BITS Pilani

presentation
BITS Pilani
Hyderabad Campus

Tanay Kumar
Fractalink Design studio

BITS Pilani
Hyderabad Campus

Course No. ECON C372- International Trade

and BoP- Lec-3
Date: 12.1.2013

CHAPTER 2
The Law of Comparative Advantage
Learning Objectives

1. What is the basis for trade and what are the gains from
trade?
2. What is the pattern of trade? That is, what commodities are
traded and which commodities are exported and imported by
each nation?

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The Mercantilists Views on Trade

During 17th and 18th centuries group of men wrote essays and
pamphlets on international trade that advocated an economic
policy known as mercantilism.
According to this view, nations become rich and powerful was
to export more than imported.
The resulting export surplus would than be settled by an inflow
of bullion, or precious metals, primarily gold and silver.
Thus the government had to all, in its power to stimulate the
nations exports and restrict nations imports.

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Munns Mercantilistic Views on Trade

Thomas Mun (17 June 1571 21 July 1641) was an English writer
on economics who has been called the last of the early
mercantilists. He was among the first to recognize the
exportation of service, or invisible items, as valuable trade,
and made early statements strongly in support of capitalism
Thomus Munn (1571-1641) was perhaps the most influential of
the mercantilist writers, and his Englands Treasure by Foreign
Trade was outstanding exposition of mercantilist thought on
trade.

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Following is the excerpt from Munns writing .. We must ever

observe this rule; to sell more to strangers yearly than we
consume of theirs value. For that part of our stock
[exports] which is not returned to us in wares [imports] must
necessarily be brought home in treasure [bullion]
Mercantilism was the dominant school of thought in Europe
throughout the late Renaissance and early modern period
(from the 15th to the 18th century).

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Mercantilism encouraged the many intra-European wars of the

period and arguably fueled European expansion and
imperialism both in Europe and throughout the rest of the
world until the 19th century or early 20th century.
England began the first large-scale and integrative approach to
mercantilism during the Elizabethan Era (15581603).
An early statement on national balance of trade appeared in
Discourse of the Common Weal of this Realm of England,
1549: "We must always take heed that we buy no more from
strangers than we sell them, for so should we impoverish
ourselves and enrich them.

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Trade Based on Absolute advantage

Introduction
While the mercantilists believed that one nation could gain only
at the expense of another nation and advocated strict
government control of all economic activity and trade,
Adam Smith believed that all nations would gain from free trade
and strongly advocated a policy of Laissez-faire (little
government interference).
According to him, free trade could cause world resources to be
utilised most efficiently and would maximise world welfare.

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According to Adam Smith, trade between two nations is based

on absolute advantage. When one nation is more efficient
than another in the production of one commodity but less
efficient than the other nation in producing the a second
commodity then both nations can gain by each specializing in
the production of the commodity in which they have absolute
advantage.
By this process, resources are utilized in the most efficient way
and output of both commodities will rise.

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ILLUSTRATION OF ABSOLUTE ADVANTEAGE

Absolute advantage

Wheat (bushels/man-hour)
Cloth (yards/man-hour)
If US exchanges 6 W = 6C
US gains 2C or man-hour
UK gains 24C or 5 man-hours

U.S
6
4

U.K
1
5

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After trade assuming that US completely specializes in

wheat and UK specializes in cloth

Wheat (bushels/man-hour)
Cloth (yards/man-hour)

U.S
12
0
12

U.K
0
10
10

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