The Theory of Cost assumed that the factors of production are perfectly mobile within the country but totally immobile between countries. Moreover, it is assumed that there is no cost of transportation to be charged and there are no restrictions on the movement of goods from one country to another.
Different Types of Cost Differences. As the theory explains that the relative or comparative cost differences give rise to the international trade. At this time, it is pertinent to know about the different types of cost differences. Three types of cost differences may be distinguished —
(i) Absolute differences,
(ii) Equal differences, and
(iii) comparative differences.
(i) Absolute Cost Difference. Absolute differences in cost refers to the differences in the cost of production of certain commodities in the large proportion in one country than in the another country. Sometimes, absolute differences in production costs between two countries develop. In such case international trade between them is inevitable. We can explain it with the help of an illustration.
Suppose Australia can produce with one unit of labor either 2 units of jute or 1 unit of cotton. Canada on the other hand produces with unit of labor either 2 unit of cotton or 1 unit of jute. It is evident here that Australia has natural advantage in the production of Jute while Canada enjoys natural advantage in the production of cotton. Hence Australia will specialize in the production of Jute and Canada in Cotton. Australia will export Jute to Canada in exchange for cotton. The exchange rate between the two countries, on the basis. of labor costs, will be fixed as under-
1 unit of cotton in Australia =2 units of jute
1 unit of cotton in Canada = 1/2 unit of jute
The international trade between Australia and Canada will continue so long as Australia is able to get more than one unit of cotton in exchange for 2 units of jute. If Australia gets only one unit of cotton for 2 units of Jute, international trade will not be possible because there is no gain in this trade to Australia. Similarly, Canada and Australia will continue trade so long as Canada gets more than 1/2 unit of jute from Australia in exchange for one unit of export of cotton. If Canada gets less than or equal to 1/2 unit of jute from Australia against one unit of Cotton, no trade is possible between Australia and Canada international trade between two countries is possible if both the countries are in advantage. Next