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Lecture 3
Mercantilism
1. Rise of the modern nations in Europe during 15th and 18th centuries
i. Nations create wealth and power
ii. National security is a top priority
Need strong military
Europe fought many wars
2. Differences
i. Economics International trade
Everyone wins
Positive sum game
Free trade creates income and wealth for all participants
ii. Mercantilism one gains while another loses
Free trade is a myth
Us versus them
The goal is to capture income and wealth
3. Mercantilism state promotes exports and limits imports
i. Creates trade surplus
ii. Causes inflow of money into country, i.e. gold and silver
iii. Could cause inflation
iv. Creates wealth and power
v. Founded colonies
Colonies shipped raw materials to mother country
Mother country shipped manufactured products to colony
Manufactured goods have higher value than raw materials, creating trade suplus for
mother country
4. Expand definition
i. Nations finance industries
ii. Build roads and ports employ workers
iii. Improve record keeping, navigation and shipping
iv. States imported skilled labor to build ships and ports
v. Trade protection - financed by imposing taxes on imports
5. Who benefits?
i. King used the gold to build a strong military
Military is expensive
Wealth allows countries to buy weapons
ii. King granted licenses and permission to industry
Allowed monopolies to form
Allowed exporting firms to export products
Businessmen paid the king for these rights
iii. Gov. bureaucrats expand gov.
iv. Merchants and joint stock companies
6. Does mercantilism work?
o Japan was devastated after WWII and became the second largest economy within one
generation
o Asian tigers and China
o Price-specie-flow doctrine
Works only in short run
Large flow of money into economy causes inflation
Higher prices reduce exports and increases imports
Soybeans 50 > 20
Laptops 6 < 10
o World gains from free trade
U.S. produces soybeans, while China produces laptops
Thus, the U.S. exports soybeans and imports laptops
Free commerce makes nations efficient
Encourage innovation
o Problem What if a country has an absolute advantage in all trade?
No incentive to trade
U.S. has higher productivity than China
Soybeans 50 > 20
Laptops 20 > 10
2. Law of Comparative Advantage (David Ricardo) - a country produces a product that has a relative
cost advantage
o Countries with absolute advantage still have an incentive to trade
o Opportunity cost to produce one more unit of soybeans, a country gives up production
on laptops
Industries shift resources, like labor, capital, materials, etc. from one industry to
another
o Divide productivity of one product by the productivity of another
Tomatoes (max) 50 60
2. Draw the PPCs
o Comparative advantage
o Opportunity cost is slope of the line; also called the marginal rate of transformation (MRT)
North-South Dilemma
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