Another assumption is that there are constant returns to scale, this is so that varying and increasing amounts of goods may be produced without diminishing effects which would affect the results on trade meaning that the more trade that takes place the less beneficial it becomes, due to diminishing marginal returns to scale.
There are also no barriers to trade, such as tariffs and transport costs are also assumed as low or non-existent. This is so that trade is assumed as encourage and is in no way deterred form occurring.
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.
A weakness of the theory is that with MacDougall’s study it is vindicated in the products where the UK/US export ratio was negatively related to the labour requirement and the labour cost. This can be partially explained by the US labour costs being twice that of the UK’s. Therefore it explains that trade can still (and does) occur even when trade flows are contrary to the comparative trade theory (i.e. that trade occurs when there is no comparative advantage). Using these empirics 19 out of 25 products in this supported the theory.
Bhagwati’s critics of the model suggest other strengths and weaknesses that explain trade patterns. The first weakness is theoretical in that it is only concerned with supply. This leads on to price being the only factor in trade, which of course is not so as quality if the product affects whether it is purchased or not. As this is not taken into account it affects the actual trade patterns as quality in different products is dependant upon labour insensitivity.
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.
