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Trade Theory and Development

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Here, i is also assumed that barter economy prevails in the countries. To countries produce two different goods and these two goods are produced and exchanged between the countries. N monetary transaction is involved in this aspect and the economies are involved in trading of one good in exchange of the other. Te consumption function is homothetic i. bth the countries consume the two goods at a fixed proportion, rgardless of the level of income. Mre specifically, to countries with homothetic preferences will involve same price level and a free trade is presumed (Ruffin, 2002).

Rcardo’s model is also based on general equilibrium that incorporates circular flow of money in exchange of goods and services. Terefore, te revenue generated from selling goods and services is used for paying wages to the labours. Te wages in turn is used to buy the same goods and services produced by the firm. I this way, te cycle becomes a simultaneous process of achieving general equilibrium. Rcardian model holds good in a market economy where no transaction and taxation cost exist.

production i. lbour and the quantity produced by the two countries are exogenous variables i. te variables are process driven and not described within the model. I contrast, te 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). Rcardo’s model of comparative advantage shows that a country will produce product which it has a comparative advantage and accordingly it will trade that good in exchange of other good produced by the country, tat holds competitive advantage in producing that particular good.

Fr simplification in calculation, i is considered that there are two countries in the world i. hme country (H) and foreign country (F) producing two goods such as Food (F) and Manufacturing (M) respectively. Te only factor of production is labour which is domestically mobile but such mobility is restricted in international context. Terefore, te total labour required producing one unit of Food in Home country is aLF and the labour required for producing Manufacturing good in the Home country is aLM.

Te total quantity of Food and Manufacturing good. ..

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