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- 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.
Assumptions of Opportunity Cost Theory
Haberler makes the following assumptions for his theory.
- There are only two nations.
- There are only two commodities in both the nations.
- There are only two factors of production such as labour and capital in both the nations.
- There is perfect competition in both the factor and commodity markets.
- The price of each commodity equals its marginal money costs.
- In each employment, the price of each factor equals its marginal value productivity.
- Supply of each factor is fixed.
- In each country there is full employment.
- No change in technology.
- Factors are not mobile between two countries.
- Within countries factors are totally mobile.
- 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
Good X 2
PPF PPF*
O Good X 1
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 X 1 in terms of X (^) 2. 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 X 1 and X (^) 2. The concave curve, PPF*
shows that the more that is produced of X 1 the more and more we have to give up of X (^) 2. In other words, opportunity cost of X 1 in terms of X 2 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
Comparative Cost Defined in Terms of Opportunity Costs
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,
- Superiority over comparative cost theory, and
- Criticisms.
- 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
- Analyses the Pre-trade and Post-trade situations Completely: The opportunity 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.
- Highlights the Importance of Factor Substitution: The opportunity cost theory highlights the importance of factor substitution in trade theory. It is vital in the production process especially for a growing economy.
- Facilitates the Easy Measurement of Opportunity Cost: The opportunity cost can be measured easily.
- Explains the Time, Reason etc. about Trade: The opportunity cost theory explains why trade takes place or when it should take place, showing how the gains shared between the countries etc.
- Explain about the Complete Specialisation: It explains when complete specialization is possible and when it is not possible etc.
- (^) Criticisms
