International Economics: Mercantilism, Trade, and Comparative Advantage
International Economics
Chapter 1: The World of International Economics
World trade in services
The main agreements and legislation on trade in services are seen in the GATT (General Agreement on Tariffs and Trade) and then became the WTO (World Trade Organization) in 1995.
Gradual change in economic interdependence
The relative size of trade is measured in relation to exports compared to its gross domestic product. The increases in the ratio of exports/GDP indicate a very high percentage of the output of goods and services produced within the borders of a country is sold abroad. These increases indicate greater international interdependence and a network of international trade more complex, corresponding to not only commercial goods and services.
Countries experience the economic benefits that accompany the international exchange of goods and services, but also their own economic prosperity depends on the economic prosperity of the world combined. This increases the competition for markets, and countries must adapt their production to new technologies used in the world in order to be consistent with production costs worldwide (be competitive).
Although many times the profit is good, the adjustment costs to obtain a benefit for the countries are very high, so you may end up facing very significant adjustment costs.
As more countries seek economic benefits, the links that accompany global economic and political integration will be stronger.
Chapter 2: First Trade Theories
Mercantilism
Mercantilist economic system
Among the main factors that helped the development of mercantilism were the exploration of geographies, increasing population, the impact on the cultural renaissance, the emergence of the social class of merchants, the discovery of precious metals, the change of conception of religion on earnings and on the accumulation, and the emergence of nation-states.
The mercantilist view was that the economic system had three components: the manufacturing sector, the rural sector, and foreign colonies. They saw the business class as the most important, and they used the theory of value – work, involving an allocation of value to goods depending on the work involved.
Mercantilists emphasized the fact that you had to have more exports over imports; the trade balance should be favorable or positive. This implies that wealth came from the accumulation of precious metals.
The economy was operating at a lower level than full employment, so that increasing the money supply caused a growth in output and full employment, not just inflation.
The role of government
The government’s economic policies under mercantilism were monitoring the use and exchange of precious metals (metals), only allowing the departure of these species when needed.
Governments tried to control exports through specific policies to maximize the likelihood of a positive trade balance and the entry of species. Exports were subsidized, and quotas and high tariffs were imposed on imports of consumer goods. Tariffs on imports of raw materials were low, as they became exportable goods and of high value.
Navigation policies sought to control international trade and maximize the inflow of shipping services; the policy prohibited foreign vessels in local ports market.
Trade policy was focused on controlling the flow between countries and maximizing the input of species from international trade.
Mercantilism and domestic policy
Increased regulation using lists of exclusive products, tax extensions, subsidies, and the granting of special privileges; there was the regulation of production by craftsmen.
The aim was to keep wages related to the social class to which he belonged and the work they performed.
Rich mercantilist nations will consist of large numbers of very poor people.
David Hume: The price-specie mercantilism
Hume argued that the accumulation of gold and wealth through a trade surplus would increase the money supply and hence prices and wages, which reduced the competitiveness of the country in surplus. On the other hand, if the loss of gold for a deficit country would reduce the money supply, prices, and wages and increase their competitiveness.
The movement of species between countries serves as an automatic adjustment mechanism that always seeks to match the value of exports to imports (trade balance = 0).
The price-specie flow mechanism includes 4 classic assumptions:
- Theory of money quantity: MsV = PY, where Ms is money supply, V is the velocity of money (Change of hand), P is the price level, and Y is the real output level. This means that any change in the money supply is accompanied by a change in the price level.
- The demand for traded goods is price elastic; it is necessary to ensure that an increase in price leads to a decrease in the total cost of goods traded.
- It is assumed perfect competition in product markets and factors in order to establish the necessary link between the behavior of prices and wages and equal in mind to ensure that prices and wages are flexible upwards and down.
- Gold standard: under this system, all currencies are tied to gold and thus are tied to each other, all currencies are freely convertible into gold, gold can be bought and sold at will, and governments do not offset the impact of gold flows from other activities to influence the money supply.
Adam Smith and the invisible hand
Smith felt that the wealth of a nation is reflected in its productive capacity, not in the possession of precious metals. Smith believed that if people were free to pursue their own interests, it would lead individuals to specialize and exchange goods based on their own special abilities that provide the best environment for increasing the wealth of the nation.
Smith concluded that countries should specialize and exploit those goods and services which should have an absolute advantage and import those whose business partner had an absolute advantage.
Chapter 3: The Classical World of David Ricardo and Comparative Advantage
Basic assumptions of the Ricardian model
- Each country has a fixed endowment of resources, and all units of each particular action are identical.
- The factors of production are fully mobile between alternative uses within a country. This assumption implies that prices of production factors are equal among alternative uses.
- The factors of production are completely immobile externally, i.e., not move between countries; therefore, the prices of factors may differ between countries by trade.
- The model uses the theory of labor value, which implies that the relative value of an asset is based solely on job content.
- The level of technology is fixed in both countries, although the technology may differ between them.
- Unit production costs are constant; therefore, they imply that the supply curve of a well is horizontal.
- There is full employment.
- The economy is characterized by perfect competition.
- Hence, no government-imposed obstacles.
- The internal transport costs are 0.
- The model is limited to two countries.
Ricardo’s Comparative Advantage
If country A produces a good at a lower cost than country B, the latter should buy it rather than produce it. We then say that country A has a comparative advantage to B. As a result, tariffs have a negative effect on the economy because they deprive consumers of cheap products, and those who produce the good cheaper benefits. Also, it is clear that David Ricardo argued that the value of the property was established from work.
Economic Analysis:
- alx = duty cycle of the product X Factor
- Aly = work of Y
(Alx / aly) < (aL’x / aL’y)
We say that we have a comparative advantage in producing good x.
Provided that:
- (Px / Py) = Relative price of the goods.
(Px / Py) > (alx / aly)
Product X has a comparative advantage to product Y.
As it is determined that we produce the good X, and therefore specialize.
Where:
(Px / Py) = (alx / aly)
We will not have any comparative advantage as well will produce or the other.
Ricardo said that the gains in terms of working time saved by considering the trade essentially as a mechanism to reduce the use of work required to obtain goods since this work involved work effort and costs. Another way of expressing this result is that trade can get more goods for the same amount of work with autonomy.
Comparative advantage and the total trade gains
The comparative advantage exists whenever differ on work requirements between the two goods. This simply means that when work-related requirements are different, the domestic opportunity cost of the two goods is different in the two countries.
For both countries to gain, international terms of trade should be somewhere between the autarky price ratio.
Chapter 4: Extensions and Tests of the Classical Model of Trade
The classical model in monetary terms
The domestic value for each property was calculated by multiplying the labor requirement per unit by the appropriate salary. This helps determine the attractiveness of buying or selling overseas; it does not change the autarky prices.
From this point arises the exchange rate, and you cannot express all prices in a common unit without an exchange rate of the currency country A to country B. Once established the exchange rate can be set any property in a common currency.
If for some reason the terms of trade do not generate a balanced trade, then there is a movement of gold into the country with a surplus of exports from the country with a trade deficit. When this occurs, the flow mechanism price – species will cause prices in the country in surplus and prices increase in the deficit country are reduced. These adjustments will take place until the international terms of trade will generate a balanced trade.
Limits wages and exchange rate
The export status corresponds to the minimum condition for a country to export analyzed:
a1j W1e < A2J W2
Where:
- a1j = labor requirement per unit in the country for good j 1
- W1 = wage in country 1 in the currency of country 1
- e = exchange rate of the currency of country 2
- A2J = work requirement/unit in country 2 for good j
- W2 = wage in country 2 in country 2 currency
Now if we add to the model transport, the boxes would be:
(A1j + trj) / A2J < W2 / W1e; Condition of Export
(A1j + trj) / A2J > W2 / W1e; Condition of Importation