x 1HZWUDGHWKHRU\SRUWHU¶VWKHRU\RIQDWLRQDOFRPSHWLWLYHDGYDQWDJH± justifying some limited government
intervention to support the development of certain export-oriented industries
x England, mid 16th century
x ,WLVLQDFRXQWU\¶VEHVWLQWHUHVWVWRPDLQWDLQDWUDGHVXUSOXV± export more than it imports
x Accumulate $$, increase national wealth, prestige, power
x Advocates government intervention to achieve a surplus in the balance of trade
x No virtue in large volume of trade, recommended policies to maximize exports and minimize imports ± imports
limited by tariffs and quotes, exports were subsidized
x Flaw: viewed trade as a zero-sum game (one in which a gain by one country results in a loss by another)
x Adam smith and David Ricardo showed how this approach was short-sighted and demonstrated that trade is a
positive-sum game, where all countries can benefit
x Mercantilism is not dead
x Neo-mercantilists equate political power with economic power, and economic power with a balance-of-trade
x Many nations have adopted a neo-mercantilist strategy that is designed to simultaneously boost exports and
limit imports ± ex. China ± deliberately keeping its currency low against the US dollar in order to sell more
goods to the US, therefore getting a trade surplus and foreign exchange reserves.
x Adam smith argued that countries differ in their ability to produce goods efficiently.
manufacturers. Due to favourable climate, good soils, and accumulated expertise, the FrencKZHUHWKHZRUOG¶V
most efficient wine producers.
o The English had an absolute advantage in the production of textiles, the French had an absolute
advantage in the production of wine
o Country has an absolute advantage in the production of a product when it is more efficient than any
other country in producing it.
x Countries should specialize in the production of goods for which they have an absolute advantage, and then
trade these for goods produced by other countries
x Country should never produce goods at home that it can buy at a lower cost from other countries
x By specializing in the production of goods in which each has an absolute advantage, both countries benefit by
engaging in trade
x Production possibility frontier PPF ± graph that shows the different combinations of goods that a country can
produce given the inputs required and the total resources available
o If neither country trades with any other, each country must divide its resources to produce
everything it needs, can produce much less of everything
o If they focus on producing what they do best, they can make much more and export that which they
x As a result of specialization and trade, output of both products is increased, consumers in both nations are able
to consume more Æ therefore trade is a positive-sum game, produces net gains for all involved
absolute advantage in the production of all goods
x Makes sense for a country to specialize in the production of those goods that it produces most efficiently, and to
buy the goods that it produces less efficiently from other countries, even if this means buying goods from other
countries that it could produce more efficiently itself. Æ Without trade, combined production is lower; each
country must consume what it produces. With trade, two countries can increase their combined production of
goods, and consumers in both nations can consumer more of both goods.
The Gains from Trade
x If each country produces what they have the comparative advantage at producing, this increases output.
x Combined output of both countries is increased.
x Both countries benefit - consumption in both countries can increase as a result of specialization and trade
x Potential world production is greater with unrestricted free trade than it is with restricted trade
x 5LFDUGR¶VWKHRU\VXJJHVWVWKDWFRQVXPHUVLQDOOQDWLRQVFDQFRQVXPHPRUHLIWKHUHDUHQRUHVWULFWLons on trade,
even in countries that lack an absolute advantage in any good