Difference Between Classical And Classical Theory

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1) Compare and contrast The Classical Theory and The Modern Theory of International trade. CLASSICAL THEORIES. It is also known as the Theory of comparative costs. According to this theories, each country specializes in production. It should export the produced goods in which it has a greater comparative disadvantage. Classical Theory is based on the following assumptions: a) There are only two countries and they produce two goods. b) Labor is the only factor of production and the cost of production is measured in terms of labor units. c) Product is the subject to law of constant return. d) All units of labor are homogeneous. e) The factors of production are perfectly mobile within the country but are perfectly immobile between two countries.…show more content…
Specialization increases the output, and the ability to enhance the increase of economies of scale. b. He learning effects are high hence they are cost savings that come from ‘learning by doing’. c. It typically demands that industries with fixed costs, i.e. the world demands require for a few competitors. d. Competitors may emerge because of ‘first mover advantage’, i.e. economies of scale may produce new entrants and role of the government become significant. e. Some argue that it generates government intervention and strategic trade policies. f. The theory also tend to analyze the reason for a nations success in particular industries. Theorists also relaxed the assumptions of constant returns to scale, and some also argue that using protectionist measures to build up a huge industrial base in certain industries will in turn allow those sectors to dominate the world market. Ha-Joon Chang, argued that the protectionist policies had facilitated the development of the Japanese auto industries in the 1950s, when quotas and regulations prevented import…show more content…
With examples explain Trade Creation and Trade Diversion. i) TRADE CREATION. This is where trade flows are redirected due to the formation of a free trade area or a custom union; It is the elimination of custom tariffs on inner border of unifying states, causing further decrease in the price of goods and services, while they may be a case of new trade flow creation of the goods between the states that decided to economically integrate. Example: when customs union is formed, the member nations establish a free trade area among themselves and a common external tariff on non-member nations. As a result, the members establish greater ties among themselves now that the protectionist barriers such as the tariffs, trade quotas, non-tariff barriers and subsidies have been eliminate. The result is an increase in trade among member nations in the good or service of each nation’s comparative advantage hence increase in trade results to higher revenues. ii) TRADE DIVERSION. Trade flow is diverted actually cost-efficient partner state to a less efficient one; but which became a member of economic union and made its goods cheaper within a union, but it is high as compared to the rest of the

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