Classical International Trade Theories

This chapter introduces the basic ideas and conclusions of classical international trade theories in mathematical form. Section 2.1 studies Adam Smith’s trade theory with absolute advantage. Although Smith’s ideas about absolute advantage were crucial for the early development of classical thought for international trade, he failed to create a convincing economic theory of international trade. Section 2.2 examines the theories of comparative advantage. Ricardo showed that the potential gains from trade are far greater than Smith envisioned in the concept of absolute advantage. Section 2.3 develops a two-good, two-factor model. Different from the common dual approach to examining perfectly competitive two-factor two-sector model in the trade literature, we use profit-maximizing approach to demonstrate the most well-known theorems in the Heckscher-Ohlin trade theory. These theorems include the factor price insensitivity lemma, Samuelson’ factor price equalization theorem, Stolper-Samuelson theorem, and Rybczynski’s theorem. In Sect. 2.4, we illustrate the dual approach for the same economic problems as defined in Sect. 2.3. Section 2.5 examines the Heckscher-Ohlin theory which emphasizes differences between the factor endowments of different countries and differences between commodities in the intensities with which they use these factors. The basic model deals with a long-term general equilibrium in which the two factors are both mobile between sectors and the cause of trade is that different countries have different relative factor endowments. The theory is different from the Ricardian model which isolates differences in technology between countries as the basis for trade. In the Heckscher-Ohlin theory costs of production are endogenous in the sense that they are different in the trade and autarky situations, even when all countries have access to the same technology for producing each good. Section 2.6 introduces the neoclassical theory which holds that the determinants of trade patterns are to be found simultaneously in the differences between the technologies, the factor endowments, and the tastes of different countries. Section 2.7 develops a general equilibrium model for a two-country two-sector two-factor economy, synthesizing the models in the previous sectors. Section 2.8 introduces public goods to the two-sector and two-factor trade model defined in the previous sections. Section 2.9 concludes the chapter. Appendix 2.1 represents a well known generalization of the Ricardian model to encompass a continuum of goods.