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Chapter 2: International Trade Theory Basis for Trade: The forces that give rise to trade between two nations; A.A. (Smith) or C.A. (Ricardo) Gains from Trade: The increase in consumption in each nation resulting from specialization in production and trading. Pattern of Trade: The commodities exported and imported by each nation. Views on Trade: Mercantilist: 17 th and 18 th century The way for a nation to become richer was to restrict imports and stipulate exports Trade was a zero-sum game where one nation could gain only that the expense of another nation o Export more than import

Wealth was the stock of precious metals possessed by a country; only obtainable by; export more and import less to gain wealth o Extractions from naturally occurring stocks – limited to few countrys o Earn precious metals through exports of goods and services as a result of payments inflow and limiting the importation of goods that would cause and outflow of precious metals. o The greater the stock of precious metals, the greater the flow of goods and services to satisfy human wants, and the higher the standard of living in the nation. Strict governmental control over economic activity to ensure a positive trade balance and economic nationalist policies Issues: o Gold and other precious metals are a limited fixed resource and trades would require one party to be a loser, while the other benefits. o A view of a group of merchants, bankers, government officials, and philosophers. Views of rulers who required precious metals to extend their spheres of domestic and global influence. Absolute Advantage – Adam Smith: The greater efficiency that one nation may have over another in production of a commodity o Voluntary trade requires both parties to gain from the trade – Smith o When one nation is more efficient than another in the production of a commodity but is less efficient than the other nation in producing a second commodity; then both nations can benefit by specializing in the production of the commodity in which they have absolute advantage and exchange them for the commodity the do not. o Laissez-faire: The policy of minimum government interference in or regulation of economic activity Idea was that free trade will lead to the most efficient use of world resources and would maximize the world welfare. Comparative Advantage – David Ricardo; our usual measure of trade A nation should specialized in and export the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage), where is has the lower opportunity cost of producing said commodity, and should import the

other commodity o Even if one nation has an absolute advantage in both commodities; it is still generally mutually beneficial to trade...