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IPPTChap002.pptxCHAPTER 2:
Early Trade Theories: Mercantilism and the Transition to the Classical World of David Ricardo
Copyright © 2014 by the McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
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Learning Objectives
Describe the basic concepts and policies associated with Mercantilism.
Examine Hume’s price-specie flow mechanism and its challenge to Mercantilism.
Discuss Smith’s concepts of wealth and absolute advantage as foundations for international trade.
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Mercantilism
A collection of economic thought in Europe during the period between 1500 and 1750.
Mercantilism is often called the political economy of state building.
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The Mercantilist Economic System
A country’s wealth is measured by its holdings of precious metals (specie).
International trade is a zero sum game.
A country should maintain a positive trade balance (that is, export more than it imports).
Mercantilism employed the labor theory of value.
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The Role of Government
“Bullionism”
Substantial regulation of the domestic economy, including
governmental granting of monopolies, and
controls of labor through craft guilds.
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The Role of Government
Policies to ensure low wages, including
policies to discourage importation and encourage exportation, and
policies to discourage exportation of specie.
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The Paradox of Mercantilism
To be rich, a country needed to have a lot of poor people!
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The Challenge to Mercantilism by Early Classical Writers
In the early 1700s, questions began to emerge regarding the logic of mercantilism.
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Hume’s Challenge: the Price-Specie Flow Mechanism
Hume (mid-18th century): maintaining a trade surplus forever is impossible.
Trade surplus inflow of specie
inflow of specie increased Ms
increased Ms higher prices (and wages)
higher prices lower exports and higher imports
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Smith’s Challenge: Absolute Advantage
Smith believed trade to be a positive-sum game.
Countries should export those goods which they can produce efficiently, and import those which they cannot.
If countries trade according to this principle, all will gain from trade (trade will be mutually beneficial).
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Absolute Advantage: An Example
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Absolute Advantage: An Example
Suppose the U.S. and Mexico agree to trade at a ratio of 1B = 4C (or 1C = ¼ B).
Suppose further that Mexico will specialize in blankets and the U.S. in corn.
From the U.S.’s perspective:
Can now buy blankets at a lower price (1B = 6C in autarky, but 1B = 4C in trade).
Can sell corn at a higher price (1C = 1/6 B in autarky, but 1C = ¼ B in trade).
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Absolute Advantage: An Example
From Mexico’s perspective:
Can now sell blankets at a higher price (1B = 5/3C in autarky, but 1B = 4C in trade).
Can buy corn at a lower price (1C = 3/5 B in autarky, but 1C = ¼ B in trade).
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Absolute Advantage: An Example
Bottom line: both countries gain from trade, even if certain industries (blanket industry in U.S., corn industry in Mexico) stand to lose.
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Limits to Smith’s Thinking
If one country has an absolute advantage in the production of both (or all) goods, Smith would say that that country cannot gain from trade.
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Absolute Advantage: The Limits to Smith’s Thinking
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Limits to Smith’s Thinking
If one country has an absolute advantage in the production of both (or all) goods, Smith would say that that country cannot gain from trade.
But David Ricardo’s Principle of Comparative Advantage (1817) took Smith’s work farther: even in the above example, trade can be mutually beneficial!
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Corn
Blankets
U.S.
1 hour/
bu
6 hrs/
bl
Mexico
3 hrs/
bu
5 hrs/
bl
Autarky Price
Ratios (APRs)
1B = 6C,
1C = 1/6B
1B = 5/3C,
1C = 3/5B
Corn
Blankets
U.S.
1 hour/bu
6 hrs/bl
Mexico
3 hrs/bu
5 hrs/bl
Autarky Price Ratios (APRs)
1B = 6C,
1C = 1/6B
1B = 5/3C,
1C = 3/5B
Corn
Blankets
U.S.
1 hour/
bu
5 hrs/
bl
Mexico
3 hrs/
bu
6 hrs/
bl
Autarky Price
Ratios (APRs)
1B = 5C,
1C = 1/5B
1B = 2C,
1C = 1/2B
Corn
Blankets
U.S.
1 hour/bu
5 hrs/bl
Mexico
3 hrs/bu
6 hrs/bl
Autarky Price Ratios (APRs)
1B = 5C,
1C = 1/5B
1B = 2C,
1C = 1/2B
