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CHAPTER 3: THE CLASSICAL MODEL OF INTERNATIONAL TRADE ABSOLUTE ADVANTAGE AS A BASIS FOR TRADE: Adam Smith’s MODEL The theory was first developed in Adam Smith, Wealth of Nations , 1776 The Pin Factory : Smith started out his idea by describing the operation of a pin factory. If workers are not educated in pin making, then one person produces one pin per day. If there is a division of labor, where pin making is divided into 18 distinct operations, then: 10 people can produce 4,800 pins /day. Smith took his example one step further: He assumed World Trade = The Factory Countries = The Workers International division of labor among countries = The division of labor in factories Then countries specialize in few goods. The effect of specialization is: World Production with specialization > Sum of individual countries’ productions with autarky. Wealth with specialization > Sum of individual wealths with autarky Surplus in each country can be divided between countries through: International trade on the basis of Principles of Absolute Advantage (according to Smith). Existing System: Mercantilism (the World around Adam Smith) Policies of Mercantilism : restrictions on International Trade by Governments. Restrictions Include taxes on imported goods, bans on importation of certain goods, laws favoring certain industries. Goals of mercantilism: Exports > Imports implies net inflow of gold.
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Mercantilists believe that gold increased the wealth of a country. Adam Smith argued that wealth is not gold but the amount of goods and services available for use and enjoyment of the nations’ citizens. He advocated free trade. By encouraging exports of goods and services and discouraging their imports, mercantilism served to lower standard of living of a country. Free Trade country How could Free Trade achieve International division of labor? Who should produce what? How goods should be distributed? We need a model for International Trade. International Trade Assumptions : Assumption 8: ( Factor Immobility Between Countries): Factors of production (labor and capital) cannot move between countries . That is, there is a barrier for L and K. Implications of A. 8: No change in the shape of PPF based on this assumption because of : No immigration (assumption is not realistic about labor) No multinational Corporation (assumption is not realistic about capital). Wages are not equal between countries. The same holds for prices of capital. Assumption 9 (Free trade in all goods): No barriers to trade in goods. Implications of A. 9: No tariffs, quotas or transportation cost . Prices are equal for the same good (one world price). Assumption 10 (no deficit or surplus): Exports must equal imports . According to this assumption, countries in essence pay for imported goods with exported goods
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This note was uploaded on 04/03/2012 for the course ECON 300 taught by Professor Gang during the Fall '06 term at Rutgers.

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