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Lecture 3

ECO230Y1 Lecture Notes - Lecture 3: Mercantilism, Money Supply, Comparative Advantage

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Masoud Anjomshoa

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Mercantilism (1500-1750) (Marxist)
- Back then, people believed that the wealth of a nation included bullion (specie) – the
more gold, the stronger a nation was
- There was the idea that there had to be a winner and a loser
- Positive trade balance: Trade surplus, exporting more than importing, so your nation
would accumulate gold, therefore becoming more militarily capable
- Good government = promoting trade surplus to increase gold
- Colonialism was based on this idea as well; economically exploit nations to increase
- relative labour content: the value of a good is relative to the amount of labour force
used to create that good (this theory is inaccurate, according to prof, because it doesn’t
take demand into account only supply, no role of capital/technology)
Home and Price-Specie Mechanism
- David Hume tries to include the role of demand
- The Price-Specie Mechanism is a “self-correcting” mechanism
- It’s impossible/meaningless to run a trade surplus all the time/forever
- More gold b/c of trade surplus increases the money supply, so people buy more
(because demand increases)
Adam Smith and Absolute Advantage
- If your labour force is more productive, than you are a richer country
- He believed that people were interested solely in maximizing profit, but under
competition you have to be more efficient
- His idea, unlike Marx and Smith, stated that both countries can benefit from trade
Ricardian Model of Trade:
- Argued that Smith was wrong; trade advantage should focus on comparative rather than
absolute advantage
- 2 x 2 x 1 Model (Two Countries/Two Goods modeled, the only production factor being
labour)- In those days, production was based only on labour because labour was the most
important factor, capital/machinery wasn’t as important
- Each country has different labour productivities
- Ricardo says that you don’t have to have absolute advantage, but comparative
- Opportunity Cost: The more of one thing you produce, the less of something else you
can produce, and opportunity costs are created. Opportunity costs deal with the next best
Relative Supply and Demand
- When you are dealing with two goods, define everything relative to the other product
Questions For Chapter 3
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