Neo-classical Theory of Trade, International Economics Assignment Help

International Economics - Neo-classical Theory of Trade, International Economics

International Economics >> Neo-classical Theory of Trade

The Neo-classical Theory of Trade: 

Besides, the classical theories have been strongly criticized for being based on many unrealistic assumptions. Gotfreid Haberler made a significant improvement in classical theories of trade, especially on the Ricardian theory of comparative advantage. Haberler has used the concept of opportunity cost of producing a commodity instead of absolute or comparative cost of production. His theory is therefore also known as the opportunity cost theory of international trade. Haberler's theory of trade is also called the neo-classical theory of trade.

Opportunity cost and production possibility curve

The concept of opportunity cost, particularly at the aggregate level, can be better explained with the use of production possibility curve. Although Haberler's theory is based on both the factors of production-labour and capital-his theory of opportunity cost can be explained with labour as the only factor of production.

The Gains from Trade: Constant Cost

As mentioned above, the actual gains from trade cannot be determined in the absence of demand function. However, it can be illustrated with a hypothetical example' that trade is gainful for both the nations. 

Increasing cost and gains from trade

The straight line production possibility curves based on constant of production. Therefore, they imply constant opportunity cost. This is an unrealistic assumption. For, in reality, all factors of production are not equally efficient in all lines of production, nor are they equally efficient at all levels of employment in the same line of production. Observed facts reveal that in most industries production is subject to diminishing return, or in other words, subject to increas­ing costs, Haberler's theory of opportunity cost and the gains from trade are explained under the condition of increasing costs.

Production Possibility Curve Under Increasing Costs

Under the condition of increasing costs, the production possibility curve is concave to the origin, concave production possibility curve implies an increasing opportunity cost. In other words, the opportunity cost of rice· increases as more and more of jute is produced, and vice versa. 


Haberler's theory of opportunity cost represents an improvement over Ricardo's theory of real cost m, at least, two respects.

First -

it shows that even if labour theory of value is discarded as invalid, and is replaced by opportunity  cost theory the comparative cost theory of Ricardo re­mains valid. As shown above, a country will specialise in the production of a commodity or commodities in which it is comparatively more efficient than others, and will gain in trade. secondly, Haberler's analysis recognises the existence of factors of production other than labour, which is a major step forward from Ricardo's simple theory. His attempt to replace the real (labour) our cost theory by the opportunity cost theory simplifies the problem of unifying the cost-structure when more than' one factor of production is involved.

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