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Foundations of Modern Trade Theory: Comparative Advantage

16 important questions on Foundations of Modern Trade Theory: Comparative Advantage

Adam Smith founded the concept of cost on the labour theory of value:

Labour is the only factor of production and is homogeneous (of one quality) and the cost or price of a good depends exclusively on the amount of labour required to produce it.

The trading principle of Adam Smith: Principle of absolute advantage:

In a two – nation, two – product world, international specialization and trade will be beneficial when one nation has an absolute cost advantage (uses less labour to produce a unit of output) in one good and the other nation has an absolute cost advantage in the other good. Each nation must have a good that is absolutely more efficient in producing than its trading partner. A nation will import goods in which it has an absolute cost disadvantage and export those goods in which it has an absolute cost advantage.

The principle of comparative advantage by David Ricardo:

A principle to show that mutually beneficial trade can occur whether or not countries have an absolute advantage, which applies to a nation that is more efficient than its trading partner in the production of all goods. It does not necessarily mean that a nation only export products that will cost them the least and create a surplus.
The same counts in case a nation has a cost disadvantage in production of both goods.

Marginal rate of transformation (MRT):

The MRT shows the amount of one product a nation must sacrifice to get one additional unit of the other product. For example:
MRT = Wheat
Autos.
Plus, the rate of this sacrifice is called the opportunity cost of a product.

Consumption gains from trade:

When 2 nations that trade achieve post – trade consumption outside their domestic production possibilities frontiers; They can consume more products than they could consume in the absence of trade.

Trading possibilities line:

When the ratio of the trade term allows both trading partners to consume at some point outside their respective production possibilities frontiers. Plus, the international terms of trade for both countries.

The region of mutually beneficial trade:

Any acceptable international terms of trade have to be more favourable than or equal to the rate defined by the domestic price line. As such, the region of mutually beneficial trade is bounded by the cost ratios of the two countries.

The commodity terms of trade (also referred to as the barter terms of trade):

Is a frequently used measure of the international exchange ratio. It measured the relationship between the prices a nation gets for its exports and the prices it pays for its imports.

Dynamic gains from international trade:

Gains that were dwarfed (verkleind) by the effect of trade on the country’s growth rate and the volume of additional resources made available to, or utilized by, the trading country. Dynamic gains from trade can arise from increased investment in equipment and manufacturing plants, economies of large – scale production, internet, and increased competition that occurs over a period of time.

1. Identify the basic questions with which modern trade theory is concerned:

· Why do nations export and import certain products?
· At what terms of trade are products exchanged in the world market?
· What are the gains from international trade in terms of production and consumption?

Both Smith and Ricardo contended that the pattern of world trade is determined by solely supply conditions. Explain:

The supply conditions relate to the costs of labour; the amount and time of labour is required to produce a good. Additionally, labour can move freely between countries.

How does the comparative – cost concept relate to a nation’s production possibilities frontier?

The principle of the Comparative Advantage means that free trade between countries will take place and benefit both, regardless of an absolute advantage.
There is no government regulation, no import tariffs or quota restrictions. Neither is there a question of protectionism.
The comparative advantage principle relates to the production possibilities frontier when all factor goods are used to produce a good efficiently such as:
Land, labour, capital and entrepreneurship.

The gains from specialization and trade are discussed in terms of
production gains and consumption gains. What do these terms means?Production gains:

Specializing in the production of goods wherein a country has an absolute cost advantage in, which results in producing more goods in a short period of time.

The gains from specialization and trade are discussed in terms of
production gains and consumption gains. What do these terms means?
· Consumption gains:

Consuming more products, due to international trade. Whereas a country would consume less goods in case of autarky, a closed economy.

What is mean by the term trade triangle?

A nation’s trade triangle denotes its exports, imports, and terms of trade. In a two – nation, two product – world, the trade triangle of one nation equals that of the other nation; one nation exports equal the other nation’s imports, and there is one equilibrium terms of trade.

With a given level of world resources, international trade may bring about an increase in total world output. Explain:

There will be more exporting of goods and the creation of more jobs, which leads to a higher level of producing goods. Additionally, more manufacturing plants will be established.

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International Economics and Businesses.

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Foundations of Modern Trade Theory: Comparative Advantage

16 important questions on Foundations of Modern Trade Theory: Comparative Advantage

Adam Smith founded the concept of cost on the labour theory of value:

The trading principle of Adam Smith: Principle of absolute advantage:

The principle of comparative advantage by David Ricardo:

Marginal rate of transformation (MRT):

Consumption gains from trade:

Trading possibilities line:

The region of mutually beneficial trade:

The commodity terms of trade (also referred to as the barter terms of trade):

Dynamic gains from international trade:

1. Identify the basic questions with which modern trade theory is concerned:

Both Smith and Ricardo contended that the pattern of world trade is determined by solely supply conditions. Explain:

How does the comparative – cost concept relate to a nation’s production possibilities frontier?

The gains from specialization and trade are discussed in terms ofproduction gains and consumption gains. What do these terms means?Production gains:

The gains from specialization and trade are discussed in terms ofproduction gains and consumption gains. What do these terms means? · Consumption gains:

What is mean by the term trade triangle?

With a given level of world resources, international trade may bring about an increase in total world output. Explain:

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The gains from specialization and trade are discussed in terms of
production gains and consumption gains. What do these terms means?Production gains:

The gains from specialization and trade are discussed in terms of
production gains and consumption gains. What do these terms means?
· Consumption gains: