Trade between different countries takes place because it is to their mutual
advantage. The main conditions under which international trade is profitable are
(1) If a country is enjoying a monopoly in the production of a certain
commodity, it will have an absolute advantage in the production of that
commodity over other countries. The other countries will find it
advantageous to buy that commodity from that country. Brazil for instance, has
an absolute advantage in the production of Coffee, South Africa in Diamonds and
Italy in Lemons, U.S.A. in Copper, Canada in Nickle,
Mexico in Silver, Scotland in whisky. The countries in which these commodities
are not found or they cannot produce it due to unfavorable climate or of soil
obtain them through exchange of goods and thus enjoy wider range of commodities.
(2) International trade takes place because of the differences in the
productive possibilities of different countries. If each country tries to
produce all the commodities which it needs, it will not be able to do so and if
at all it succeeds, it will be done at an enormous cost. Adam Smith in his book
'Wealth of Nations' writes:
"By, means of glasses and hot walls,
very good grapes can be raised in Scotland and very good wine too can be made
from them at about thirty-two times the expense from which at least equally good
wine can be brought from foreign country".
We find thus that if any country
tries to produce a commodity or commodities for which if is not best fitted, it
will involve unnecessary heavy expenditure. The best way for country is to
concentrate on the production of those commodities which it can produce at a
lesser cost than the other countries. If a country tries to produce a commodity
or commodities for which it is not best fitted, it will have to incur
unnecessary heavy expenditures. This waste of resources can be avoided if all
the countries concentrate in the production of those goods for which they are
best suited and trade them for other goods which they need from other countries.
(3) Trade between two countries is mutually profitable even when one
country is in a position to produce the goods at a cheaper rate than the other
country. For instance, if country 'A' and country 'B' both produce cotton
and wheat, if country A produces cotton more cheaply than B, it may prove
advantageous for country A to specialize in the production of cotton because it
has comparative advantage in its production.
(4) Adam smith, unlike Mercantilist, was not in
favor of putting artificial
restrictions on trade between countries. He was of the view that nations should
trade freely with each other as they are blessed with different resources.
According to him, if nation's specialize in the production of those commodities
for which they have an absolute advantage, they will gain by trading with each
other. For example, with a given labor cost, country A can produce 10 quintals
of wheat or 20 quintals of jute. Country B, with the same given labor cost can
produce 5 quintals of wheat or 40 quintals of jute.
Here country A is efficient in the production
of wheat and country B has the absolute advantage in the
production of jute. So if country A specializes in the production of wheat and
country B in the production of jute, then both the countries will gain from
David Ricardo, a British classical economist, further refined this version of
international trade put forward by Adam Smith. According to him:
two countries is beneficial even if one country is efficient in the production
of both the goods over another. Here, both the countries will gain most when
each country specializes in the production of those commodities for which its
comparative or relative costs of production are lowest".
This is in nutshell the Principle or
Theory of comparative Cost.