EC311 - Trade Theories 1

EC311: International Economics
Trade Theories |
Dr. Irfan Ullah
Email: irfanecon@nuist.edu.cn
Office Hours: Monday 08:00-9:40, Wednesday 08:00-
09:40 and Fridays 08:00-09:40
Room: N2013
Spring 2020/21
1
The Mercantilists Views on Trade
The economic philosophy known as Mercantilism which was popular

from the sixteenth to the middle of the eighteenth century in Britain,
Spain, France and the Netherlands maintained that :
 The most important way for a nation to become rich and powerful is
to export more than its imports.
 The difference between its exports and imports is settled by an inflow

of gold and silver. The more gold and silver a nation has, the richer
and more powerful it is.
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 The mercantilists advocated that the government should stimulate

exports and restrict imports.
 Since not all nations could have an export surplus simultaneously and
the amount of gold was fixed at any one time, a nation could gain only
from trade on the expense of another
3
In any event, mercantilists advocated strict government control of all
economic activity and preached economic nationalism because they
believed that a nation could gain in trade only at the expense of other
nations (i.e., trade was a zero-sum game). These views are important for
two reasons. First, the ideas of Adam Smith, David Ricardo, and other
classical economists can best be understood if they are regarded as
reactions to the mercantilists’ views on trade and on the role of the
government. Second, today there seems to be a resurgence of neo-
mercantilism, as nations plagued by high levels of unemployment seek to
restrict imports in an effort to stimulate domestic production and
employment (this is examined in detail in Chapter 9). In fact, aside from
England during the period 1815–1914, no Western nation has ever been
completely free of mercantilist ideas (see Case Study 2-2).
Adam Smith: Absolute Advantage
In 1776, Adam Smith published his famous book ‘’The Wealth of

Nations’’ in which he attacked the Mercantilists’ views on trade. He
advocated instead the free trade as the best policy for the nations of the
world.
 Smith argued that with free trade, each nation could specialise in the
production of those commodities in which it has an absolute
advantage (i.e. produces/exports it with lower cost than others) and
import those commodities in which it has an absolute disadvantage
(i.e. produces it with higher cost than others).
5
 Given the free trade policy, the international specialisation would

result in an increase in the world’s output which can be shared by
the trading nations. Thus, a nation needs not to gain at the expense of
other nations, all nations could gain from trade simultaneously.
Consider the following table:
US UK
Wheat (Bushels/Labour-Hour) 6 1
Cloth (Yards/Labour-Hour) 4 5
6
From this table, it is clear that:
1. The US has an absolute advantage over the UK in the production of

Wheat (i.e. 6 bushels/labour-hour compared with 1 bushel/labour-
hour in the UK).
2. The UK has an absolute advantage over the US in the production of

Cloth (i.e. 5 yards/labour-hour compared with 4 yard/labour-hour in
the US).
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From this table, it is clear that:
3. If the US specialised in the production of wheat and the UK

specialised in the production of cloth, the total production of wheat
and cloth in the US and the UK will be greater than before the
specialisation and trade.
4. In the presence of free trade, the US and the UK can gain from the
international trade by sharing this increase in output in both
commodities.
8
Gains from trade:
US UK
If the US exchanges 6 bushels of wheat (6W) with 6 yards of the British

cloth (6C), the US gains 2C or saves 0.5 hour of labour time.
9
Gains from trade:
US UK
Similarly, the 6W that the UK receives from the US would require six hours
of labour time to produce in the UK. These six hours can produce 30C in
the UK. By being able to exchange 6C for 6W with the US, the UK gains
24C, or saves almost ﬁve labour - hours.
1
0
Smith’s theory faced a lot of criticism such as labour homogeneity

between nations and commodities and the transportation cost.
However, one of the main questions that Smith’s trade theory could not
answer is that, if one nation has an absolute advantage over the
production of both commodities and the other nation has an absolute
disadvantage over both commodities, Does the trade between those two
nations exist? For example:
US UK
10
If one nation has an absolute advantage over the production of both
commodities and the other nation has an absolute disadvantage over both
commodities, Does the trade between those two nations exist? For example:
Is it possible to trade in this case under the absolute advantage theory ?

Thank you

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EC311: International Economics

Dr. Irfan Ullah

The economic philosophy known as Mercantilism which was popular

 The difference between its exports and imports is settled by an inflow

 The mercantilists advocated that the government should stimulate

In 1776, Adam Smith published his famous book ‘’The Wealth of

 Given the free trade policy, the international specialisation would

Consider the following table:

From this table, it is clear that:

1. The US has an absolute advantage over the UK in the production of

2. The UK has an absolute advantage over the US in the production of

From this table, it is clear that:

3. If the US specialised in the production of wheat and the UK

Gains from trade:

If the US exchanges 6 bushels of wheat (6W) with 6 yards of the British

Gains from trade:

Smith’s theory faced a lot of criticism such as labour homogeneity

Is it possible to trade in this case under the absolute advantage theory ?

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