EarlyTradeTheories:MercantilismandtheTransitiontotheClassicalWorldofDavidRicardoChapter2LearningObjectivesDescribeMercantilistconceptsandpolicies.ExamineHume’sprice-specieflowmechanismanditschallengetoMercantilistthought.DiscussSmith’sideasofwealthandabsoluteadvantageasfoundationsofinternationaltrade.MercantilismAcollectionofeconomicthoughtinEuropeduringtheperiodbetween1500and1750.Mercantilismisoftencalledthepoliticaleconomyofstatebuilding.TheMercantilistEconomicSystemAcountry’swealthismeasuredbyitsholdingsofpreciousmetals(specie).Internationaltradeisazerosumgame.Acountryshouldmaintainapositivetradebalance(thatis,exportmorethanitimports).Mercantilismemployedthelabortheoryofvalue.TheRoleofGovernment“Bullionism”Substantialregulationofthedomesticeconomy,includinggovernmentalgrantingofmonopolies,andcontrolsoflaborthroughcraftguilds.TheRoleofGovernmentPoliciestoensurelowwages,includingpoliciestodiscourageimportationandencourageexportation,andpoliciestodiscourageexportationofspecie.TheParadoxofMercantilismToberich,acountryneededtohavealotofpoorpeople!TheChallengetoMercantilismbyEarlyClassicalWritersIntheearly1700s,questionsbegantoemergeregardingthelogicofmercantilism.Hume’sChallenge:thePrice-SpecieFlowMechanismHume(mid-18thcentury):maintainingatradesurplusforeverisimpossible.TradesurplusinflowofspecieinflowofspecieincreasedMs

increasedMs

higherprices(andwages)higherpriceslowerexportsandhigherimportsSmith’sChallenge:AbsoluteAdvantageSmithbelievedtradetobeapositive-sumgame.Countriesshouldexportthosegoodswhichtheycanproduceefficiently,andimportthosewhichtheycannot.Ifcountriestradeaccordingtothisprinciple,allwillgainfromtrade(tradewillbemutuallybeneficial).AbsoluteAdvantage:AnExampleAbsoluteAdvantage:AnExampleSupposetheU.S.andMexicoagreetotradeataratioof1B=4C(or1C=?B).SupposefurtherthatMexicowillspecializeinblanketsandtheU.S.incorn.FromtheU.S.’sperspective:Cannowbuyblanketsatalowerprice(1B=6Cinautarky,but1B=4Cintrade).Cansellcornatahigherprice(1C=1/6Binautarky,but1C=?Bintrade).AbsoluteAdvantage:AnExampleFromMexico’sperspective:Cannowsellblanketsatahigherprice(1B=5/3Cinautarky,but1B=4Cintrade).Canbuycornatalowerprice(1C=3/5Binautarky,but1C=?Bintrade).AbsoluteAdvantage:AnExampleBottomline:bothcountriesgainfromtrade,evenifcertainindustries(blanketindustryinU.S.,cornindustryinMexico)standtolose.LimitstoSmith’sThinkingIfonecountryhasanabsoluteadvantageintheproductionofboth(orall)goods,Smithwouldsaythatthatcountrycannotgainfromtrade.AbsoluteAdvantage:TheLimitstoSmith’sThinkingLimitstoSmith’sThinkingIfonecountryhasanabsoluteadvantageintheproductionofboth(orall)goods,Smithwouldsaythatthatcountrycannotga