The Ricardian theory of trade focuses on the comparative advantage of the nation. According to the Ricardian theory of trade, comparative advantage determines the pattern of trade. Ricardo asserted that even if a nation does not possess an absolute advantage, there are changes of gains through trade among the nations by comparative advantage. The Ricardian theory is based on differences in technology across nations. A nation is said to have a comparative advantage is a good if it can produce relatively more efficiently or relatively less efficiency compared to other nation.
For example, there are two countries in the world India and China. Each can produce two goods say cricket bats and footballs. Perfect competition prevails in the market for each good and each country in endowed with 100 units of labor and China with 120 units of labor. Producing one cricket bat required 10 units of labor in India and 15 units of labor in China. While producing one football requires 20 units of labor in India and 60 units of labor in China possibilities.
|Country||Product Possibility||Internal Exchange Ratio|
|India||10 cricket bat
|China||8 cricket bat
From above we can conclude that the India will specialize in football and import cricket bats from China. while China specializes in cricket bats and export cricket bats and import football and both will get gain.
The most important assumptions of Ricardo’s theory is:
- Production technologies in both the trading countries exhibit constant return on the scale.
- Both has fixed supply of production
- Factors of production can be easily and cost less moved from one sector to the other.
- There is no technology innovation.
- There is full employment in all the countries before and after the trade.
- There should be not restrictions and barriers between two countries.