J.S. Mill restated the comparative costs doctrine in terms of comparative advantage whereas Ricardo had dealt with it in terms of comparative labour cost. Mill pointed out that the same amount of labour can yield different outputs in different countries. It signifies that effectiveness of labour in one country may be more or less than in another country. This can be illustrated through Table 5.1.
This table shows that country A has an absolute advantage in producing both the goods as it is capable of producing both the commodities at relatively lesser labour cost than B. Country A has, however, a greater comparative advantage in producing X than in Y.
It is evident from the fact that the ratio:
Similarly country B has a comparative advantage in producing Y as the ratio:
These ratios signify that country A will specialise in the production and export of commodity X, while country B will specialise in commodity Y. The trade between them will be guided by the exchange ratios as established by the relative effectiveness of labour in two countries. The domestic exchange ratio of two commodities in respective countries will set the limits within which the actual exchange ratio will get settled.
The domestic exchange ratios are as below:
1 unit of X = 0.63 unit of Y
1 unit of X = 0.80 units of Y
If the actual international exchange ratio is 1 unit of X = 0.63 unit of Y, there is no gain from trade for country A and the whole gain will accrue to country B. In the opposite situation of international exchange ratio having been settled as 1 unit of X = 0.80 units of Y, there is no gain from trade for country B, the whole gain going over to country A. In both these situations, no trade will become possible.
It is, therefore, obvious that the actual exchange ratio will have to be settled within the limits set by domestic exchange ratios. The fundamental determinant of this actual exchange ratio is the intensity of reciprocal demand i.e., the intensity of each country’s demand for the product of the other country. It is measured through the elasticity of demand in each country for the imports for the other.