Classical International Trade Theory

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Classical international trade theory is a departure from mercantilism, which mainly introduces the idea that free trade could be mutually beneficial for trading countries. The notion that depends on absolute advantage was initially developed by Adam Smith, in his book titled “Wealth of Nations (1776)”. According to Smith, countries should produce goods only if they can produce them at a lower cost compared to any other country in the world. This idea briefly states that when a country is capable of producing a product at a lower cost than any other country, that country has an absolute advantage in the production of that good.

This simple concept was revised by David Ricardo and then he developed a new notion namely the comparative advantage.
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Siebert claims that environmental impact and pollution risk are also crucial factors in the determination of the price of a commodity. If the less polluting product is produced more efficiently than the more polluting product, the price ratio of former to latter is an increasing function of shadow price of assimilative capacity. Since more capacity means lower shadow price, the country which has resources, has also the comparative advantage. As a result, country can increase the production and export of pollution-intensive…show more content…
In this approach, instead of cost differences among countries, sources of these cost differences are taken into consideration and it is claimed that these sources depend on relative factor endowments of the countries. Therefore this approach is called theory of factor endowment in the trade literature. Briefly, Heckscher-Ohlin (H-O) theorem states that factor endowment is the key source of comparative advantage and the ways of trade when it is assumed that countries have the same technology (Feenstra, 2004). Although there are several assumptions on constraints, this theory brings an important point of view by questioning the reasons of cost differences and as a consequence it has become a remarkable approach among new trade

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