International Trade different

from Interregional Trade

CLASSICAL THEORY OF
INTERNATIONAL TRADE
Theory By Aam
Smith In Terms of
ABSOLUTE
ADVANTAGE
MODEL
DAVID RICARDO
Expanded it Further
which was called
COMPARATIVE
ADVANTAGE
MODEL
Adam Smith Theory Of Absolute Cost
Difference
Assumptions
Labor is the only factor of Production
There is Full Employment In the economy
Labor is Perfectly Immobile Between the
Countries
Law of constant returns is in Operation
EXPANTION OF THE THEORY

ABSOLUTE DIFFERENCE IN COST
COUNTR
Y
COMMODITY -
X
COMMODITY-
Y
A 10 5
B 5 10
RICARDOS THEORY OF COMPARATIVE COST
ADVANTAGES
Assumption Of the theory
They use a 2 * 2 * 1 model
The cost of Production equals total labor cost
All the units of labor are homogeneous
Production Function are Characterized by constant
costs
There is perfect competition
No Transportation cost
No barriers to Trade
Absolute Difference In costs
Equal Difference in costs
Comparative Differences in cost
P
R
O
S
T
Q
OX = COMMODITY
x
OY = COMMODITY
Y
x
y
Criticism of the comparative
cost
Unrealistic assumptions of constant cost
Unrealistic assumption of labor
Unrealistic assumptions of full employment
Transport cost are not considered in the theory.
The theory is unrealistic and static.
MODERN THEORY OF
INTERNATIONAL TRADE
Heckscher-ohlin
thesis
MODERN THEORY IN THREE STAGES
The basis of trade lies in the differences in the final
price of a commodity
The difference in the final price of a commodity is
due to difference in the comparative cost of
producing that commodity
Finally it examines the root cause which produces
this difference in the comparative cost
ASSUMPTIONS OF THEORY
Perfect competition
Mobility of factors
Factors are identical
Factor supplies
Trade is free and costless
The physical amounts
Techniques of producing identical goods
Classification of goods
Production function
Factor intensities
P
O
Q
Q2
Q1
X
Y
C
A
P
I
T
A
L
LABOUR
CRITICISM
THE ASSUMPTIONS OF TWO-BY-TWO-BY-TWO MODEL
IS NOT REALISTIC
LIKE THE CLASICAL THEORY THE OHLIN MODEL IS
STATIC IN NATURE
FACTORS ARE NOT HOMOGENOUS
PRODUCTION TECHNIQUES CANNOT BE
HOMOGENOUS
LEONTIEF PARADOX HAS FALSIFIED THE THEORY