List and extensively discuss the classical and modern theories of trade.

List and extensively discuss the classical and modern theories of trade.




Classical theories of trade-


The law of of comparative advantages was introduced by David Ricardo in 1871 in his famous book Principle political Economy and Taxation. This theory is also called as classical theory of international trade or law of comparative cost.

According to law of comparative advantages every country should specialize in production. Export those goods which it has greater comparative advantages in that production and import those good which it has greater comparative disadvantage in that production. This comparative advantages theory tell that why does international trade take place.

But according to J.S. Mill international trade theory of terms of trade state that price were determine by the principle of reciprocal demand.
Basic Assumption:

1. This theory theory based on there are 2 countries and they produce 2 goods.

2.Labor is the only one factor production and cost measured in term of labor unit cost.

3.there is full employment in the country.

4. Factor of production are perfectly mobile with in the country but immobile between 2 countries.

5. All unit of labor are homogenous.

6. Production is based on law of constant return.

7. There is no transportation cost in trade.

Basic International trade is- (i) Absolute difference in cost (ii) Comparative difference in cost (iii)equal difference in cost.

According to Adam Smith the main basic difference in international trade is absolute difference in cost. It means this difference in absolute cost arise when one country is in right position to produce a good at very low cost compared to the first country.

According to David Ricardo comparative difference in cost is the sole cause of international trade. It means that a country is in position to produce both commodity at the low cost than the other country. It has greater comparative advantages in the production of other good.

Finally equal difference means when the production of ratio of two commodities in two countries equal.

Limitation of the theory:

Increased in specialization lead to diseconomies of scale.

This theory theory measure only static advantages but not any dynamic advantages.

Government may prohibited trade.

Transportation cost are main limitation it is included in trade.

Modern theories of trade-


Modern theory is also know as Heckscher-Ohlin theory (H-O theory) of factor endowment. This H-O theory state that why countries trade goods and service with each other and focus on beign on the difference of resources between two country. This theory the main pattern of determination are specialization in production and trade among the region with relatively factor supplies.

Basic Assumption:

1.It is two-by-two-by-two model that means 2 countries (Country A and Country B), 2 goods (X and Y) and 2 factor of production (Capital and labor).

2. There is no transportation cost assumed.

3.Free trade between the countries.

4. Both nation same technology use in production.

5. Good X has capital intensive and good y has labor intensive in both nation.

6. There is perfect competition in both goods and factor market in both nation.

7.All resources are fully utilized in both country.

8. International trade between in two nation is balance.

Since the H-O theory express in terms of factor intensity and factor abundance, it is crucial that meaning of these term precise and very clear. This two very important in H-O theory. It explain the richness in factor endowment in terms of price.

According to this theory if capital is relatively cheap in country 1, the country is called capital abundant. On the other hand if a country labor is cheap in country 2, it is called labor abundant country. So country 1 wil be export the capital intensive good and country 2 will export the labor intensive goods.

Asked on February 15, 2018 in economics.
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