Trade Theory

Trade Theory

Absolute advantage and Comparative advantage theories

The absolute theory was developed by Adam smith, this theory explains why countries trade, when a country has an advantage in producing a good and the other country has an advantage in producing the other good then the countries will benefit from trading and therefore they will trade. This theory considers labour to be the only factor that determines the value of the final good, therefore when one country uses more labour than the other to produce a good then it has absolute advantage inn producing that good.

Adam smith theory states that trade is caused by differences in labour productivity, he stated that cost differences between countries will cause trade, this theory states that if country a produces two products y and x, and also country b produces the same products then if country a has absolute advantage in producing good x whereby it uses 10 units of labour and country b uses 20 units of labour to produce the same product then the two countries will trade.

The comparative advantage theory was developed by David Ricardo, in this theory he compares two good that are produced by two countries. In his discussion he states that e even if one country has absolute advantage in producing the two good it would be still be possible for the two to trade and benefit from trade.

David Ricardo theory states that even if one of the countries either country a or country b is more productive in all the products they trade the two countries can till gain through trade, he considered Portugal and England who produce both wine and cloth, Portugal has absolute advantage in the production of both wine and cloth, however Portugal was more efficient and more comparative advantage in the production wine, therefore the two countries would still gain through trade.

Trade Theory

Standard Comparative advantage theory focuses on two products and two countries, but can be extended to more than two products and countries. Discuss.

These theories can still be extended to more than one country; this is because David Ricardo explains the issue of comparative advantage to find out which product each country has comparative advantage over the others. Therefore when we have more than one country we will simply calculate the comparative advantage of each country for each good they produce and this way we will determine which good will be produced by a certain country.

Given the concept of outsourcing, assess its advantages and burdens.

Outsourcing allows firms in country to access cheap paid labour, the advantage is that the cost of production will be lower when there is outsourcing. An advantage is that outsourcing will lead to employment increase in the host country. The disadvantage is that outsourcing may lead to unemployment

Can international trade generate equality factor prices?

International trade can generate equality of factor prices, this is depicted by the edge Bowley box diagram, this theory states that if factors of production cannot freely move from one country to another but goods produced can freely move from one country to another then the free movement of goods will eventually equalise factor prices when there is trade.

Trade Theory