Theories Of Comparative Advantage

1130 Words5 Pages Comparative Advantage:
Smith’s assumption of invisible hands of the market was subjected to criticisms from the second half of the nineteenth century. Some of the critics were related to the situation in which two countries might benefit from trade with each other although one holds an absolute advantage over the other in the production of all goods. The explanation of this situation became known as the “theory of comparative advantage”. According to Ricardo if a country does not have an absolute advantage in any good, this country and all other countries would benefit from international trade, in which each country specializes in the production of those goods in which they have the greatest absolute advantage or the least absolute disadvantage (Husted & Melvin, 2007, pp. 60-61).
1.4.3 Neo-classical Theories:
Neo-classical theories developed during the second half of the nineteenth century. According to neo-classical economics, there are suggestions that the price of a commodity is not determined only by the cost of production but also by the utility obtained by the consumer. Pure Trade Theory:
Neo-classical economics embraced
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One idea that has received increasing attention by economists is the role of increasing returns to scale in the production process. When allowing for increasing returns to scale, firms will have incentives to expand their output. The expansion by some firms will eventually force others to exit the market, causing the number of firms in the market to decline. In monopolistic competition, there are many firms, and entry into the industry is free, unrestricted and each producing a variety of differentiated goods. So, opening up trade between two countries in monopolistic competition models results in the decline in the number of firms on the market, while the remaining firms, and output increases, exploiting economies of scale (Brobely, 2006, pp.
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