Chapter 2 Flashcards
(20 cards)
What was the mercantilist trade philosophy? (1500-1800)
Emphasized accumulating gold and silver through a favorable trade balance (more exports than imports) to boost national wealth and employment
Mercantalist tools:
Advocated heavy government intervention, tariffs, quotas, and regulations- to restrict imports and protect the domestic industry
What was David Hume’s criticism? What did his price-specie-flow doctrine show?
Showed that trade surpluses increase domestic prices, reducing exports and increasing imports, making long-term surpluses unsustainable
What did Adam Smith’s Revolution argue?
Argued in The Wealth of Nations (1776) that wealth is not fixed; trade increases global output via division of labor and specialization
What is the idea of absolute advantage (Smith)?
A country benefits from trade if it can produce a good using fewer labor hours than another country. A country should export goods that it produces more efficiently
What is the Labor Theory of Value (Smith)?
Costs determined by labor hours required- Assumes labor is the only factor of production and homogeneous (every worker produces the same amount of work) within each country
Why did Ricardo invent comparative advantage?
Developed because some nations may have an absolute advantage in all goods; so Ricardo showed that trade is beneficial even in this case
What is comparative advantage, defined?
A country should specialize in goods for which it has the lowest opportunity cost, even if it’s less efficient in absolute terms
What are Ricardian assumptions when the idea of comparative advantage is suggested?
That there are two countries, two goods, only labor as input, constant technology, no transportation costs, free trade, and balanced trade
What is the result of the Ricardian model?
Both countries can gain by specializing in the product with the lowest opportunity cost (for them)- even if one country is better at producing everything
What does the Production Possibilities Frontier (PPF) show?
Shows different combinations of goods a nation can produce using all resources efficiently; illustrates trade-offs
What is the Marginal Rate of Transformation (MRT)?
Slope of the PFP; represents the opportunity cost of one good in terms of the other (e.g. how many autos per bushel of wheat)
What is the constant opportunity cost case?
It is a straight-line PPF; assumes resources are perfectly substitutable across industries and identical in quality
When thinking of the basis and direction of trade, we know a country with a lower MRT for a good exports that good. Give an example
U.S. exports autos (lower MRT), Canada exports wheat (higher MRT)
What are the gains from specialization (production)?
With specialization, both countries produce more total goods than under autarky (doing it alone); net global output increases
What are the gains from trade (consumption)?
Allows countries to consume beyond their PPF’ post-trade consumption points lie outside the production frontier
Define Terms of Trade (TOT):
The rate at which one good is exchanged for another between nations; the equilibrium TOT lies between each country’s domestic cost ratio
What is the theory of reciprocal demand?
TOT is determined by the relative demand of each country for the other’s goods; stronger demand yields better trade terms
Do small or big nations gain more from trade?
Small nations often gain more from trade; larger countries get less favorable terms because their demand dominates
