Classical Trade Theories and Their Limitations in International Economics

Classical trade theories such as the Theory of Absolute Advantage by Adam Smith and the Theory of Comparative Advantage by David Ricardo highlight the benefits of free trade and specialization based on natural advantages. However, these theories have limitations, such as the inability to explain scenarios where one country is advanced while another is backward. Assumptions, production examples, and major drawbacks of these theories are discussed in detail.

• Trade Theories
• International Economics
• Classical Economics
• Absolute Advantage
• Comparative Advantage

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1. Classical Trade Theories Supply Side Analysis Demand Side Analysis 1. Adam Smith Theory of Absolute Advantage 1. J. S. Mill Theory of Reciprocal Demand 2. David Ricardo Theory of Comparative Advantage

2. Theory of Absolute Advantage Adam Smith

3. Free Trade Division of labour enhanced in International Market Total Output Maximised Win-Win situation enhances international Welfare

4. Specialization: Specialisation among countries based on Absolute Advantage Principle. It is of the Nature of natural Advantage. Specialization Complete Specialisation Partial Specialisation No production of other products than having Natural Benefits Majority of production of product having natural Benefits but production of other products is also done

5. Assumptions: 1. 2 X 2 X 1 Model 2. Factors of production are Fully Employed. 3. Constant returns to Scale in production. 4. No Transportation Cost. 5. All Labour Units Are Homogenous. 6. Free Trade: No barrier as tariff or Quota exist. 7. Labour is the only Factor of production.

6. Production of One unit of Labour Nation A Nation B total = 30 unit Food 20 unit 10 Unit =14 unit Cloth 6 Unit 8 Unit Hence, Absolute advantage for: Nation A Food Nation B- Cloth

7. Production of One unit of Labour Nation A Nation B total Food 20 unit 10 Unit =40 unit(new) Cloth 6 Unit 8 Unit = 16 unit (New)

8. Major Drawback: If one country is advanced and another is backward , than this situation can not be explained with this theory.