Description:
The Comparative Cost Advantage theory of international trade suggests the basis for trade (in which both the trading partners stand to gain) is 'comparative advantage'. A nation is said to enjoy a comparative advantage in producing a good relatively cheaper in comparison to the other one in which the other country enjoys the same advantage. In such a case, it is advisable for the countries to produce the goods that they produce comparatively cheaper (less amount of labor per unit of output). Labour (the only productive factor in) being finite entails imply that in order to produce a good certain amount of other goods needs to be foregone. So it is advisable for a nation to devote the productive resources in the production of the good it can produce more efficiently. The theory remains valid until today. But the next question that needed to be answered was to find the source of 'comparative advantage', H-O theory (discussed in this video) is one such attempt. Though it works under certain restrictive assumptions but has significant implication for international trade order. Theory suggests that the source of comparative advantage is 'Factor Endowment'. each nation is endowed with certain amounts of two factors - labor and Capital (the factors considered in the model). The statement of the theory is 'a nation will export the good production of which requires the intensive use of the factor a nation is endowed with abundance. So the nation with abundant labor will export labor-intensive good as it enjoys a comparative advantage in its production because this factor being available in large amount has to be cheaper. By the same logic, the country with more capital will export capital intensive good as it has a comparative advantage in the production of such goods. Analysis leads to significant implications. For example, if the theory is empirically found to be valid and if its assumptions hold it will lead to factor price equalization.
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