EK 4307 chap 2 Salvatore Mercantalist View: The way for a nation to become rich was to export more than it imported. They measure wealth of a nation by the stock of precious metals it possessed. Today, we measure the wealth of a nation by its stock of human, man-made and natural resources available for producing g/s.

Adam Smith's View For 2 nations to trade w each other voluntarily both nations must gain Based on ABSOLUTE ADVANTAGE When one nation is more efficient or has an absolute advantage over another in the production X but is less efficient in producing Y then both nations can gain through specialization Example: U.S produces 6 bushels of wheat/hr and UK produces 1 bushel of wheat/hr. US produces 4 yards of cloth/hour and UK produces 5 yards of cloth/hour Therfore US has absolute advantage over UK in the production of wheat while UK has absolute advantge over US in the production of cloth If US exchanges 6w for 6C, the US gains 2C or saves ½ man-hour of labour time (since US can only exchange 6W for 4C domestically)‏ The 6W UK recives from US would require 6 man-hours to produce in the UK. These same 6-man hours can produce 30C in the UK By being able to exchange 6C for 6W in the US, the UK gains 24C or saves 5 man-hours

David Ricardo Law of comparative advantage Even if one nation is less efficient than the other nation in the production of both commodities there is still basis for mutually beneficial trade UK should specialize in the production and export the commodity in which its absolute disadvantage is smaller and import the commodity in which its absolute disadvantge is greater. Example: U.S produces 6W/hr and UK 1W/hr and U.S produces 4C/hr and UK produces 2C/hr US could exchange 6W for 6C with UK US would gain 2C (save ½ man-hour)‏ 6W that UK receives would require 6 man-hours to produce in the UK, these hours could instead be used to produce 12 C and give up only 6C for 6W from US. Thus UK would would gain 6C or save 3-hours of labour time.

Comparative advantage w money How can UK export anything to the US if it is less efficient in the production of both W and C? Answer: Wages in UK < Wages in US Example: Wages in US $6/hr and UKGBP1/hr In U.S: Pw= $1 and Pc = $1.50 ($6/4C) and in UK Pw= GBP1 and Pc=GBP0.5 (GBP1/2C)‏ If the exchange rate is GBP1=$2 then Pw=GBP1=$2 and Pc=GBP0.5=$1 in the UK Hence the $ price of W in US< the $ price of W in UK and the $ price of C in UK < the $ price of C in US