Foreign Trade

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CHAPTER T W O

2

International Economics
Tenth Edition

The Law of Comparative Advantage (Part 1)
Dominick Salvatore
John Wiley & Sons, Inc.

In this chapter:
 Introduction

 The Mercantilists’ Views on Trade  Trade Based on Absolute Advantage: Adam

Smith  Trade Based on Comparative Advantage: David Ricardo  Comparative Advantage and Opportunity Costs  The Basis for and the Gains from Trade under Constant Costs

Introduction
 Basic questions:  What is the basis for trade?


What determines which country exports each good?



What are gains from trade?


What benefits do countries get from international trade? Which goods are exported/imported by each country?



What is the pattern of trade?


 Assume two-nation, two-good world

The Mercantilists’ Views on Trade
 Mercantilism


Economic philosophy in 17th and 18th centuries, in England, Spain, France, Portugal and the Netherlands.
Belief that a nation could become rich and powerful only by exporting more than it imported. A nation’s wealth is measured by the amount of precious metals it owns.





The Mercantilists’ Views on Trade
 Mercantilism

 



Export surpluses bring inflow of gold and silver. Trade policy was to encourage exports and restrict imports. Mercantilists advocate excessive government intervention to impose this trade policy. Trade is a zero-sum game: One nation gains only at the expense of another. In other words, mutual benefits from trade are impossible!

The Mercantilists’ Views on Trade
 Mercantilists measured the wealth of a nation

by the stock of precious metals it possessed.
 Today, we measure wealth of a nation by its

stock of human, man-made and natural resources available for producing goods and services.

Trade Based on Absolute Advantage: Adam Smith
 A nation has absolute advantage over…...

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