The development of the classical theories of international trade between countries
March 30, 2016
March 30, 2016
1 Mercantilism 2
2 Absolute Advantage 2
3 Comparative Advantage 3
4 Factor Proportions 4
5 Bibliography 6
International trade may seem simple. It is simply the exchange of goods between two people or entities from two different countries. People trade because they get some kind of benefit in the transaction. Sometimes it is something that they need and sometimes it is something that they desire.
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In 1776, Adam Smith questioned the leading mercantile theory of the time. Smith believed that unrestricted trade and free international competition is more beneficial for a country, rather than the Mercanlistic view.
The economic theory he came up with, the absolute advantage, focused on the ability of a country to produce a good more efficiently than another nation. He believed that trading between countries should not be restricted to government policy or be intervened with. If for instance Country A could produce corn at a cheaper and faster rate with better quality than country B and Country B can produce sugar cheaper and faster, etc. Then Country A would focus and specialise more in corn and Country B would specialise in Sugar. Even if the two countries can produce both, they would still only produce those products, because then the labor will be more skilled as they only have to focus on one set of skills. By specialising, they become more efficient.
Smith’s theory reasoned that with increased efficiencies, people in both countries would benefit and trade should be encouraged (Anonymous, 2012). His theory stated that a nation’s wealth shouldn’t be judged by how much gold and silver it had but rather by the living standards of its people (Anonymous, 2012).
There is a challenge to absolute advantage. Even though it seems obvious that if one country is better at producing one good and another country is better at producing a different good (assuming both countries demand both goods) that they should trade (Globalization101, 2016). But what happens if one country is better at producing both goods? Should the two countries still trade? These are the type of question David Ricardo asked when he came to the theory of comparative advantage.
Ricardo was of the opinion that even if Country A (from the previous example) had absolute advantage in both corn and sugar, there could still be specialisation and trade.
The good in which a country would have comparative advantage is the good the country produces that has the lowest opportunity cost. In other words if the it takes you one hour to produce 1 loaf of bread but two hours to make a pan of muffins, assuming the both have the same income. Then you would have the comparative advantage in baking bread. If you...