Econ 4130
Topic 10: The Transition Period
I. The Free Trade Era in Europe. During the mercantilist era, trade was seen as a zero-sum game: one country’s gain was another country’s loss. If Spain imported more from England that she exported to England, she had to send specie to England to make up the difference. In the mercantilist view, this was viewed as a loss for Spain and a gain for England. So, countries established policies to encourage favorable trade balances: they subsidized export industries and restricted imports through tariffs and quotas.
The foundation of modern trade theory though was provided by David Ricardo (1772-1823) in his Principles of Political Economy (1819).
A. Ricardo and comparative advantage.
Suppose there are only two countries, Portugal and England and two goods, wine and corn. The following table provides the yield per acre for each good in each country:
Portugal England
Wine 30 jugs 15 jugs Corn 60 bushels 45 bushels
1. Portugal can produce more of both goods per acre than can England. So Portugal has the absolute advantage in both goods: for a given amount of inputs, Portugal can achieve higher output in wine (or corn) than can England.
2. Comparative advantage is determined by the “price” of one good in terms of the other good within each country.
3. Law of comparative advantage: A country in its trade with another country will export the good at which it has a comparative advantage in producing and import the good in which it has a comparative disadvantage in producing. By trading along the lines of comparative advantage, both countries can experience gains.
So by trading with each other, both countries are able to push out their consumption frontiers. The aggregate consumption of both goods can increase.
B. Where does a country’s comparative advantage come from?
1. Technology differences.
2. Hecksher-Ohlin theory of comparative advantage. Two Swedish
I. The Free Trade Era in Europe. During the mercantilist era, trade was seen as a zero-sum game: one country’s gain was another country’s loss. If Spain imported more from England that she exported to England, she had to send specie to England to make up the difference. In the mercantilist view, this was viewed as a loss for Spain and a gain for England. So, countries established policies to encourage favorable trade balances: they subsidized export industries and restricted imports through tariffs and quotas.
The foundation of modern trade theory though was provided by David Ricardo (1772-1823) in his Principles of Political Economy (1819).
A. Ricardo and comparative advantage.
Suppose there are only two countries, Portugal and England and two goods, wine and corn. The following table provides the yield per acre for each good in each country:
Portugal England
Wine 30 jugs 15 jugs Corn 60 bushels 45 bushels
1. Portugal can produce more of both goods per acre than can England. So Portugal has the absolute advantage in both goods: for a given amount of inputs, Portugal can achieve higher output in wine (or corn) than can England.
2. Comparative advantage is determined by the “price” of one good in terms of the other good within each country.
3. Law of comparative advantage: A country in its trade with another country will export the good at which it has a comparative advantage in producing and import the good in which it has a comparative disadvantage in producing. By trading along the lines of comparative advantage, both countries can experience gains.
So by trading with each other, both countries are able to push out their consumption frontiers. The aggregate consumption of both goods can increase.
B. Where does a country’s comparative advantage come from?
1. Technology differences.
2. Hecksher-Ohlin theory of comparative advantage. Two Swedish