International Trade . . The Classical Theory of International Trade Introduction Adam Smith ( ) developed the theory of absolute cost advantage. But it was David Ricardo who formulated as an explicit and precise theory, namely, the theory of comparative cost advantage, which was later improved and refined by the economists like J.S Mill, Cairnes, Bastable,Taussig and Haberler.
We shall first discuss the Adam Smith’s theory of absolute cost advantage. - - International Economics . . .
Adam Smith’s Theory of Absolute Cost Advantage Adam Smith argued that all nations can be benefitted when there is free trade and specialisation in terms of their absolute cost advantage. The Theory According to Adam Smith, the basis of international trade was absolute cost advantage. Trade between two countries would be mutually beneficial when one country produces a commodity at an absolute cost advantage over the other country which in turn produces another commodity at an absolute cost advantage over the first country. Classical Trade Theories Mercantilism (pre - 16th century) Takes an us-versus - them view of trade Other country's gain is our country's loss Free Trade theories Absolute Advantage (Adam Smith, ) Comparative Advantage (David Ricardo, ) Specialization of production and free flow of goods benefit all trading partner's economies Free Trade refined Factor - proporations (Heckscher - Ohlin, ) International Product life cycle (Ray Vernon, ) Assumptions .
There are two countries and two commodities ( x model). . Labour is the only factor of production. .
Labour units are homogeneous. . The cost or price of a commodity is measured by the amount of labour required to produce it. .
There is no transport cost. Illustration Absolute cost advantage theory can be illustrated with the help of the following example. Absolute Cost Advantage Country India China (Output per unit of labour) Wheat Cloth From the illustration, it is clear that India has an absolute advantage in the production of wheat over China and China has an absolute advantage in the production of cloth over India.