Notes On International Economics - Assignment Example

s on International Economics Section 2 Mercantilism Introduction The school of thought composed of highly nationalists who were against free trade during 17th and 18th centuries is commonly known as mercantilism. Key Points Mercantilists believed in followings: Foreign trade including all other economics activities should be controlled by the state. Trade should not be privatized because in this case people can waste the precious metals by importing commodities like sugar and Lenin, etc. When import level will increase, the favorable trade balance could not be attained. They deemed bullion i.e. gold and other precious metals a medium of exchange. They believed in favorable trade balance which is obtained only if the receipts from foreign trade are more than the expenditures on imports. Production was based on the notion of protecting high quality goods along with low cost. The reason behind this production regulation was the attainment of strong position in foreign markets. Mercantilism declined with the arrival of the Industrial Revolution and of laissez-faire. Henry VIII, Elizabeth I, Oliver Cromwell and Jean Baptiste Colbert advocated mercantilism in the Great Britain and France respectively. The examples of successful mercantilist policies are the creation of a skilled industrial population and a large shipping industry In England. Holland was the principal rival of England but it was demolished by a series of Navigation Acts England. Mercantilist view point of international economics was very strict which is why it is also referred as a theory of economic war. This is so because they believed in a static international economic relations which means one can only gain if the other losses. Criticism Mercantalism are criticized on the following grounds: One of the loopholes of the mercantilist policies was the production of an oversupply of money which was responsible for severe inflation. Adam Smith criticized mercantilism on the point that the nations can never gain simultaneously by following mercantilist policies because the export of one is the import of the other country. David Hume criticized mercantilism on the point that the attainment of favorable trade balance is impossible. The explanation of Hume’s criticism is given below: In case of superfluous trade Surplus trade balance → increase in gold receipts →price level moves up →comparative advantage drop off →X decline →Surplus removed In case of deficit trade balance Deficit trade balance → gold receipts moves down →price level decrease →comparative advantage gain →X increased → Deficit removed Adam’s Smith Theory of Absolute Advantage Introduction Adam smith was the pioneer of classical economics who for the first time explained the term absolute advantage in the context of international economics in 1776. His theory of absolute advantage is based on a notion that the country should only manufacture and specialize in the goods which it can produce with the lower cost. Adam smith was a great proponent of free trade. His views of international trade are based on labor division and international specialization. Assumptions There is no transportation cost. Two countries model. Two goods model. The production shows constant returns to scale. It is assumed that there are no trade barriers. The only factor of production is labor. No mobility of factors of production outside the countries. Explanation of Theory via example Assume that there are two countries i.e. UK and USA which are trading two goods i.e. wheat and cloth internationally. UK produces wheat by hiring 10 labors whilst US has an advantage to produce the same amount of wheat by employing 6 labors. On the contrary US have to engage 10 labors for the production of 1 unit of cloth whilst the same amount of cloth can be produced by hiring only 6 labors in UK. The above statistics reveal that US has labor specialization in the production of wheat and UK specialize in the production of cloth. This situation leads to trade between US and UK for wheat and cloth respectively. According to Smith’s theory of trade US should export wheat whilst UK should export cloth if they want to gain from the trade. Criticism Smith did not give any idea about the settlement of terms of trade (TOT) between US and UK by saying that it is the matter of demand side. Section: 3 Ricardo’s Theory of Comparative Advantage Introduction David Ricardo presented his theory of comparative advantage in 1817.He proposed that to get the benefit from international trade following condition needs to be satisfied: Absolute advantage of a country ‘A’ in the production of two goods and an absolute disadvantage of the country ‘B’ in the production of the same two commodities. Explanation of Theory with the help of statistical example Assume that there are two countries i.e. Portugal and UK trading in two goods i.e. wine and cloth. The production statistics of both countries by employing labor is given below: Country Goods Wine Cloth Portugal 80 labors 90 L UK 120 L 100L Portugal has absolute advantage in wine and cloth production over UK. According to the theory UK will export cloth because its absolute disadvantage is less here as compared to the production of wine. Contrarily Portugal should export wine as its absolute advantage in case of wine is greater comparatively. Production and consumption in Autarky Before trade production of wine requires 120 labors whilst cloth’s production involves 100 labors which means production of cloth is cheaper in UK. This is so because 1 unit of wine will cost 1.2 (120/100) units of cloths. More precisely, with a labor UK can either produce 1 unit of wine or 1.2 units of cloth. The situation is reverse in Portugal as it has absolute advantage in the production of both goods. However, the production of wine is cheaper as compared to the cloths’. This is so because 1 unit of wine cost 0.89 units of cloth. After trade production + Consumption If price ratio of 1: 1 is settled after trade then it will benefit both countries because UK will be able to get 1 unit of wine by offering 1 unit of cloth. However, in her country UK has to produce 1 unit of wine at the cost of 1.2 units of cloth. Likewise Portugal will also be benefited by the above stated price ratio as she will be able to get 1 unit of cloth which is more than the domestic production of cloth of 0.89. Wine production in UK International = 1 unit of wine against 1 unit of cloth Domestic = 1unit of wine at the cost 1.2 units of wine (120/100) Cloth production in Portugal International = 1 unit of cloth against 1 unit of wine Domestic = 0.89 (80/90) units of cloth at the cost of 1 unit wine UK gain = Get 1 unit of wine 1. On the same lines, this price ratio is also beneficial for Portugal as she was getting just 0.89 units of cloth (0.89 Read More