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Trade Theory and Development Essay Example

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Trade Theory and Development

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Here, it is also assumed that barter economy prevails in the countries. Two countries produce two different goods and these two goods are produced and exchanged between the countries. No monetary transaction is involved in this aspect and the economies are involved in trading of one good in exchange of the other.The consumption function is homothetic i. both the countries consume the two goods at a fixed proportion, regardless of the level of income. More specifically, two countries with homothetic preferences will involve same price level and consumption proportion, as free trade is presumed (Ruffin, 2002).Ricardo’s model is also based on general equilibrium that incorporates circular flow of money in exchange of goods and services. Therefore, the revenue generated from selling goods and services is used for paying wages to the labours. The wages in turn is used to buy the same goods and services produced by the firm. In this way, the cycle becomes a simultaneous process of achieving general equilibrium.Ricardian model holds good in a market economy where no transaction and taxation cost exist. Factor of production i. labour and the quantity produced by the two countries are exogenous variables i. the variables are process driven and not described within the model. In contrast, the unit of labour used for producing one unit of goods as well as total labour required for producing the aggregate amount of products and services in both the countries is endogenous variable which indicates that values of those variables are determined within the model (Todaro and Smith, 2012).Ricardo’s model of comparative advantage shows that a country will produce that product in which it has a comparative advantage and accordingly it will trade that good in exchange of other good produced by the country, that holds competitive advantage in producing that particular good. For simplification in calculation, it is considered that there are two countries in the world i. home country (H) and foreign country (F) producing two goods such as Food (F) and Manufacturing (M) respectively. The only factor of production is labour which is domestically mobile but such mobility is restricted in international context. Therefore, the total of labour required for producing one unit of Food in Home country is aLF and the labour required for producing Manufacturing good in the Home country is aLM. The total quantity of Food and Manufacturing good

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