Pure theory of international trade Assignment Help

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Pure theory of international trade:

Based on the considerations  of absolute advantage, Adam Smith argued as to how countries can gain  through international trade. This forms  the basis for the pure theory of international  trade. The theory of absolute advantage can be explained through a simple  example. Suppose two goods  A and B can be produced by labour alone.  It takes 100  units of labour  to manufacture one unit of good A  in country Xbut 200 labour units in country Y Conversely,  it  takes 200 units of labour  to manufacture one unit of good B in country X but only 100 labour units  in country Y:  In other words, country X  is more efficient in producing good A, because  it uses less  labour  per unit of output  than country Y: By the same logic, country Y  is more efficient  in producing good B.Then country X is said to have the absolute advantage in producing good A, while country Y has an absolute advantage in producing good B.

Now country Y may gain by producing one unit of B, using 100 labour units, and exporting  it to country  Xin exchange for one unit of A. In effect, country Y has used  100 labour units to obtain one unit of A  indirectly, rather than using the same labour to produce 0.5 unit of A directly. Correspondingly, country X must have used  100 units of  labour to produce the unit of A  for export, in exchange for which  it received one unit of B. But if it had tried to produce one unit of B itself, it would have required 200 units of  labour. Thus, it may be concluded  that by trading, both countries could have gained by having more of both goods.

The above example clearly demonstrates  that two countries can gain through international trade if  they  have absolute advantage  in producing  different  goods. However, gains from international exchange of goods need not be limited to the situations of absolute advantage. It was later shown by Ricardo as to how the benefits  from  trade can be  reaped  also in situations of comparative advantage, which came to be known as the theory of comparative  advantage.

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