ABSTRACT
The pure theory of international trade, as expounded by classical, neoclassical, and modern economists, seeks to provide an explanation of the factors, originating both from demand and supply side which tend to influence the observed pattern of trade flows and specialization among nations, and their welfare implications measured in terms of Pareto optimality, for each of the trading partners and for the world as a whole. The principle of comparative advantage was developed by Torrens (1808) and used by Ricardo (1817) to explain the pattern of trade and the benefits flowing from free trade and competition. Ricardo argues that trade between countries arises because of the relative differences in the pre-trade prices of the goods, on the assumption that the relative production costs of goods and hence relative prices (PX/PY) in a closed economy, under competitive equilibrium conditions in both commodity and factor markets and a simple production function with the single input and constant returns, are entirely determined by relative labour inputs (LX/LY), i.e.:
and the differences in the pre-trade domestic price ratios of the goods and the comparative advantage and disadvantage, in costs between countries will be mainly due to differences in relative labour productivity. The theory assumes, among other things, immobility of the factors of production internationally, with negligible transport costs, and unchanged technology, factor inputs and demand patterns.
