Explain Why the Theory of Comparative Advantage Is the Basis for International Trade (Mutual Benefit from Trade).

Topics: Economics, International trade, Comparative advantage Pages: 2 (494 words) Published: November 13, 2005
The modern version of the Ricardian model and its results are typically presented by constructing and analyzing an economic model of an international economy. In its most simple form the model assumes two countries producing two goods using labour as the only factor of production. Goods are assumed homogeneous, across firms and countries. Labour is homogeneous within a country but heterogeneous, across countries. Goods can be transported costlessly between countries. Labour can be reallocated costlessly between industries within a country but cannot move between countries. Thus each country would export the good in which they have a comparative advantage. Trade flows would increase until the price of each good is equal across countries. In the end, the price of each country's export good, will rise and the price of its import good will fall. The higher price received for each country's comparative advantage good would lead each country to specialize in that good. To accomplish this, labour would have to move from the comparative disadvantaged industry into the comparative advantage industry. One striking result here is that even when one country is technologically superior to the other in both industries, one of these industries would go out of business when opening to free trade. Thus, technological superiority is not enough to guarantee continued production of a good in free trade. A country must have a comparative advantage in production of a good, rather than an absolute advantage, to guarantee continued production in free trade The movement to free trade generates an improvement in welfare in both countries both individually and nationally. Specialization and trade will increase the set of consumption possibilities, and will make possible an increase in consumption of both goods; nationally these aggregate gains are often described as improvements in production and consumption efficiency. Free trade raises aggregate world production efficiency because more...

Bibliography: http://internationalecon.com/v1.0/ch40/40c000.html
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