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econ434notes9 - History of Economic Doctrines Lecture 9...

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History of Economic Doctrines Lecture 9 David Ricardo (1772-1823) Trade and Comparative Advantage David Ricardo replaced the “absolute advantage” approach of Adam Smith as a foundation for trade with the “law of comparative advantage.” Ricardo also argued that trade facilitates focusing on more and better specialization and divisions of labor. law of comparative advantage: The law of com place between t No Trade Ex: Suppose that, initially, without trade, the exchange rate is 10 coffees for one acrylic bearskin rug in Brazil, and one coffee for 10 acrylic rugs in Brazil. The absolute value of the slope of the PPF = relative prices of goods. The interior straight lines in this figure are the initial production possibilities frontiers and the consumption possibilities frontiers as well. Free Trade with Complete Specialization When trade commences, both nations’ consumption possibility curves shift outward so that more consumption of both goods occurs in both countries. With trade, the slope of the consumption possibilities frontier (CPF) equals the relative prices ( terms of trade ) given by the red line above. Why? Trade allows for one to focus on the thing that you are best at you sell the things that you are relatively good at producing, in exchange for purchases of the things that you are relatively less efficient in producing.
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Thus trade in accord with comparative advantage ultimately allows both Brazilians and Alaskans to consume more of both goods. F OUR C ATEGORIES OF G AINS FROM T RADE Mercantilists are often viewed as vehement opponents of imports. They were not. Most mercantilists recognized the gains derived from trading domestic production for goods that could not be produced domestically – the uniqueness gains from trade. The gains from trade described by David Ricardo [above] can be thought of as static gains from specialization and exchange in accord with comparative advantage. In addition to the gains recognized by these early theorists, more modern economists have identified numerous dynamic gains and political gains from trade. 1. Comparative Advantage : Static Gains from trade. David Ricardo’s “Law of Comparative Advantage” 2. Uniqueness Gains : Some goods are almost impossible to produce domestically: ex: chrome or diamonds. 3. Dynamic Gains : Trade as a Foundation for Economic Growth i. Technology transfers and inventions. ii. Investment: MPC<1 and Y=C+S, then what you do not consume is S which is used for investment. More capital/investment will expand the PPF curve outwards and thus; benefit society by being able to produce more. iii. Competition: Monopoly power in one country is significantly reduced by foreign competition. The globalization of competition induces more rapid innovation of efficient technologies.
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