chapter 6 Flashcards
mercantilism
it advocated that all countries should simultaneously encourage exports and discourage imports. its echoes remain in modern poltical debate and in trade policies of many countries. the main tenet was that it was in a country’s best interests to maintain a trade surplus and to export more than it imported. it would increase its national wealth, prestige, and power by accumulating gold and silver. the flaw was that it viewed trade as a zero-sum game. it emerged in England in the mid-16th century.
free trade
refers to a situation in which a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country.
Smith
Smith’s theory was the first to explain why unrestricted free trade is beneficial to a country. he argued that the invisble hand of the market mechanism, rather than government policy, should determine what a country imports and what it exports.
Ricardo’s theory of comparative advantage
explains in terms of international differences in labour productivity. showed that it makes sense for a country to specialise in the production of the goods that it produces most efficiently and buy the goods that it produces less efficiently, even if this means buying goods from other countries that it could produce more efficiently itself. it suggests that potential world production is greater with unrestricted free trade. it views trade as a positive-sum game in which all countries participate realise economic gains. thus, it encourages free trade.
Heckscher-Ohlin theory
emphasises the interplay between the proportions in which the factors of production (such as land, labour, and capital) are available in different countries and the proportions in which they are needed for producing goods. it argues that comparative advantage arises from differences in national factor endowments.
new trade theory
stresses that in some cases, countries specialise in the production and export of products, not because of underlying differences in factor endowments but because in certain industries the world market can support only a limited number of firms. in such industries, firms that enter the market first can build a competitive advantage that is difficult to challenge. thus the observed pattern of trade may be due to the ability of firms within a nation to capture first-mover advantages. it focuses on the important implication of the ability to attain economies of scale.
zero-sum game
trade where a gain by one country results in a loss by another. Smith and Ricardo showed the limitations of this approach and demonstrated that trade is a positive-sum game, or a situation in which all countries can benefit.
absolute advantage
when the production of a product in a country is more efficient than any other country producing it.
production possibility frontier (PPF)
shows the different combinations that a country can produce of two types of goods.
constant returns to specialisation
assumes that the units of resources required to produce a good are assumed to remain constant no matter where one is on a country’s PPF.
diminishing returns to specialisation
occur when more units of resources are required to produce each additional unit. they imply a convex PPF, rather than a straight line as depicted in a simple comparative advantage model.
Paul Samuelson’s critique
when a rich country enters into a free trade agreement with a poor country that rapidly improves its productivity after the introduction of a free trade regime, the lower prices that rich consumers pay for imported goods, may not be enough to produce a net gain for the rich economy if the dynamic effect of free trade is to lower real wage rates in the rich country.
factor endowments
the extent to which a country is endowed with such resources as land, labour, and capital. nations have varying factor endowments, and different factor endowments explain differences in factor costs. specifically, the more abundant a factor, the lower its cost.
Leontief paradox
based on the Heckscher-Ohlin theory, Leontief argued that because the US was abundant in capital, they would be an exporter of capital-intensive goods and an importer of labour-intensive goods. however, the US exports were found to be less capital intensive than US imports.
Product Life-Cycle Theory
proposed by Vernon based on the observation that in the 20th century, a very large proportion of the world’s new products had been developed by US firms and sold first in the US market. this was explained by the wealth and size of the US market, which gave US firms incentive to develop new consumer products. also, the high cost of US labour gave US firms incentive to develop cost-saving process innovations. however, this now seems ethnocentric and increasingly dated.
