Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

Wine 
Cloth 
U.S.A. 
40 
50 
U.K. 
20 
10 
One hour of time in the U.S.A. gives 40 bottle of win and 50 
yards of cloth while One hour of time in the U.K. gives 20 bottle of 
win and 10 yards of cloth in this case U.S.A is having much better 
then U.K. and there is no use of trade. As per the Ricardo‘s view 
concern there can be trade between these two countries. In this 
case he suggests that U.S.A. must emphasis on the production of 
the Cloth and U.K. should produce the Wine and trade the 
specialized product to each other. 
12.2.3 EXCHANGE RATIO: 
One consequence of trade is specialization and higher 
production. Impact upon price or exchange ratio is no less 
important. Before trade 40 bottles of wine or 50 yards of cloth 
require same labour time in the case of the U.S.A. which means the 
rate of exchange is 4:5. In U.K. 1 yard of cloth is equivalent to 2 
bottles of wine. She will agree to buy cloth from the U.S.A. provided 
cloth can be had by sacrificing less than 2 bottles of wine. This is 
the only way she can gain from trade. Exchange ratio in the U.S. 
economy ensures that and so U.K. can gainfully participates in 
trade. Similarly U.S. view towards trade will be that she will sell 50 
yards of cloth to U.K. only if she gets more than 40 bottles of wine. 
The post trade exchange ratio ensures that also. In U.K. 50 yards 
of cloth was equivalent to 100 bottles of wine indicating that the 
U.S.A. can profitably engage in trade. 
The equilibrium exchange ratio after trade then must lie 
somewhere between the two pre trade ratios namely 4:5 and 1:2. If 
trade is to be mutually beneficial post trade price ratio must lie 
between these two extremes. 
12.2.4 MONEY PRICE & COMPARATIVE ADVANTAGE: 
The table that was given to illustrate the principle of 
comparative advantage was in terms of physical quantity of output. 
In real life however comparative advantage has to be determined 
with regard to cost or price which is given in terms of money. How 
do we attain this transformation of goods in terms of money? 
Output per man hour as we have considered represents the 
benefit to the producer. It must have another side and that is cost. 
Cost information is given by hourly wage rate. Let us assume that 
wage rate per hour in the U.S.A. is $20 and that in the U.K. pound 
5. Because there is perfect competition and labour is homogenous 
same wage rate applies to both the industries. If one unit of labour 
is engaged for one hour in the U.S. wine industry money wage that 

---

has to be given is dollar 20 whereas output is 40 bottles of wine. So 
cost per bottle comes to dollar .50. In U.K. in order to produce 20 
bottles of wine we have to pay pound 5 to one unit of labour. So 
average cost per bottle is pound 25. 
It is clear that average cost figures do not tell anything 
clearly about comparative advantage because there is no easy way 
to compare these two different currency units. To facilitate 
comparison we need to know the conversion rate or rate of 
exchange between two currencies. If pound 1 < dollar 2 U.K. will 
have a comparative advantage in wine.