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Historical development of trade theory

Historical development of trade theory. Mercantilism positive trade balance Absolute advantage (Adam Smith) Countries benefit from exporting what they make cheaper than anyone else Comparative advantage (David Ricardo)

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Historical development of trade theory

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  1. Historical development of trade theory • Mercantilism • positive trade balance • Absolute advantage (Adam Smith) • Countries benefit from exporting what they make cheaper than anyone else • Comparative advantage (David Ricardo) • Nations can gain from specialization, even if they lack an absolute advantage

  2. Absolute & Comparative Advantage Absolute advantage: each nation is more efficient in producing one good Output per labor hour Nation WineCloth United States 5 bottles 20 yards United Kingdom 15 bottles 8 yards Comparative advantage: the US has an absolute advantage in both goods, but UK has comparative advantage in … Output/labor hour Oppty Cost NationWineCloth of Wine United States 40 bottles 40 yards 1 yd/bottle United Kingdom 20 bottles 10 yards ½ yd/bottle

  3. Marginal Rate of Transformation A Slope = MRT = 0.5 B Wheat C

  4. Transformation schedules: constant opportunity costs Comparative advantage Slope = 2.0bu/car = MRT Wheat Wheat Slope=0.5 bu/car=MRT

  5. Trading under constant opportunity costs (terms of trade = 1:1) Comparative advantage Trading possibilities line (terms of trade 1:1) B’ Trading possibilities line (terms of trade 1:1) D’ C’ E Wheat Wheat A’ C A F B D

  6. Consumption gains from trade: constant opportunity costs Before After Net Gain Specialization Specialization (Loss) AutosWheat AutosWheatAutosWheat US 40 40 60 60 20 20 Canada 40 80 60 100 20 20 World 80 120 120 160 40 40

  7. Changing comparative advantage MRT = 0.67 Autos Autos MRT = 0.5

  8. Increasing opportunity costs Trading possibilities line tt (1A =1W) Trading under increasing costs: US tUS (1A = 0.33W) Wheat

  9. Increasing opportunity costs Trading possibilities line B’ C’ tt (1A =1W) D’ Trading under increasing costs: Canada tC (1A = 3W) Wheat A’

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