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CH1&2 - Summarised notes
International Economics (University of the Free State)
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Chapter 1 & 2
Changing degree of economic Favourable/Positive Balance of Trade –
interdependence – refers to the extent to occurs when a country exports more goods and
which different countries or regions are services than it imports
economically interconnected through trade, Mercantilist countries believed that a
investment, and other forms of economic positive balance of trade was essential for
activity their economic success, as it allowed them
Economic interdependence implies that the to accumulate more precious metals and
economic fortunes of one country are linked other resources
to the economic fortunes of others Thus, they sought to achieve a positive
Mercantilism as an Economic System balance of trade by promoting exports and
Mercantilism – was an economic system that restricting imports through tariffs, quotas,
dominated Europe between 1500 – 1700 and other trade barrier
It was based on the idea that a nation's The Role of Government
wealth and power were determined by its Bullionism – means that government controls
stock of gold and silver, which were seen as the use and exchange of precious metals
the most important measures of a country's Under bullionism, the government played a
wealth central role in controlling the flow of
To accumulate gold and silver, mercantilists precious metals, often through policies that
advocated for policies that promoted exports restricted exports and encouraged imports
and limited imports, in order to achieve a In particular, countries attempted to prohibit
favourable or positive balance of trade the export of gold, silver, and other precious
Zero-Sum Game – means the total amount of metals by individuals, and rulers let capital
wealth or resources in a system remains leave the country only out of necessity.
constant, and any gain by one person or group One of the main policies associated with
must be balanced by a corresponding loss by bullionism was trade maximization
another person or group Def – involved promoting exports and
Mercantilist countries believed that limiting imports in order to achieve a positive
international trade was a zero-sum game in balance of trade
which one country's gain was another To achieve this goal, governments often
country's loss imposed tariffs and other trade barriers on
As a result, they focused on promoting imported goods, while offering subsidies
exports and limiting imports to increase their and other incentives to promote exports
own wealth at the expense of other Domestic Economic Policy
countries Mercantilism pursed the regulation of economic
The Labour Theory of Value – held that the activity within the country through the control of
value of a good/service was determined by the industry and labour
amount of labour that went into producing it Comprehensive systems of regulations were
This view implied that wealth could be put into effect utilizing exclusive product
created through the production and export charters, tax exemptions, subsidies etc.
of goods, and that a country's strength was Labour was subject to various controls
based on its ability to produce goods more through craft guilds
efficiently than other countries Mercantilists argued that these regulations
It is relevant to mercantilism because it contributed to the quality of both skilled
suggests that a country's wealth is based on labour and the manufactures such labour
the amount of labour that it can command, helped produce, quality that enhanced the
rather than on the amount of precious ability to export and increased the wealth of
metals or other resources it possesses the country
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Low wages policy was another aspect of Challenge to Mercantilism
mercantilism's domestic economic policy One of challenges of mercantilism is the
Because labour was the critical factor of Price-specie-flow mechanism
production, low wages meant that It suggests that a nation's trade surplus or
production costs would be low and a deficit will lead to corresponding
country’s products would be more inflows/outflows of gold and silver, which will
competitive in world markets then impact the nation's price levels
It was widely held that the lower classes Hume argued that the price-specie-flow
must be kept poor in order to be industrious mechanism was flawed because it assumed
and that increased wages would lead to that the supply of gold and silver was fixed, and
reduced productivity that trade imbalances would be automatically
Because labour was viewed as vital to the corrected through the flow of precious metals
state, governments stimulated population He noted that while a nation with a trade
growth by encouraging large families, giving surplus would receive more gold and silver,
subsidies for children, and providing it would also experience an increase in
financial incentives for marriage prices, which would make its goods more
Mercantilism also placed great importance on expensive and less competitive in the global
saving as a means of funding wars and other market
government activities Conversely, a nation with a trade deficit
Governments often encouraged saving and would experience a decrease in prices,
thrift among the population through the making its goods more competitive and
establishment of savings banks and other potentially correcting the trade imbalance
institutions without the need for a flow of precious
The accumulation of wealth through saving metals
was seen as essential for funding wars, Hume also argued that the price-specie-flow
which were a common occurrence during mechanism could be disrupted by changes in
the mercantilist era the money supply, which could impact prices
and trade balances independently of flows of
precious metals
Today the Classical price-specie-flow
mechanism is seen as resting on several
assumptions
1. There must be some formal link between
money and prices, such as that provided in
the quantity theory of money when full
employment is assumed:
If one assumes that the velocity of money is
fixed by tradition and institutional
arrangements and;
that Y is fixed at the level of full
employment, then any change in the supply
of money is accompanied by a proportional
change in the level of prices
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2. Demand for traded goods is price elastic – This Absolute advantage – refers to a situation
is necessary to ensure that an increase in price where one country or individual is able to
will lead to a decrease in TE for the traded produce a certain good/service more efficiently
goods in question and that a price decrease will than another country or individual
have the opposite effect Basically, countries and individuals should
If demand is price inelastic, the price- specialize in producing goods/services in
specie-flow mechanism will tend to worsen which they have an absolute advantage,
the disequilibrium in the trade balance and trade with others to obtain goods or
However, demand elasticities tend to be services that they cannot produce as
greater in the long run than in the short run efficiently
as consumers gradually adjust their
behaviour in response to price changes
3. Perfect competition in both product and factor
markets is assumed in order to establish the Comparative advantage – refers to a situation
necessary link between price behaviour and where one country or individual has a lower
wage behaviour opportunity cost of producing a certain good or
As well as to guarantee that prices and service than another country or individual
wages are flexible in both an upward and a In other words, even if one country or
downward direction individual can produce all goods more
4. It is assumed that a gold standard exists. efficiently than another, there can still be
Under such a system, all currencies are gains from trade if each specializes in
pegged to gold and hence to each other producing the goods in which they have a
All currencies are freely convertible into comparative advantage and trades with
gold, gold can be bought and sold at will, others
and governments do not offset the impact of
the gold flows by other activities to influence
the money supply
If all of these assumptions are satisfied, the
automatic adjustment mechanism will restore
balanced trade anytime it is disrupted
Another challenge on mercantilist ideas
came in the writing of Adam Smith
Smith perceived that a nation’s wealth was
reflected in its productive capacity (i.e., its
ability to produce final goods and services),
not in its holdings of precious metals
The invisible hand principle – refers to the idea
that individuals pursuing their self-interest in a
free market can unintentionally promote the
general welfare of society as a whole, without
the need for centralized control or direction
Laissez-faire – refers to the idea that
government intervention in the economy should
be minimal, and that markets should be allowed
to operate freely, without excessive regulation
or interference
