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International trade involves the movement of goods, services, and capital across borders. Mercantilism, absolute advantage, and comparative advantage are influential theories. Comparative advantage, developed by David Ricardo, is the most important concept in modern international trade theory.
International trade is an exchange or economic transaction that involves the movement of goods, services, and capital across borders from one country or territory to another. Although trade has circulated around the world for thousands of years, it is in modern times that its economic importance has increased significantly. In most countries, international trade now plays an important role in their economies. Over time, economists have developed various theories of international trade not only to better understand it, but to guide governments in making policies and help businesses benefit from it. Some of the most influential international trade theories have been mercantilism, absolute advantage, and comparative advantage.
Mercantilism was the most influential early business theory; It dominated the economies of most Western European nations from the 16th century to the late 18th century. The main doctrine of this theory was that the economic well-being of a country could be improved only by exports; imports were to be reduced and, if possible, avoided. All trade was conducted under government authority, and a country’s financial wealth was defined by the amount of gold it accumulated. A major problem with market theory is that the focus on exports at the expense of imports actually hinders the development of international trade.
In the late 18th century, the economist Adam Smith developed the theory of absolute advantage, which became the most dominant international trade theory of its time. This theory holds that profits can be made from importing and exporting. Furthermore, this theory actually encouraged imports by maintaining that each country should focus on producing and exporting what it is best at: the goods and services that it has an absolute advantage in producing. National wealth is measured not by owning gold, but by the standard of living of the population. This theory fails because it cannot explain why a country without an absolute advantage in the production of any product would engage in international trade.
Developed in the early 19th century by economist David Ricardo, the theory of comparative advantage became the basis for future theories of international trade. It is often seen as the most important concept in modern international trade theory. Its central principle is that a country must specialize in the export and production of products that have a relative or comparative advantage compared to other nations, and must import those products with which it is at a comparative disadvantage. This theory has continued to be refined in modern international trade theories because some of the assumptions it makes limit its application in the real world.
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