III.

Modern Trade Theory

The classical theory of trade developed by Smith, Ricardo, and Mill was concerned primarily with the analysis of the gains from trade. Modern trade theory, by contrast, takes the principle of comparative advantage for granted. It is mainly concerned with the analysis of the basis for trade and with accounting for differences in comparative advantage.

Classical theorists assumed that differences in comparative advantage resulted from differences in the productivity of resources, reflecting the unequal distribution of technologies and labour skills among nations. A more complete explanation was offered by several 20th-century economists, who noted that differences in the prices of final goods tend to reflect differences in the prices of productive resources and that the latter are accounted for mainly by differences in the availability of resources. Countries specialize in the production and export of goods requiring relatively large amounts of those resources that they possess in abundance, and they import goods requiring relatively large amounts of resources that are scarce within their borders.