both countries have 2, 2 uni5ts of labor at their disposal to produce both the goods in this situation.
BALES OF COTTON BALES OF JUTE
Pakistan will produce 12 + 06
Bangladesh will produce 06 + 12
Total products 18 + 18
Thus in the absence of specialization, with 4 units of labor the total output of the two goods in the countries will be 18 bales of jute.
After specialization Pakistan devotes its 2 units labor only to produce cotton, while Bangladesh only to produce jute. Hence,
Thus after specialization, the total output of the two goods will be 24 bales of cotton + 24 bales of jute, which is greater than that in the absence of specialization.
ASSUMPTIONS:
Riparian Theory of comparative cost advantage is based on the following assumptions
There are two countries, which intend to exchange two same goods.
Labor is the only factor of production. All labor is homogenous and the supply of labor is fixed.
Prices of the two goods are determined by the labor cost.
Production is subjected to law of constant returns.
There is no change in technology and the tastes and preferences of the people.
Factors of production are perfectl6y mobile within each of the two countries.
There are no transport costs.
CRITICISM:
The comparative cost theory has been criticized on the following grounds.
Assumption of constant cost is not a valid assumption since beyond a point law of increasing or decreasing costs is bound operating.
Labor cost assumption is the weakest point of the theory. It has totally ignored all the other necessary costs like cost of raw-material and cost of capital; interest and profit, etc.
Assumption of perfect mobility inside the country but immobility outside the country free movement of factors of production is not allowed as has been supposed.
Assumption of complete special8ization can prove its validity only in a small country. It is not workable in a big country.
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