1. Lec 1:
Introduction

2. Subject Outline Trade Finance Policy Trade Theory International
Economics
Trade
Policy
Finance

3. Trade Theory Mercantilism Heckscher-Ohlin Stolper-Samuelson
Factor Price Equalisation
Comparative Advantage
Trade
Theory
Trade
Theory
Study Guide 1
Rybzcynski
Absolute Advantage
Immiserising Growth
Mercantilism

4. Theory used to explain and predict. What is International Trade?
Trade Theory
Theory used to explain and predict.
What is International Trade?
Why do nations trade?
What are the gains from trade?
Who gains from trade?

5. Trade Policy Other Trade Policies Regional Trade Agreements Tariffs
International Resource
Movements
Tools of the Trade Policy Analysis

6. Finance Study Guide 3 Weeks 9-12 Exchange Rates Current Account
Deficit
Finance
Study Guide 3
Weeks 9-12
Exchange rate
theorems
Interest Arbitrage

7. Absolute Advantage Mercantilism Trade Theory Week 1 Heckscher-Ohlin
Stolper-Samuelson
Factor Price Equalisation
Comparative Advantage
Trade
Theory
Trade
Theory
Study Guide 1
Rybzcynski
Absolute Advantage
Week 1
Mercantilism
Immiserising Growth

8. Adam Smith - both nations can gain from trade.
Trade Theory
Why do Nations Trade?
Mercantilism - zero sum game - one nation gains at the expense of the other.
Adam Smith - both nations can gain from trade.
Absolute Advantage - each nation should specialise in production of the good which it is most efficient at producing.

9. Assumptions Perfect Competition in Product and Factor Markets (P=MC)
Trade Theory
Why do Nations Trade?
Assumptions
Perfect Competition in Product and Factor Markets (P=MC)
Each Country has a fixed endowment of resources that are fully used and are homogeneous
Technology is Unchanging
No Transportation Costs or barriers to trade
Factors of Production are perfectly mobile between industries but are immobile between countries
2x2x1

10. The way for a nation to become rich
Trade Theory
Why do Nations Trade?
Mercantilism
Thomas Munn ( )
The way for a nation to become rich
and powerful is to export more than
to import

11. Why do Nations Trade? ENGLAND FRANCE Trade Theory Mercantilism Imports
Exports
Exports

12. Introduction
Adam Smith ( )

13. Introduction
David Ricardo ( )

14. International Economics By Robert J. Carbaugh 7th Edition
Chapter 2:
Foundations of modern trade theory

15. Historical development of trade theory
Foundations of trade theory
Historical development of trade theory
Mercantilism
positive trade balance
Absolute advantage (Adam Smith)
Countries benefit from exporting what they make cheaper than anyone else
Comparative advantage (David Ricardo)
Nations can gain from specialization, even if they lack an absolute advantage
Carbaugh, Chap. 2

16. International Trade Theories:
Mercantilism (1500 – 1750):
1. International trade is a zero-sum game:
Static view of world resources:
One’s gains = Other’s losses
2. Wealth: Acquisition of precious metals—gold or silver
Well-being = Accumulating gold
3. Economic growth =Enhancement of power with strong
army, strong navy and merchant marine, and enlargement
of foreign colonies.

17. 4. Productive = maintaining and increasing the power
5. Regulations or restrictions on importable activities
6. Favorable positive trade balance:
Exports > Imports  Inflows of specie (gold)
 Money supply increases
 Stimulates output and
employment
 Economic growth

18. Role of the government and domestic economic policy
Mercantilism :
Role of the government and
domestic economic policy
Control the use and exchange of precious metals (Bullionism)
High tariffs, quotas on imports of consumption goods
Tax exemptions and subsidies to exports
Allows trade monopolies and monopsonies
Pursues low wage policies
Encourage large family, providing financial incentives for marriage and stimulate population growth
Emphasis the important of the merchant class

19. 1. Link between money and price:
David Hume (1752):
Price-Specie-Flow Mechanism
Accumulate specie with internal automatic repercussions.
Assumptions:
1. Link between money and price:
MV = PV; Full employment; Fixed velocity of money
2. Demand for trade goods is price elastic:
Stable equilibrium in trade sector.
3. Perfect competition: product and factor markets
Link between prices and wages (W).
4. Gold standard exists:
Gold is directly linked to money and specie.

20. Exports > Imports Exports < Imports Net inflow of specie
Price-Specie-flow Mechanism:
Trade surplus vis-à-vis Trade Deficit
Country A Country B
Exports > Imports
Exports < Imports
Step 1 :
Net inflow of specie
Net outflow of specie
Step 2 :
Money supply increase
Money supply decrease
Step 3 :
Prices and wages increase
Prices and wages decrease
Step 4 :
Increase in imports &
Decrease in exports
Decrease in imports and Increase in exports
until
Exports = Imports

21. Laissez faire and free trade is a positive-sum game:
Adam Smith (1723 – 1790) 
Laissez faire and free trade is a positive-sum game:
Nation’s wealth  production capacity not
holdings of gold
Economic growth  free environment and self-interest
and competition
Productivity gains  division of labor and specialization
of labor
Mutual beneficial  exchange and free trade

22. Foundations of modern trade theory2
Foundations of modern trade theory

23. Historical development of trade theory
Foundations of trade theory
Historical development of trade theory
Mercantilism
positive trade balance
Absolute advantage (Adam Smith)
Countries benefit from exporting what they make cheaper than anyone else
Comparative advantage (David Ricardo)
Nations can gain from specialization, even if they lack an absolute advantage
Carbaugh, Chap. 2

24. Absolute & Comparative Advantage
Absolute advantage: each nation is more efficient in producing one good
Output per labor hour
Nation Wine Cloth
United States 5 bottles 20 yards
United Kingdom 15 bottles 8 yards
Comparative advantage: the US has an absolute advantage in both goods
United States 40 bottles 40 yards
United Kingdom 20 bottles 10 yards
Carbaugh, Chap. 2

25. Ricardo’s Comparative Advantage in money prices
Cloth (yards) Wine (bottles)
Nation Labor Wage Quant. Price Quant. Price
US 1 hr $20/hr 40 $ $0.50
UK 1 hr £5/hr 10 £ £0.25
UK 1 hr $8 10 $ $0.40
(at $1.6 = £1)
Carbaugh, Chap. 2

26. Transformation schedules
Comparative advantage
Generalizes theory to include all factors, not just labor
Shows combinations of products that can be made if all factors are used efficiently
Slope, or marginal rate of transformation, shows the opportunity cost of making more of one good (how much of one good must be given up to make more of another)
Carbaugh, Chap. 2

27. Marginal Rate of Transformation
Comparative advantage
Marginal Rate of Transformation A
Slope = MRT = 0.5 B
Wheat C
Carbaugh, Chap. 2

28. Transformation schedules: constant opportunity costs
Comparative advantage
Transformation schedules: constant opportunity costs
Slope = 2.0 = MRT
Wheat
Wheat
Slope = 0.5 = MRT
Carbaugh, Chap. 2

29. Supply schedules: constant opportunity costs
Comparative advantage
Supply schedules: constant opportunity costs
S Canada
S US
Bushels of wheat per auto
S US
Autos per bushel of wheat
S Canada
Carbaugh, Chap. 2

30. Trading under constant opportunity costs
Comparative advantage
Trading under constant opportunity costs
Trading possibilities line (terms of trade 1:1) B’
Trading possibilities line (terms of trade 1:1) D’ E C’
Wheat
Wheat A’ C A F D B
Carbaugh, Chap. 2

31. Production gains from specialization: constant opportunity costs
Comparative advantage
Production gains from specialization: constant opportunity costs
Before After Net Gain
Specialization Specialization (Loss)
Autos Wheat Autos Wheat Autos Wheat US
Canada
World
Carbaugh, Chap. 2

32. Consumption gains from trade: constant opportunity costs
Comparative advantage
Consumption gains from trade: constant opportunity costs
Before After Net Gain
Specialization Specialization (Loss)
Autos Wheat Autos Wheat Autos Wheat US
Canada
World
Carbaugh, Chap. 2

33. Complete specialization under constant opportunity costs
Comparative advantage
Complete specialization under constant opportunity costs
S Canada
S US
Aa’ Aw
Bushels of wheat per auto
S US
Autos per bushel of wheat
S Canada Aa
Aw’
Carbaugh, Chap. 2

34. Changing comparative advantage
MRT = 0.67
Autos
Autos
MRT = 0.5
Carbaugh, Chap. 2