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International Economics
Test 1- classical and neoclassical trade theory (chapters 1-7)
Undergraduate 4

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Nature of Merchandise Trade

  • countries are more interdependent
  • industrialized countries dominate the world
  • Commodity composition of trade is 75% of trade.
  • decling importance of primary markets-- esp in developing countries, it makes them difficult for them to obtain gains from growth.
  • D for primary markets tends to be less responsive to income growth and more likely to demonstrate P fluctutations.
US international Trade
  • Canda-- mvp geographically
  • Nafta partners
  • China
  • 43.5% of US trade deficit can be traced to China, Canada and Japan
  • agriculture is single largest export
World service in trade
  • Sercive count for largest share of income in industrialized countries
  • commercial services, Investment Incomce, gov services
  • hard to contain acc. estimates (prob. underestimated)
Changing Degree of Economic interdependence
  • increase in X/GDP ratio indicate a higher % of output of final goods are produced in the country-- sold abroad
  • more interdependent
  • more complex trade network emcompasing C goods, K goods, intermediate goods, primary goods and communal services
  • rel. imp. of X has increased in almost all countries
  • means ind. countries can gain from trade
  • greater comp in markets
  • need policy coordination
  • collection of economic thought in Europe in 1500-1750--> political economy of state building
  • national wealth was reflected in holdings of precious metals (specie to maintain war chest)
  • static view of world resources
  • zero sum game
  • labor theory of value
  • postive trade balance (X>M)
  • economy was at less than full employment--> a change in MS would stimulate economy--> generate growth and output
mercantillist view of gov.
  • bullionism- gov controlled the Xchange of precious metals
  • trade monopolies (Dutch East India Company)
  • gov tried to controll international trade to max positive trade balance
  • external policies
    • Dutch east india company
    • monopsony-- monopoly in money markets
    • control waters
    • subsidize X
    • tarrif M
    • control resources
  • internal policies
    • keep W low
    • high T
    • monopolies (trade routes)
Mercantilists and domestic Political Economy
  • industry and labor regulated (guilds)
  • policies kept w low bc L was a cost of production
  • gov policy to stimulate population growth
  • Made a Rich country of Poor people!
David Hume and Political Discourse (1752)
  • first to challenge mercantilists view that accumulation of specie would not hurt its international competitive position
  • The Price Specie Flow Mechanism

Price Specie Flow Mechanism


  • accure gold= increase in MS= change in P and W (not Y or N)= can't continue a + trade balance forever
  • the movement of specie btw countries serves as an automatic adj mechanism that always tries to equlize the value of X and M
  • Assumptions
    • formal link btw M and P: quantity theory of money-- when in full employment: MV=PY. If one assumes velocity is fixed (by tradition, institutions) and Y is fixed at level of full employment then any change in MS = a proportional change in P
    • Demand for non traded goods is price elastic (so an increase in P will lead to a decrease in total expenditure)
    • Perfect competition-- necessary link btw price behavior and wage behavior.  P and W are flexible and move together. P=MR=MC.  P
    • a gold standard exists

Adam Smith and the Invisible Hand

Wealth of Nations (1776)

  • wealth is reflected in nation's productive capsity
  • laissez- faire
  • gov should remove barriers to trade
  • specialization and exchange btw countries
  • countries should specialize (division of labor) in and X goods in which they have a absolute advantage and should import those commodities in which trading partners and abs. ad.
  • trade is a positive sum game

Specie Flow mechanism with Deficits and surpluses


  • Surplus (X> M)
    • inflow of specie
    • increase MS
    • increase P and W
    • Increase M, Decrease X
  • Deficit (X<M)
    • outflow of specie
    • decrease MS
    • decrease in P and W
    • decrease in M and increase in X until M=X
Assumptions of the Ricardian Model
  1. each country has fixed endowments of resources and all units of production of each resource is identical
  2. the factors of production are completely mobile btw alt. uses with in a country (implies prices of factors of production also are the same among these alt.)
  3. the factors of production are completely immobile externally (btw countries) and there for factor prices may differ between countries
  4. labor theory of value-- the relative value of a commodity is based solely on its realitive labor content. from a production stand point: no other imputs are used in production process.  any other inputs are measured by their labor content, and other input/labor ratio is same in all countries 
  5. level of technology is fixed in both countries (can very btw them)
  6. unit cost of production are constant-- thuse the hrs of labor/unit of production of a good do not change, regardless of Q produced (s is horizontal)
  7. there is full employment
  8. perfect competition
  9. no gov imposed obstacles to economic activity
  10. internal and extrenal transportation costs are 0.
  11. we intially confine our analysis to a 2 county, 2 commodity world
Ricardian Comp. advantage

The principle of comparative advantage shows that even if a country has no absolute advantage in any product (ie. it is not the most efficient producer for any good), the disadvantaged country can still benefit from specializing in and exporting the product(s) for which it has the lowest opportunity cost of production.

Terms of Trade
  • the closer the terms of trade are for the two countries in autarky price ratio, the smaller the gain for that country from international trade
Equilibrium Terms of Trade
  • are those that bring about balanced trade. (X=M)
  • the actual location of the equilibrium of the terms of trade btw the 2 countries is determined by the comp. strength of the comp. ad. and the elascity of demand of each country's product for the others--> reciprical demand
resource contraints
  • to find total gains from trade. first we must est. amount of resources avail in each country(labour)
complete specialization

means all resources are devoted to the production of 1 good with no production of the other good --> even greater gains from trade!

  • allows you to moce your CPF furthest from your PPF
Production Possibilities frontier
  • reflects all possible combos of 2 products that a country can produce at a given point in time with its given resource bas, level of tech , full utilization of resourcesand economically efficient production
  • classical model assumes countries on PPF in autarky (straight line)
  • the constant cost assumption implies that op. cost varies at various levels of production-- PPF is a straight line whos slope rep. the op cost of economy wide production
  • provides a graphical picture and means for escaping Labor theory of value while retaining comp. advantage conclusions for the rest of trade
  • the values that lie on it represent the cost of all inputs not just labor
  • classical-- production happens at end points of PPFs
The Classical Model in Money terms
  • logical extension--> most economic transaction were based on money at time.
  • domestic value= (labor req./unit)x wage rate-> does not change internal Price values under autarky because of relative labor content
  • provides a set of money prices that each country can use to determine attractiveness of buying and selling abroad
  • money price can't be used until a link btw the two countries is established (must have an exchange rate)
export condition

the cost necessary for a country to export a good- can be stated in the following manner for country 1


non traded goods
  • will not enter into trade even tho on country may have comp ad in production(usually the goods that lie close to the wage ratio)
  • trans cost- goods must have a relatively large production cost advantage if country is to overcome transaction costs


GDA MacDonald

in 1951, performance of US and UK using export conditionto see if it was constant with rel. labor prod. and wagess in 2 countries.  thouse value of us X should be greater than UK X whenever the ratio of labor produced in US to that of UK in industry is greater than the ratio of wages btw the US and UK--> Confirmed

limitations of Classical model
  • labor theory of value
  • constant costs
  • not constant resource endowments-- because countries develop!
monetarizing ricardo's model
  • showed critical role of relative W and exchange rate--> lead to specific est. of internation comm. ToT and a vehicle which specie flow could work if trade was unbalanced
  • indicatedw and or exchange rate could change only with in certain limits with out removing the basis for trade and setting the adj mechanism into operation



Multiple countries and Transactions cost


  • made model more realisti and provided an explanation for non traded goods
  • mult. showed change in rel. wage or exchange can cause a country to change for X to M (vice versa) of some commodities but not all.
  • comparative advatage determines the end spectrem but middle countries are dependent on terms of trade that emerges.
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