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... A radical theory for its day. ... Smith argued that proper international division of labour would be one where countries specialised in the production of goods in which they have an absolute advantage. ...
The Classical Theory: The classical theory of international trade was developed by Adam Smith 200 years ago. ... David Ricardo expanded on Adam Smiths theory by showing that even if a country did not have absolute advantage in any good it and all other countries would still benefit from international trade. This is known as the theory of comparative advantage.
David Ricado and the Theory of Comparative Advantage:
David Ricardo, working in the early part of the 19th century, realised that absolute advantage was a limited case of a more general theory. ... It can be seen that Portugal can produce both wheat and wine more cheaply than England (ie it has an absolute advantage in both commodities). ... Because relative or comparative costs differ, it will still be mutually advantageous for both countries to trade even though Portugal has an absolute advantage in both commodities.
Portugal is relatively better at producing wine than wheat: so Portugal is said to have a COMPARATIVE ADVANTAGE in the production of wine. England is relatively better at producing wheat than wine: so England is said to have a comparative advantage in the production of wheat. ...
The simple theory of comparative advantage outlined above makes a number of important assumptions:
• There are no transport costs. ...
• The theory assumes that traded goods are homogeneous (ie identical). ...
The major purpose of the theory of comparative advantage is to illustrate the gains from international trade. Each country can gain by specialising in those occupations in which it is relatively efficient; it should export part of that production and take in exchange those goods in whose production it is, for whatever reason, at a comparative disadvantage. The theory of comparative advantage thus provides a strong argument for free trade—and indeed for a laissez-faire attitude with respect to trade. ... Comparative-advantage theorists concede that free trade would affect the relative income position of such groups, and perhaps even their absolute income level. ...
The Heckscher-Ohlin (HO) theory predicts that countries will export the products that use their abundant factors intensively—capital-intensive and skill-intensive goods in the case of advanced countries, and labour intensive goods in the case of developing nations.
Building on this theory, the Stolper-Samuelson (SS) theorem shows that, given several restrictive assumptions, freeing trade will reduce the returns to the scarce factor of production in each country. ... A country that may have enjoyed an advantage because of lower labour costs or because it had good supplies of some natural resources, could also become uncompetitive in some goods or services as its economy develops. ...
After the demise of mercantilism the theory of comparative advantage probably has the greatest impact on world trade today. It is this theory that states that even if a country is not the very best at producing anything it can still benefit from trading provided that it specialises and produces the things that it is best at.
Approximate Word count = 3084
Approximate Pages = 12.3
(250 words per page double spaced)
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