Overview Trade Theories International Economics For Merge
Overview trade theories International Economics
Classical trade theories
Explanation
Absolute advantage theory (Smith)
* When one nation is more efficient than another in the production of one commodity but is less efficient than the other nation in producing a second commodity, then both nations can gain by each specializing in the production of the commodity of its absolute advantage (most efficient commodity) and exchanging part of its output with the other nation for the commodity of its absolute disadvantage (least efficient commodity).
Comparative advantage theory (Ricardo)
* According to the law of comparative advantage, even if one nation is less efficient than (has an absolute disadvantage with respect to) the other nation in the production of both commodity one and two, there is still a basis for mutually beneficial trade. The first nation should specialize in the production of and export the commodity in which its absolute disadvantage is the smallest (=commodity of its comparative advantage) and import the commodity in which its absolute disadvantage is greater (=comparative disadvantage).
Shortcomings Classical trade theories
Explanation
1) Labour theory of value
Ricardian theory of international trade assumes the application of labour theory of value (amount of labour going into the production determines the value or price of a commodity) not able to use since the labour theory itself is based upon unrealistic assumptions: for it to be valid, labour should be homogeneous, labour should be the only factor of production, or its proportionate share in total costs should be equal in all products.
2) Cost differences
Classical theories do not explain the causes of differences in efficiency of productive resources, hence it is unable to explain the phenomenon of changes in productive efficiency of an economy nowadays, there are many factors (technological, educational, institutional, political, quality of governance, economic incentives etc)
Classical trade theories
Explanation
Absolute advantage theory (Smith)
* When one nation is more efficient than another in the production of one commodity but is less efficient than the other nation in producing a second commodity, then both nations can gain by each specializing in the production of the commodity of its absolute advantage (most efficient commodity) and exchanging part of its output with the other nation for the commodity of its absolute disadvantage (least efficient commodity).
Comparative advantage theory (Ricardo)
* According to the law of comparative advantage, even if one nation is less efficient than (has an absolute disadvantage with respect to) the other nation in the production of both commodity one and two, there is still a basis for mutually beneficial trade. The first nation should specialize in the production of and export the commodity in which its absolute disadvantage is the smallest (=commodity of its comparative advantage) and import the commodity in which its absolute disadvantage is greater (=comparative disadvantage).
Shortcomings Classical trade theories
Explanation
1) Labour theory of value
Ricardian theory of international trade assumes the application of labour theory of value (amount of labour going into the production determines the value or price of a commodity) not able to use since the labour theory itself is based upon unrealistic assumptions: for it to be valid, labour should be homogeneous, labour should be the only factor of production, or its proportionate share in total costs should be equal in all products.
2) Cost differences
Classical theories do not explain the causes of differences in efficiency of productive resources, hence it is unable to explain the phenomenon of changes in productive efficiency of an economy nowadays, there are many factors (technological, educational, institutional, political, quality of governance, economic incentives etc)