Answer to Question #206895 in Economics for Lubi

Question

How different is standard trade theory from basic Ricardian model? What are other relevant theories?

Answer 1

Ricardo's theorem sounds like this: if countries specialize in the production of those goods that they can produce at relatively lower costs compared to other countries, then the trade will be mutually beneficial for both countries. Both high-productivity and low-productivity countries benefit from trade.

It should be noted that in Ricardo's model the opportunity cost is constant. The invariability of costs suggests that a country will gain the most if it specializes entirely in a commodity in which it has a comparative advantage. At constant costs, one of the two trading countries will not be able to fully specialize in exports only if the world price matches the domestic price ratio in the absence of trade. In this case, the country in which the price ratio changes is a large country, and the second is a small one. Large countries continue to produce both goods in free trade because small countries cannot export enough goods to meet the demand for these goods in a large country.

The disadvantages of the model include the following:

1) the invariability of opportunity costs in the model;

2) the law of comparative advantage allows the full specialization of countries in the production of certain goods, which actually does not happen in practice;

3) D. Ricardo's model does not take into account the difference in the endowment of individual countries with production resources;

4) the theory of comparative advantage abstracts from the impact of international trade on the distribution of income within the country, which actually takes place;

5) on the basis of the Ricardian model, it is impossible to explain the exchange of large flows of similar goods between approximately the same countries that do not have relative advantages in relation to each other;

6) following the recipes of the theory of comparative advantage means for developing countries the preservation of permanent poverty and backwardness.

Neoclassical theories of international trade. The theory of the ratio of factors of production (Heckscher-Ohlin) explains why comparative advantages arise. The Heckscher-Ohlin theory argues that the unequal relative endowment of countries with productive resources creates a difference in the relative prices of goods, which, in turn, creates the preconditions for the emergence and development of international trade. This theory can be presented in the form of two interrelated theorems: firstly, the so-called Heckscher-Ohlin theorem, which explains the structure of international trade and, secondly, the theorem of equalization of prices for factors of production, or the Heckscher-Ohlin-Samuelson theorem, which affects the effect of international trade on factor prices.