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INTERNATIONAL ECONOMICS SALVATORE 10TH EDITION PDF

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Merchants constitute a special interest group that would gain either from the emphasis on increasing their production for export or from protecting their domestic activity from the competition of foreign imports. The mercantilist view also may make sense from the point of view of building a nation state in the 17th and 18th centuries. The accumulation of bullion as reserves can help finance military to consolidate and expand state power. Finally, an inflow of gold might also help economies in recession by increasing the money supply which would promote output and employment.

The mercantilist view of the world is a dim one, however, in that not all nations can be successful from the mercantilist perspective. In the mercantilist view, trade is a zero-sum game.

Although some nations will gain from trade, defined as accumulation of bullion, the remaining nations, as a group, must lose an equal amount.

According to the mercantilist view of the world then, the net world gain from trade is always zero and nations are pitted against each other in the arena of international trade. Although mercantilism was the predominant view of trade in the 17th and 18th centuries, it is important to note that modern views of trade, including the press and 8 A trade deficit excess of imports over exports generates a good deal of criticism in the popular press with demands for polices to correct the situation.

This view often meets the approval of citizens. It was largely in response to mercantilism that Adam Smith in his classic book, An Inquiry into the Nature and Causes of the Wealth of Nations, which was published in , explained how trade produces gains to all nations.

Smith argued that if two nations freely trade according to their strengths then both nations will gain. The strength of a nation was identified in terms of labor productivity. The nation with higher labor productivity in a good has an absolute advantage in the production of the good and so should produce the good for itself and other nations. If a nation freely exports a good, then both the exporting seller and the importing downloader must gain or the transaction would not be willingly made.

The concept of absolute advantage can be explained by considering two countries, each producing two goods with one input, labor. By comparing the productivity of labor, as measured by output per laborer per some time period in each country, the absolute advantage of each country can be determined. This is best demonstrated with a numerical example.

International Economics

Table 2. Because Nation 1 can produce more of Commodity X per laborer than Nation 2, Nation 1 has an absolute advantage in the production of Commodity X. Nation 2 can produce more of Commodity Y per laborer than Nation 1, so Nation 2 has the absolute advantage in Commodity Y. In Nation 2, every laborer shifted from 9 These gains and losses due to a reallocation of one unit of in each nation labor are recorded in Table 2. The consequence of reallocating each unit of labor in each nation towards the good in which it has the absolute advantage is an increase in world production.

Specialization according to absolute advantage increases world production. World production has increased, but each country has less of one good. In this example, both nations could realize an increase in the availability of both goods if they exchanged with each other. Suppose, given the changes in production in Table 2. The results are shown Table 2. Each nation can be made better off by producing and exporting the good in which it has an absolute advantage and importing the good in which their trading partner has the absolute advantage.

In the above example, the rate at which Y exchanges for X is five-for-five. There are other rates at which Y will exchange for X for which both nations gain, but 10 The rate at which goods will trade and how the gains will be distributed between nations will be developed in Chapter 4.

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The concept of absolute advantage brings up the question of what happens when one country has the absolute advantage in both goods, an example of which is shown in Table 2. In a two-nation, two-good model, will the nation with the absolute advantage in both goods out-compete the other nation?

A contribution of the British economist David Ricardo to international trade theory was to show that it is comparative advantage rather than absolute advantage that determines the pattern of trade between countries, although in many cases the two advantages are identical.

Output per Laborer and Comparative Advantage Nation 1 Nation 2 Commodity X 10 1 Commodity Y 5 1 If a nation has an absolute advantage in both goods its comparative advantage exists where its absolute advantage is relative greater. If a nation has an absolute disadvantage in both good its comparative advantage exists where its absolute disadvantage is relatively smaller. In Table 2.

Nation 2 has an absolute disadvantage in both goods, but its disadvantage is relatively less in Commodity Y, so Nation 2 has a comparative advantage in Commodity Y.

Based on comparative advantage, Nation 1 should specialize in Commodity X and export it to Nation 2 in exchange for Commodity Y. To show this, assume a reallocation of labor in each nation. Let Nation 1 reallocate 1 laborer towards Commodity X, the good in which Nation 1 has a comparative advantage. Let Nation 2 reallocate 7 laborers towards Commodity Y, the good in which Nation 2 has a comparative advantage.

As shown in Table 2. Specialization according to comparative advantage can increase world production. Changes in Production from Reallocating Labor Nation 1: Reallocation of 1 Laborer Nation 2: Exchange, however, can now increase the amounts of both commodities available in both nations. Assume that 8 units of X exchange for 6 units of Y. If Nation 1 exports 8 units of X in return for 6 units of Y, then Nation 1 will have more of both goods.

This rate of exchange will mean Nation 2 imports 8 units of X and exports 6 units of Y. The goods available to each nation as a result of the exchange are shown in Table 2. Exports 8 units of X, imports 6 units of Y Nation 2: Exchanging at the rate of 8 units of X for 6 units of Y is one way to increase the quantity of both goods in both nations.

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The conclusion is worth summarizing and emphasizing: Even if a nation has an absolute advantage in the production of both goods, two nations can engage in mutually beneficial trade if each nation specializes in and exports the good in which it has the comparative advantage.

The point of comparative advantage can also be understood in the activities of individuals. If individuals do not specialize and exchange, then each individual must produce all of the goods that each individual consumes.

Consider your own consumption if you had to produce all of the goods that you consume, e. Individuals specialize in order to increase production and then exchange in order to realize those gains 12 Without the ability to exchange goods and services, we would be unable to trade the surplus of goods in which we specialize for the surplus of goods in which others specialize.

Although self-sufficiency may be appealing, the cost of self-sufficiency is a significantly lower standard of living. The above description of trade was described in terms of bartering some number of units of Commodity X for some number of units of Commodity Y. If instead, monetary exchange is introduced, whereby money is exchanged for X and Y, then the outcomes are identical to the barter analysis.

Mexicans will compare that 40 peso price for good X produced in the US with the price of good X produced in Mexico. The price of a good, in turn, depends upon the cost of producing it which is dependent on the wage rate of labor and the productivity of labor. Suppose that at some wage rates in US and Mexico and some exchange rate between the peso and the US dollar that the US has cheaper prices for all goods. Although this situation is possible, it is a disequilibrium situation that cannot be maintained.

There will be demand, from both nations, for the products of the US but no demand for the products of Mexico. The demand for the products produced by the laborers of US will cause the wage rate in the US to increase relative to the wage rate in Mexico, and the cost of a dollar on the foreign exchange market to increase.

The increase in US wages and the cost of the dollar on the foreign exchange market will cause the price of products produced in the US to increase. The lack of demand for products produced by the laborers of Mexico will cause the wage rate in Mexico to decrease, and the cost of peso on the foreign exchange market to fall, both of which will lower the price of Mexican products. This will continue until there is some demand for Mexican products. There will also have to be demand for US products or the reverse would occur.

The product in which Mexico will eventually compete will be the product in which it has the smaller absolute disadvantage because prices will not have to fall as much for this product in order to make Mexico competitive. An example of comparative advantage in a monetary economy and possible equilibrium wages and exchange rates is provided in Question 4 of Section III below.

The comparative advantage model rejects the argument that nations with lower wages will perpetually out-compete nations with high wages, and that nations 13 International Economics, Twelfth Edition Study Guide with higher productivity will perpetually out-compete nations with lower productivity.

It is not wages alone or productivity alone that determines competitiveness, but wages relative to productivity. If one nation has lower prices for all goods due to low wages, then it is a disequilibrium situation. Similarly, high productivity nations will not continually out-compete low productivity nations. Comparative advantage was identified above as greater relative absolute advantage or smaller relative absolute disadvantage.

A more appealing and equivalent explanation of comparative advantage is in terms of opportunity cost. The opportunity cost of one unit of a good is defined as the number of units of one good foregone in order to produce one unit of another good. This says the amount of Y that must be given up in Nation 1 to produce a unit of X is less than that of Nation 2.

In producing Commodity X it is better for it to be produced in Nation 1 because fewer units of Commodity Y will be given up to produce Commodity X. Because the opportunity cost of X is lower in Nation 1, Nation 1 has a comparative advantage in the production of good X.

Return to Table 2. Expressing cost in terms of opportunity cost makes it apparent that if one nation has a comparative advantage in the production of one good, then the other nation must have a comparative advantage in the other good. If Nation 1 has a lower opportunity cost for X, then Nation 2 must have a lower opportunity cost for Y.

Thus, it is impossible for one nation to have a comparative advantage in the production of both goods. Questions 1. The outputs per laborer per day in the production of computers and autos in Nation 1 and in Nation 2 are given in the table below. International Economics, Twelfth Edition Study Guide f What do your answers suggest about the effect of the terms of trade on the gains from trade for each nations and what a mutually beneficial terms of trade might be?

The outputs per laborer per day for Tanzania and Zaire for fish and lumber are given in the table below. Assuming the numbers in the above table are constant at all levels of production, draw the production possibility frontier for Tanzania and for Zaire in Fig.

Figure 2. Refer to the table and the production possibility frontiers produced in Question 2. The outputs per laborer per day for wine and cheese for France and the U. Labor is the only input. Assume that the current exchange rate is one Euro per one U. With labor as the only input, the price of cheese and wine will equal the cost of labor to produce that cheese if markets are competitive price equals the average cost of production in competitive markets in the long run.

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Editions of International Economics by Dominick Salvatore

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No notes for slide. Solutions manual for international economics 12th edition by salvatore 1. Adam Smith 2. David Ricardo 2. The Petition of the Candlemaker 2. This is a long and crucial core chapter and may require four classes to cover a adequately. In the first lecture, I would present Sections 1, 2, and 3.

These are short s sections and set the stage for the crucial law of comparative advantage. In the second lecture of Chapter 2, I would concentrate on Section 4 and carefully explain the law of comparative advantage using simple numerical examples as in the text.

The crucial parts here are 4b which explains the law and 4d which establishes the link between trade theory and international finance. I find that the numerical explanations before the graphical analysis really helps the student to truly understand the law.

The simple lawyer-secretary example should also render the law more immediately relevant to the student. I would also assign Problems In the third lecture, I would cover Sections 2. I would pay particular attention to Sections 2. In the fourth lecture, I would cover the remainder of the chapter. The crucial section here is 2.

The appendixes could be made optional for the more enterprising students in the class. Answer to Problems 1. In case B, the United States has an absolute advantage so that the United Kingdom has an absolute disadvantage in both commodities. In case C, the United States has an absolute advantage in wheat but has neither an absolute advantage nor disadvantage in cloth.

In case D, the United States and the United Kingdom have a comparative advantage in neither commodities. In case A, trade is possible based on absolute advantage. In case B, trade is possible based on comparative advantage. In case C, trade is possible based on comparative advantage. In case D, no trade is possible because the absolute advantage that the United States has over the United Kingdom is the same in both commodities.

See Figure 2. The United Kingdom, on the other hand, would be specializing completely in the production of cloth and exchanging 20C for 30W with the United States. Since the United Kingdom trades at U. See Figure 3 on page 15 and the discussion in the last paragraph of Section 2. Restricting textile imports would keep U. The Mercantilists did not advocate: According to Adam Smith, international trade was based on: What proportion of international trade is based on absolute advantage?

All b. The commodity in which the nation has the smallest absolute disadvantage is the commodity of its: If in a two-nation A and B , two-commodity X and Y world, it is established that nation A has a comparative advantage in commodity X, then nation B must have: If with one hour of labor time nation A can produce either 3X or 3Y while nation B can produce either 1X or 3Y and labor is the only input: With reference to the statement in Question 6: With reference to the statement in Question 6, if 3X is exchanged for 3Y: With reference to the statement of Question 6, the range of mutually beneficial trade between nation A and B is: Ricardo explained the law of comparative advantage on the basis of: Which of the following statements is true?

The combined demand for each commodity by the two nations is negatively sloped b. A difference in relative commodity prices between two nations can be based upon a difference in: In the trade between a small and a large nation: Part One: Chapter Outline 2. Chapter Summary and Review This chapter introduces and begins the development of the law of comparative advantage.

Comparative advantage is the principal idea at the core of modern trade theory, so it is worthwhile to learn it well now. Subsequent material is more 7 International Economics, Twelfth Edition Study Guide complex and assumes the law of comparative advantage is understood and mastered.

Consequently, the summary of the material in this chapter will tend to be somewhat more extensive than subsequent summaries. One prominent view of trade during the 17th and 18th centuries is known as mercantilism. Although mercantilism is a mostly loose collection of writings by merchants, government officials, and economists, there is a clear thread about trade that emerges.

The mercantilist view of trade is that exports should be promoted because they produce payments from other countries, while imports should be discouraged because they produce payments to other countries.

During the mercantilist period, gold or silver bullion was the primary form of domestic and international payments. This meant that an excess of exports over imports would generate an inflow of such bullion. In the mercantilist view, the accumulation of bullion is how a nation gains from international commerce, so the role of government is to pursue policies that encourage exports and discourage imports.

Mercantilist policies could be beneficial to a nation or special interest groups in a nation. Merchants constitute a special interest group that would gain either from the emphasis on increasing their production for export or from protecting their domestic activity from the competition of foreign imports. The mercantilist view also may make sense from the point of view of building a nation state in the 17th and 18th centuries.

The accumulation of bullion as reserves can help finance military to consolidate and expand state power. Finally, an inflow of gold might also help economies in recession by increasing the money supply which would promote output and employment.

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The mercantilist view of the world is a dim one, however, in that not all nations can be successful from the mercantilist perspective. In the mercantilist view, trade is a zero-sum game. Although some nations will gain from trade, defined as accumulation of bullion, the remaining nations, as a group, must lose an equal amount.

According to the mercantilist view of the world then, the net world gain from trade is always zero and nations are pitted against each other in the arena of international trade. Although mercantilism was the predominant view of trade in the 17th and 18th centuries, it is important to note that modern views of trade, including the press and 8 A trade deficit excess of imports over exports generates a good deal of criticism in the popular press with demands for polices to correct the situation.

This view often meets the approval of citizens. It was largely in response to mercantilism that Adam Smith in his classic book, An Inquiry into the Nature and Causes of the Wealth of Nations, which was published in , explained how trade produces gains to all nations.

Smith argued that if two nations freely trade according to their strengths then both nations will gain. The strength of a nation was identified in terms of labor productivity. The nation with higher labor productivity in a good has an absolute advantage in the production of the good and so should produce the good for itself and other nations.

If a nation freely exports a good, then both the exporting seller and the importing downloader must gain or the transaction would not be willingly made. The concept of absolute advantage can be explained by considering two countries, each producing two goods with one input, labor.

By comparing the productivity of labor, as measured by output per laborer per some time period in each country, the absolute advantage of each country can be determined.