What is the Critical Appraisal of Trade?

The reciprocal demand theory is based upon the following assumptions:

1. Full employment conditions;

2. Perfect competition;

3. Free foreign trade;

4. Free mobility of factors;

5. Principle of comparative costs and specialisation; and

6. Two countries, two commodities model.

Thus, the theory loses much practical significance when these conditions are not present in the actual phenomena. It may, however, be noted that the theory adheres to sound logic and draws useful conclusions under given assumptions. The theory is criticised on various counts.

Shadwell, for instance, criticised Mill’s contention that the exchange ratio will be fixed at a point at which the value of imports and exports is in equilibrium, as a mere truism which does not throw any light on the determination of terms of trade. Bastable, however, dismissed this criticism as flimsy, since Mill’s doctrine not only states the equilibrium but also indicates the forces that are operating to bring about the equilibrium.”

Further, as noted in the preceding chapter, Jevons criticised the concept of barter terms of trade as an inadequate measure of the gain from trade.

On the other hand, Professor Graham, though, he agreed with Mill that normally the gain from trade is likely to be divided between the trading countries, opined that, the classical doctrine of gains from trade is only a limited case and not a general one, for the gain from trade will be divided between the two countries only when these are approximately of the same size and when goods produced are almost equally important and consequently each specialises completely in the production of a single good. Further, he stressed that the supply condition rather than demand condition is an important factor in determining international values or terms of trade.

To him, the determination of domestic values. That is to say, international values, like the domestic terms of trade, will be determined by the relative costs of production in the two countries. Graham, therefore, criticised the reciprocal demand aspects of the theory of international value as presented by J.S. Mill and Marshall Edgeworth as being fallacious in their essence.

In his view, they have grossly exaggerated the role of reciprocal demands and totally neglected the comparative cost conditions (which are very important in the long run) in determining the terms of trade.

Viner, however, regards Graham’s criticism as invalid. He points out that “The terms of trade can be directly influenced by the reciprocal demands and by nothing else. The reciprocal demands

in turn and ultimately are determined by the cost conditions, together with the basic utility function. Viner further points out that Graham committed error in his analysis, because he failed to distinguish between the reciprocal demands and the basic utility functions and to see the inclusion of supp conditions in reciprocal demands.

Jacob Viner thus concludes that though, the reciprocal demand analysis is an imperfect attempt it is superior to the other alternatives so far available to describe the phenomena of international values.