Regional Economic Structure with Endogenous Knowledge
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Although Adam Smith held that a country could gain from free trade, he failed to create a convincing economic theory of interregional trade. It is generally agreed that David Ricardo is the creator of the classical theory of trade. The theories of comparative advantage and the gains from trade are usually connected with Ricardo. In this theory the crucial variable used to explain international trade patterns is technology. The theory holds that a difference in comparative costs of production is the necessary condition for the existence of international trade. But this difference reflects a difference in the techniques of production. According to this theory, technological differences between countries determine the international division of labor and consumption and trade patterns. It concludes that trade is beneficial to all participating countries. This conclusion is in contradiction to the viewpoint about trade held by the doctrine of mercantilism. In mercantilism regulation and planning of economic activity are held to be efficient means of fostering the goals of a nation. This theory assumes that production costs are independent from factor prices and the composition of output. Since it lacks consideration of the demand side, the theory cannot determine how and at what value the terms of trade are or should be. The Ricardian theory failed to determine the terms of trade, even though it can be used to determine the limits in which the terms of trade must lie. It was recognized long ago that in order to determine the terms of trade, it is necessary to build trade theory that not only takes account of the productive side but also the demand side.
KeywordsService Sector Transportation Cost Industrial Sector Economic Geography Land Rent
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