© 2001 J. Douglass Klein Smith, Chapter II 1.Discuss the relationship between the British and American corn industries. (Note: As used here, "corn" is an old British term meaning "grain", including wheat, oats, etc.) 2. What is Smith's invisible hand? (This is one of the most often quoted parts of the Wealth of Nations.) 3.Why do British cattle farmers have protection from imports, even without tariffs? 4. Summarize Smith's two justifications, and two other possible justifications for imposing or continuing a tariff. 5. What does Smith have to say about the mobility of the factors of production, especially labor? 6. Why is mobility important to Smith's ideas?

© 2001 J. Douglass Klein The Invisible Hand “[B]y directing [his] industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this … led by an invisible hand to promote an end which was no part of his intention.” (423) “The statesman, who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which … would no-where be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.” (423)

© 2001 J. Douglass Klein The Capacity of an Economy “The general industry of the society never can exceed what the capital of the society can employ.” (421) “No regulation of commerce can increase the quantity of industry … beyond what its capital can maintain.” (421) “It can only divert a part of it into a direction into which it might not otherwise have gone; and it is by no means certain that this artificial direction is likely to be more advantageous to the society than that into which it would have gone of its own accord.” (421)

© 2001 J. Douglass Klein Production Possibilities Frontier Corn Woolens Britain A How do economists evaluate the gains from trade?

© 2001 J. Douglass Klein Gains from Trade Corn Woolens Britain A Corn Woolens North America C A country is said to have a comparative advantage in producing a good if it is relatively more efficient in producing that good. Which country has a comparative advantage in producing which good? How do you know?

© 2001 J. Douglass Klein Gains from Trade Corn Woolens Britain A Corn Woolens North America C The marginal rate of transformation ( MRT ) between two goods is the rate at which production of one good can be shifted to production of the other along the PPF (i.e., assuming that all resources remain fully employed). What is the MRT of woolens into corn in each country?

© 2001 J. Douglass Klein Gains from Trade Corn Woolens Britain A Corn Woolens North America C A trade is called Pareto Optimal or Pareto Efficient if it leaves everyone at least as well off, and no one worse off than before the trade.

© 2001 J. Douglass Klein 5. Explain some of the differences between the northern and southern American Colonies. “…our northern settlements, we have found, are full of farmers, fisherman, seamen; -but no planters. This is precisely the case with Britain herself; consequently a rivalry between them must inevitably take place.” (p. 96) “American corn cannot come to an European market without doing mischief to the corn trade of England” (p. 97) Under what circumstances will there be the greatest gains from trade?

© 2001 J. Douglass Klein Gains from Trade Specialize and trade If countries specialize in those goods in which they have a comparative advantage, and then trade with countries specializing in other goods, all countries can consume outside their individual production possibilities. This kind of trade is Pareto Optimal -- EVERYONE GAINS Can you suggest a way that trade between the two economies could clearly make consumers in both economies better off? Link to: Gains from Trade worksheetGains from Trade worksheet

© 2001 J. Douglass Klein Gains from Trade Corn Woolens Britain A Corn Woolens North America C Can you suggest a way that trade between the two economies could clearly make consumers in both economies better off? Specialize and trade -- Who should specialize in what? A’ C’ The exchange rate should be between the two MRTs (between 2.5 and.5)

© 2001 J. Douglass Klein Freedom to Choose “It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.” (424) “By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be bought from foreign countries.” (425)

© 2001 J. Douglass Klein Justifications for Protection??? GENERALLY 1. National Defense. (429) 2. When the same domestic product is taxed. (431) SOMETIMES 3. Retaliation. (434) 4. Where a tariff has long been in force, and people’s livelihood depends on it. (435) Note the importance of factor mobility.

© 2001 J. Douglass Klein Effects of a Tariff Economics 24 Effects of ProtectionCONNECT TO ECO 24 WEB SITECONNECT TO ECO 24 WEB SITE Consider the British corn industry, and suppose, initially, that there is free trade in corn. The situation for the British corn market and a typical British corn farmer are shown in figure 1, below. The world price of corn is PW. SB is the British domestic supply curve, and DB is British demand for corn. The typical farmer produces qf1, and earns zero economic profit, and British consumers import an amount of corn equal to QD1 - QS1.