Foreign Trade And Policy - Haberler?s Theory of Opportunity Cost in International Trade - Notes - , Study notes for Foreign Trade
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Foreign Trade And Policy - Haberler?s Theory of Opportunity Cost in International Trade - Notes - , Study notes for Foreign Trade

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According, Production, Commodity, Disadvantage, Commodities In Both The Nations, Labour And Capital, Marginal, Each Factor Is Fixed, Technology, Full Employment, Production, Possibility, Combination, PPF, Additional, Com...
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6. Haberler‟s Theory of Opportunity Cost in International Trade:-

Professor Gottfried Haberier propounded the opportunity cost theory in 1993. According

to the opportunity cost theory, the cost of the commodity is the amount of the second commodity that must be given up to release just enough resources to produce one additional unit of the first

commodity. Like comparative cost theory, here assumptions like labour is the only factor of

production, labour is homogeneous, or cost of commodity depends on its labour content only etc. are not made. As a result, the nation with the lower opportunity cost in the production of

commodity has a comparative advantage in that commodity (i.e. comparative disadvantage in the second commodity). Thus the exchange ratio between the two commodities is expressed in terms

of their opportunity costs.

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Assumptions of Opportunity Cost Theory

Haberler makes the following assumptions for his theory.

1. There are only two nations.

2. There are only two commodities in both the nations.

3. There are only two factors of production such as labour and capital in both the nations.

4. There is perfect competition in both the factor and commodity markets.

5. The price of each commodity equals its marginal money costs.

6. In each employment, the price of each factor equals its marginal value productivity.

7. Supply of each factor is fixed.

8. In each country there is full employment.

9. No change in technology.

10. Factors are not mobile between two countries.

11. Within countries factors are totally mobile.

12. There is free and unrestricted trade between the two countries.

Haberier demonstrated his theory by constructing a simple diagram that is called

Production Possibility Frontier which shows the trade-offs that an economy faces between producing any two products. The community can produce either one of the goods or some

combination of the two. The curve shows the additional amount of one good that can be obtained

by foregoing a particular quantity of the other.

Illustration of Opportunity Cost Using PPF

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Good X2

PPF PPF*

O Good X1

We have drawn two production possibility frontiers-one linear Production possibility frontier, PPF and the other non-linear production possibility frontier, PPF* which is concave.

The slope of any production possibility frontier is the opportunity cost of X1 in terms of X2. In

the linear case the slope is constant. In case of concave production possibility frontier, the opportunity cost changes as we change the combinations of X1 and X2. The concave curve, PPF*

shows that the more that is produced of X1 the more and more we have to give up of X2. In other

words, opportunity cost of X1 in terms of X2 increases.

Opportunity Cost

The opportunity cost is defined in terms of the alternative use of the resources. The minimum amount of Good X which has to be given up for

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producing an additional unit of Good Y is called the opportunity cost of Good Y in that country.

Table – 4 Labour Requirements per Unit of Output

Country A Country B

Commodity X 4 6 Commodity Y 2 12

The concept of opportunity cost is explained with hypothetical figures in Table-4. In

country A labour coefficients for commodity X and Commodity Y are 4 and 2 respectively. In country B the corresponding figures are 6 and 12. How many units of commodity X should

country A give up in order to produce one more and of commodity Y? It is half a unit of X. This is the opportunity cost of producing Y in terms of X in country A. Compare this with the position

in country B. How many units of X should country B give up in order to produce one more unit

of Y? The answer is 2 units. Hence the opportunity cost of producing Y in terms of X in country B is 2.

It should be noted here that opportunity cost of X in terms of Y is the reciprocal of opportunity cost of Y in terms of X. For example, in country A opportunity cost of X in terms of Y is 2 and in country B the opportunity cost of X in terms of Y is ½.

Comparative Cost Defined in Terms of Opportunity Costs

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It follows that country A has comparative advantage in the production of Y, because opportunity cost of Y in terms of X is lower in country A than in country B. On the other hand,

country B has a comparative advantage in the production of X the opportunity cost of X in terms of Y (2 × ½) is lower in country B than in country A. Once comparative advantage is defined in

terms of opportunity cost, It makes no difference whether commodities are actually produced by labour alone. Thus classical conclusion is saved. Hence opportunity cost theory is useful to

strengthen Ricardian conclusions.

Critical Appraisal

The critical appraisal of Haberler‘s opportunity cost theory can be discussed under two heads namely,

1. Superiority over comparative cost theory, and

2. Criticisms.

1. Superiority over Comparative Cost Theory

Haberler‘s opportunity cost theory is regarded as superior to the comparative cost theory of international trade formulated by the classical economists like Adam Smith and David Ricardo. The arguments put for the superiority are summarized below:

1. Dispenses with the Unrealistic Assumption of Labour Theory of

Value: The classical theory is based on the unrealistic assumption of labourtheory of value. But Haberler‘s opportunity cost theory dispenses with such unrealistic assumption and is more realistic.

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2. Analyses the Pre-trade and Post-trade situations Completely: Theopportunity cost theory analyses pre-trade post-trade situations under constant, increasing and decreasing opportunity costs, whereas the comparative cost theory is based on the constant cost of production within the country with comparative advantage and

disadvantage between the two countries. Hence,

Haberler‘s opportunity cost theory is considered to be more realistic over the classical theory.

3. Highlights the Importance of Factor Substitution: The opportunitycost theory highlights the importance of factor substitution in trade theory. It is vital in the production process especially for a growing economy.

4. Facilitates the Easy Measurement of Opportunity Cost: Theopportunity cost can be measured easily.

5. Explains the Time, Reason etc. about Trade: The opportunity costtheory explains why trade takes place or when it should take place, showing how the gains shared between the countries etc.

6. Explain about the Complete Specialisation: It explains whencomplete specialization is possible and when it is not possible etc.

2. Criticisms

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Haberler‘s opportunity cost theory is also not free from criticisms. It has been vehemently criticized by Jacob Viner in his ―Studies in the Theory of International Trade (1937) . Some of the important criticisms are listed down below:

1. Inferior as a Tool of Welfare Evaluation: Jacob Viner says thatopportunity cost approach is inferior as a tool of welfare analysis when compared to classical real

cost approach. Further he says that the doctrine of opportunity cost fails to measure real costs in the form of Sacrifices or Disutilities.

2. Fails to consider Changes in Factor Supplies: Viner furthercriticizes that the production possibility curve of opportunity cost theory do not consider changes in the factor supplies.

3. Fails to consider Preferences for Leisure against Income: Vineralso criticizes the opportunity costs theory on the ground that the production possibility curve does not take into account the preference for leisure against income.

4. Unrealistic Assumptions: Haberier‘s opportunity cost theory is basedon many assumption like two countries, two commodities, two factors, perfect competition, perfect factor market, full employment, no technical change etc. All these assumptions are unrealistic because they do not hold in the real word.

that is very useful
It's superb but there are key points missing like trade under:1. Constant 2. Increasing 3. Decreasing opportunity costs
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