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Outline the Classical / Ricardian theory of International Trade - What do you regard as the main strengths and weaknesses of this theory as an explanation of trade patterns?

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Introduction

Outline the Classical / Ricardian theory of International Trade. What do you regard as the main strengths and weaknesses of this theory as an explanation of trade patterns? Adam Smith said that by trading freely this would benefit countries as people would consume more then they otherwise would. This is true because different countries produce differing goods and by trading with one another consumers can consume those foreign goods. If there was no trade then only domestic goods could be consumed. Ricardian theory is one of comparative advantage. This is where a country chooses to produce then trade with a country within a good of which it has a comparative advantage in its production. The assumptions underlying the comparative advantage theory are as follows; the first is that the countries have only one factor production this is labour. Although this is the only factor countries have differing productivities. ...read more.

Middle

It is also a two good, two-country model in that each country produces to goods in which they have a comparative advantage in one of them in order for trade to take place. This is for simplistic purposes and so that there may actually be a comparative advantage in the production. In the theory if there is not an advantage in one of the good s production then it is not beneficial for trade to take place. MacDougall's study identifies some of the problems and strengths of the Ricardian theory. The first problem in actually testing the theory is that the assumption of free trade is not possible as there are trade barriers therefore to test the theory he had to use UK-US trade performances in third countries so to get a free trade policy. This is because the trade flows could not be looked at due to the trade barriers such as cost of transporting and some trade tariffs between the UK and US. ...read more.

Conclusion

In empirical terms the theory is both positive and negative. Its strength is that there is a shown correlation post trade prices and export shares. However on the other side there is a negative correlation between relative costs and relative prices. A strength is that it does explain why a country if it has an absolute advantage would want to trade. As in it can benefit from sharing or specialising production and exporting in one good (assuming the two good model) rather then producing both goods. This therefore enhances total trade within the trade economy. Another strength is that through knowing comparative advantages you can predict the trade patterns, which means that policy conclusions can occur. The Ricardian Theory does explain why trade should and indeed does take place where the absolute advantage theory says that it shouldn't exist between some countries. Therefore it does explain trade patterns, even though Bhagwati's theory suggests that it is incorrect. However it can be said that this theory is at times too restrictive. - 1 - ...read more.

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