Wednesday, 18 December 2019

Unit 2: Classical International Trade Theories

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Unit 2: Classical International Trade Theories

More meaningful are relative production costs, which determine whether trade should take place and what items to export or import.

According to Ricardo’s Principle of Relative (or Comparative) Advantage, a country may be better than another countries in producing many products but should only produce what it produces the best.

The Ricardian Model of Comparative Cost is based on only on production.

Manufacturing centres can move from the developed to the developing countries, which have low labour cost.

Several studies have investigated the validity of the classical trade theories.

There are several classical trade theories like the Adam Smith Theory, Classical Economic Theory,    31 Unit 2: Classical International Trade Theories Theory of Mercantilism, Absolute and Comparative advantage theories, Factor Notes Endowment Theory, etc.

The studies conducted by Leontief revealed that the United States actually exports labour intensive goods and imports capital-intensive products.

One limitation of classical trade theory is that the factors of production are assumed to remain constant for each country because of the assumed mobility of such resources between countries.

Labour, as a factor is relatively immobile.

Immigration laws in most countries severely limit the freedom of movement of labour between the countries.

As a result, production cost and product prices are completely equalised across countries.

The most serious shortcoming of classical trade theory is that they ignore the marketing aspect of trade.


Classical Economic Theory: The theory claims that leaving individuals to make free choices in a free market results in the best allocation of scarce resources within an economy and the optimal level of satisfaction for individuals Factor Endowment Theory: A trade theory which holds that nations will produce and export products that use large amounts of production factors that they have in abundance and will import products requiring a large amount of production factors that they lack.

Factor Price Equalization: It is an economic theory, which states that the relative prices for two identical factors of production in the same market will eventually equal each other because of competition.

International Trade: It refers to the exchange of capital, goods, and services across international borders or territories.

Mercantilism: It is a body of economics thought popular during the mid-16th and late 17th centuries that held that money was wealth, accumulation of gold and silver was the key to prosperity, and one nation’s gain was another’s loss.

Neomercantilism: It is a term used to describe a policy regime which encourages exports, discourages imports, controls capital movement and centralizes currency decisions in the hands of a central government.

Principle of Absolute Advantage: A country has an absolute advantage over it trading partners if it is able to produce more of a good or service with the same amount of resources or the same amount of a good or service with fewer resources.

Principle of Comparative Advantage: A country has a comparative advantage in the production of a good or service that it produces at a lower opportunity cost than its trading partners.

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