International Economics
Chapter 2: The theory of trade
2.1. Introduction
The British corn laws marked the start of the era of free international trade in 1846.
Corn laws = duties on imports of grain (in force in England since the 15th century) Which
established to stabilize the price of wheat. The Corn laws were beneficial for the agricultural
sector since these high prices for grain increased the value of land. The emerging
manufacturing sectors fought for free trade which triumphed in the 19th century.
2.2. Mercantilism
Classic liberalism is often described as the dominant ideology of capitalism. It is associated
with the industrialization of western Europe. Mercantilist economic thinking is a philosophy
of political economy before classical liberalism.
The following features characterized the mercantilist system as it operated before the rise of
free trade in Europe:
- Extensive regulation of imports and exports
Some imports were forbidden, other were subject to high rates of import duty.
- Trade monopolies
Governments permitted only one merchant to sell good in domestic and foreign
markets, this resulted in selling goods without price competition among sellers.
- Smuggling
Large profits were made by traders willing to import and export prohibited goods.
- Colonial empires
It was extremely profitable for European governments to establish colonial empires.
Colonies enabled a European country to control trade with a weaker country. The
colony provided cheap raw materials and a protected market for the manufactured
goods from the European country.
Mercantilism supports governmental influence on trade, such as trade barriers. Tariffs were a
source of revenue for governmental expenditures like the army. They believed import
restrictions would stimulate domestic manufacturing by keeping out foreign competition.
In the 17th century it became apparent that regulations were hindering the growth of domestic
enterprises. The emerging capitalists needed greater freedom of trade to pursue profitable
investments.
Adam Smith published a book, Wealth of Nations in 1776 about this issue and is regarded as
the foundation of modern market economics.
2.3. Adam Smith and absolute advantage
Smith is the first professional economist. His book, Wealth of Nations, is described as the
most profound intellectual achievement of classical liberalism.
The basis of Smith’s criticism of mercantilism was that it enabled certain merchants to enrich
themselves by exploiting monopoly concessions and other extraordinary privileges. Such
activities did not profit the welfare of society.
, What Smith favored was a free market where hard work, enterprise and thrift would be
rewarded. Entrepreneurs would be encouraged to behave in a competitive, efficient and
dynamic manner.
2.3.1 Specialization and exchange
Smith observed the division of labor and its increase of productivity and wealth. Individuals
who specialize in certain activities become more skillful and more productive. But they also
become more dependent on others, which implies exchange of goods. Specialization and
exchange enable everyone to benefit by purchasing goods and services from low-cost sources
of supply. This principle did not just count for members of a society but also for entire
countries. If something could be bought cheaper abroad than it would be to produce
domestically its profitable for the entire country. Trade restrictions would just decrease
welfare for both parties.
There are three powerful ideas to bear in mind:
- A nations wealth depends on its productive capacity
- Laissez-faire is the best way to increase productive capacity, Governments should
remove restrictions and privileges to permit the expansion of industry and trade.
- International trade is mutually beneficial for all trading countries.
2.3.2 Absolute advantage
Smith claimed that a country should specialize in, and export, commodities in which it had an
absolute advantage.
Absolute advantage = when a country can produce a commodity with less labor per unit
produced than its trading partners.
By the same reason it should import commodities in which it has an absolute disadvantage.
Absolute disadvantage = when a country could produce a commodity only with more labor
per unit produced than could its trading partner.
Everyone gains from specialization and exchange, though we may note from the outset that
there is no reason to expect everyone to gain equally.
2.3.3 Labor theory of value
Economist regard labor to be the sole source of value. The quantity of labor put into a
commodity measures the value of the commodity.
Although Smith did not develop a price-related demand schedule he did recognize that
demand for a product should be taken into account. Market demand would determine what
commodities were to be exchanged and the relative amounts to be produced. He also saw the
difference between different workers and therefore he claimed that ‘Labor was alone the
ultimate and real standard by which the value of all commodities can at all times and places
be estimated and compared’
Chapter 2: The theory of trade
2.1. Introduction
The British corn laws marked the start of the era of free international trade in 1846.
Corn laws = duties on imports of grain (in force in England since the 15th century) Which
established to stabilize the price of wheat. The Corn laws were beneficial for the agricultural
sector since these high prices for grain increased the value of land. The emerging
manufacturing sectors fought for free trade which triumphed in the 19th century.
2.2. Mercantilism
Classic liberalism is often described as the dominant ideology of capitalism. It is associated
with the industrialization of western Europe. Mercantilist economic thinking is a philosophy
of political economy before classical liberalism.
The following features characterized the mercantilist system as it operated before the rise of
free trade in Europe:
- Extensive regulation of imports and exports
Some imports were forbidden, other were subject to high rates of import duty.
- Trade monopolies
Governments permitted only one merchant to sell good in domestic and foreign
markets, this resulted in selling goods without price competition among sellers.
- Smuggling
Large profits were made by traders willing to import and export prohibited goods.
- Colonial empires
It was extremely profitable for European governments to establish colonial empires.
Colonies enabled a European country to control trade with a weaker country. The
colony provided cheap raw materials and a protected market for the manufactured
goods from the European country.
Mercantilism supports governmental influence on trade, such as trade barriers. Tariffs were a
source of revenue for governmental expenditures like the army. They believed import
restrictions would stimulate domestic manufacturing by keeping out foreign competition.
In the 17th century it became apparent that regulations were hindering the growth of domestic
enterprises. The emerging capitalists needed greater freedom of trade to pursue profitable
investments.
Adam Smith published a book, Wealth of Nations in 1776 about this issue and is regarded as
the foundation of modern market economics.
2.3. Adam Smith and absolute advantage
Smith is the first professional economist. His book, Wealth of Nations, is described as the
most profound intellectual achievement of classical liberalism.
The basis of Smith’s criticism of mercantilism was that it enabled certain merchants to enrich
themselves by exploiting monopoly concessions and other extraordinary privileges. Such
activities did not profit the welfare of society.
, What Smith favored was a free market where hard work, enterprise and thrift would be
rewarded. Entrepreneurs would be encouraged to behave in a competitive, efficient and
dynamic manner.
2.3.1 Specialization and exchange
Smith observed the division of labor and its increase of productivity and wealth. Individuals
who specialize in certain activities become more skillful and more productive. But they also
become more dependent on others, which implies exchange of goods. Specialization and
exchange enable everyone to benefit by purchasing goods and services from low-cost sources
of supply. This principle did not just count for members of a society but also for entire
countries. If something could be bought cheaper abroad than it would be to produce
domestically its profitable for the entire country. Trade restrictions would just decrease
welfare for both parties.
There are three powerful ideas to bear in mind:
- A nations wealth depends on its productive capacity
- Laissez-faire is the best way to increase productive capacity, Governments should
remove restrictions and privileges to permit the expansion of industry and trade.
- International trade is mutually beneficial for all trading countries.
2.3.2 Absolute advantage
Smith claimed that a country should specialize in, and export, commodities in which it had an
absolute advantage.
Absolute advantage = when a country can produce a commodity with less labor per unit
produced than its trading partners.
By the same reason it should import commodities in which it has an absolute disadvantage.
Absolute disadvantage = when a country could produce a commodity only with more labor
per unit produced than could its trading partner.
Everyone gains from specialization and exchange, though we may note from the outset that
there is no reason to expect everyone to gain equally.
2.3.3 Labor theory of value
Economist regard labor to be the sole source of value. The quantity of labor put into a
commodity measures the value of the commodity.
Although Smith did not develop a price-related demand schedule he did recognize that
demand for a product should be taken into account. Market demand would determine what
commodities were to be exchanged and the relative amounts to be produced. He also saw the
difference between different workers and therefore he claimed that ‘Labor was alone the
ultimate and real standard by which the value of all commodities can at all times and places
be estimated and compared’
