The classical theory of international trade deals with three problems:
(i) The condition for international trade, i.e., under what conditions the trade between two countries is possible?
(ii) The determination of the direction of trade, i.e., which commodity a country will export and which it will import? And
(iii) The determination of terms trade, i.e., at what rate the commodities will be exchanged in the international trade?
Adam Smith and Ricardo concentrated on the first and second question, while the third question is left to be taken up by J.S. Mill. Later on economists like Cairnes, Bastable, Taussig, Haberler, etc. introduced many modifications to theory.
The classical theory of international trade is the comparative cost theory which states that a country, in the long run, will tend to specialise in the production of and to export that commodity in whose production it experiences comparative cost advantage and import that commodity in whose production it experiences comparative cost disadvantage.
In order to know the comparative cost advantage, we have to compare cost ratios and not costs and it matters little whether we compare the cost ratios of two commodities in one country or of one commodity in two countries.
Specialisation and trade, according to the comparative cost principle, will not only make all the trading countries better off but also maximise the world production through international division of labour.
The classical theory of international trade on the following assumptions:
(i) Labour is the only factor of production and the value of a commodity is proportional to the quantity of labour required in its production.
(ii) All labour units arc homogeneous, i.e., all the labourers are equally efficient.
(iii) Since there is a single factor of production, commodities are produced at constant costs.
(iv) Under the constant cost conditions, prices are determined by supply and the changes in demand have no effect on them.
(v) Factors of production are perfectly mobile within the country but completely immobile among countries.
(vi) There is free trade and government does not interfere in trade.
(vii) There are no transportation costs.
(viii) There is perfect competition in both commodity and factor markets.
(ix) The theory is based on two countries – two commodity model.
(x) The two countries have common monetary standard and the quantity theory of money is considered valid.
In order to understand the classical theory of international trade more clearly, three types of cost differences are to be distinguished: (a) equal cost difference, (b) absolute cost difference, and (c) comparative cost difference.