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Classical Theory Of International Trade

What do you mean by International Trade?

International trade is the trade of imports and exports of the goods and services between two or more countries. These international trades are explained through various theories which are made by expert economists around the world. Trade is basically an irreversible concept which involves two individual entities or countries who indulge in the process of exchange of goods and services. These entities usually exchange the goods and services as they believe that the benefits reaped from it are highly grateful for both the parties and countries. The goods or services are maybe wanted or needed by the other country or party. International trade sounds very simple but have many theories, policies and business strategies which are very important for this. These constitutes the international trade and makes changes as per the need.

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What do you mean by the classical theory of international trade?

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The classical theory of international trade primarily means that every country should have a brief specialization in the production. The countries should export those goods or services mainly which are more of higher comparative advantage and have the imports of those specified goods which are present in the production which have a greater sense of disadvantage. The terms of trade are mainly determined by the important principle of reciprocal demand.

What are the prime assumptions of the classical theory of international trade?

The major assumptions were that the:

  • There are mainly two countries which produce two different goods
  • The nature of all the units of labor is homogenous
  • The countries which are concerned in the trade have full employment
  • Factors of production are perfectly mobile within the country but are perfectly immobile between the two specific countries.
  • Production is rational to the subject to law of constant returns.
  • The only factor of production and the cost of production which is measured in the labor units are the labor.

What are the classical internal trade theories?

1. Mercantilism

This theory was originated in the sixteenth century and is one of the earliest. It was an overall one of the first economic theory. Mercantilism theory stated a country’s wealth and richness is measured in the terms of the gold as well as silver holdings. In a simpler sense, the economists who developed this theory believed that the countries should increase their holds of gold and silver by encouraging exports and discouraging imports. In other context, if people in a country buys more from country number 2 than what they sell to the country 1, which is called imports, then eventually they will have to pay you the difference incurred in the terms of gold or silver. The primary objective of each country at that time was to have a trade surplus, or even a similar situation where the value of exports are higher than the value of imports, which ultimately avoids a trade deficit, or in other words a situation where in the value of imports is much greater than the value of exports. By increasing exports and also the trade, the rulers at that time were fully able to amass and conquer the part of the world having more gold and wealth for their countries. The restrictions were imposed on the exports done by the new nations which was one way. The strategy followed here was protectionism and is still in use as of today.

2. Absolute advantage

This classic theory of international trade was developed by Adam Smith in 1776 which was named absolute advantage. This theory mainly focused on the skills and abilities of a specific country which produces a particular good better than others. The trade occurring between the countries will not be effected by the regulations and the restriction by a government intervention or policy. The trade will flow smoothly as per the market forces and no intervention from any entity is regulated on this. For instance, if country A is producing goods or providing services cheaper and much faster than country B, then country A reaps the advantage of profits and can be more specialized in making those goods or services. On the other hand, if country B is better at making a particular product efficiently, then it should focus on specializing in production of that good. It is because their labor force could be specialized in doing that skill job. As a result, production would also become more efficient and money saving, because there would be an implied incentive for the creation of faster and better production methods for the increase in the specialization.

3. Comparative advantage

This is a very prominent theory of international trade and is concerned with the production and specializing of one country in more than one goods then the international trade benefits will be reaped by that country efficiently. This theory was originated by David Ricardo who was an English Economist in the year of 1817. This theory of comparative advantage is occurred when the country is not able to produce a particular product more efficiently or profitably than the other respective countries. But, on the other had it can produce a good which is better than the other countries. Comparative advantage theory is just a much more different take on the Absolute advantage theory. Comparative advantage focuses more on the relative productivity differences, on the other hand the absolute advantage looks at the absolute productivity proportionate.

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