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INTERNATIONAL ECONOMICS CHAPTER 2 (THE LAW OF COMPARATIVE ADVANTAGE) -…
INTERNATIONAL
ECONOMICS
CHAPTER 2
(THE LAW OF COMPARATIVE ADVANTAGE)
Mercantilism
political economy system aims at
generating wealth by limiting imports
encouraging
exports
The belief that rich & powerful just by
exporting more than imports
lead to inflow of bullion
gold & silver is fixed (cannot
have surplus at the same time)
one nation could gain
only at the expense of another
• 3 mechanism used
trade surplus
govt intervention
colonialism
ADAM SMITH THEORY OF
ABSOLUTE ADVANTAGE
Attack the mercantilists view
market forces (dd & ss)
should determine the direction
volume & composition of
trade
Suggest both nation could enjoy higher level of production
& consumption with trade.
A country has an advantage if possible produce more benefits than other countries, use the same amount of resources
profitable trade can occur if the country specialist and export products that have advantages and importing the product has less advantages
ASSUMPTION OF ABSOLUTE ADVANTAGE
Only 2 countries
Only 2 products
Full employment of factors of production
All resources in both countries are homogenous
Perfect mobility of resources
One nation has an absolute cost advantage in one
good while the other nation has an absolute
advantage in the other good
David Ricardo Theory of Comparative
Advantage
A country is said to have a comparative advantage if it has the least cost of opportunity in the production of one of the two products. The country will specialize in these products and will export them
Opportunity cost represent amount of good that has to
be sacrificed when it want to produce
another good
Lower opportunity cost = higher
efficiency in the production of such products.
ASSUMPTIONS OF
COMPARATIVE ADVANTAGE
•Only 2 countries
Only 2 product
• Full employment of factors of production
All resources in both countries are homogenous
Perfect mobility of resources