The reason for international trade is explained by the theory of comparative advantage.
This Law states that “the total output of goods and services would increase if countries specialise in producing those commodities in which they have the greatest comparative cost advantage over others”. Hence, the law states that all countries engaged in international trade would be better off if each country specialised in the production of those things for which it had the greatest advantage over other countries. To explain the theory of comparative cost advantage, some assumptions have to be made.
(i) There is perfect competition.
(ii) There is mobility of factors of production.
(iii) There is no transport cost.
(iv) There is no restriction or barriers to trade.
(v) There is no lack of currency problem.
(vi) There are two countries and two commodities.
(vii) There is identical cost curve for the participating countries.
(viii) Labour supply and technology are constant.
Illustrations of the Law of Comparative Cost Advantage
To make our understanding easy, let us take our example of two countries i.e. trade between Nigeria and Sierra Leone. Let us further assume that each country is using the same amount of resources (20 units of labour each).
From the table above, if there is no trade, Nigeria and Sierra Leone will produce both cocoa and rice respectively, since each country needs the two commodities. Nigeria will therefore produce 55 tons of cocoa and 20 tons of rice. And Sierra Leone will produce 40 tons of rice and 25 tons of cocoa. Total output of the two countries will be 80 tons of cocoa and 60 tons of rice.
If Nigeria traded with Sierra Leone, it is better and beneficial for Nigeria to specialise in the production of cocoa, where it can produce twice as much as Sierra Leone. If it were to specialise in rice, it can only produce half of what Sierra Leone can produce with the same amount of resources. In this case, it would be observed that Nigeria has a higher comparative cost advantage over Sierra Leone in the production of cocoa.
On the other hand, Sierra Leone will be better off if it specialises in the production of rice where it can produce twice as much as Nigeria, given the same 20 units of labour. This is to say that Sierra Leone has a higher comparative cost advantage over Nigeria in the production of rice.
When each of these countries (Nigeria and Sierra Leone) specialises in the production of commodities in which each has a comparative cost advantage, total output of cocoa and rice will be higher. Thus, if Nigeria concentrates on the production of cocoa, it will produce 100 tons of cocoa. In the same manner, when Sierra Leone concentrates on the production of rice, it will produce more rice, i.e. 80 tons against 20 tons of rice produced without specialisation.
From the table above, some points emerge:
(i) The total output of the commodities has increased with specialisation. For example, with specialisation, total output of cocoa increased from 80 tons to 100 tons and rice increased from 60 tons to 80 tons using the same amount of resources.
(ii) There is more efficient allocation of productive resources among trading countries. This is because the trading partners have specialised in the production of the commodity in which they have a comparative advantage over others. Hence, both countries are better off as they engage in international trade.