EC311: International Economics

Trade Theories |
Dr. Irfan Ullah

Email: irfanecon@nuist.eud.cn

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The Mercantilists Views on Trade

The economic philosophy known as Mercantilism which was popular

from the sixteenth to the middle of the eighteenth century in Britain,
Spain, France and the Netherlands maintained that :

 The most important way for a nation to become rich and powerful is
to export more than its imports.

 The difference between its exports and imports is settled by an inflow

of gold and silver. The more gold and silver a nation has, the richer
and more powerful it is.

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The Mercantilists Views on Trade

 The mercantilists advocated that the government should stimulate

exports and restrict imports.

 Since not all nations could have an export surplus simultaneously and
the amount of gold was fixed at any one time, a nation could gain only
from trade on the expense of another

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Adam Smith: Absolute Advantage

In 1776, Adam Smith published his famous book ‘’The Wealth of

Nations’’ in which he attacked the Mercantilists’ views on trade. He
advocated instead the free trade as the best policy for the nations of the
world.

 Smith argued that with free trade, each nation could specialise in the
production of those commodities in which it has an absolute
advantage (i.e. produces it with lower cost than others) and import
those commodities in which it has an absolute disadvantage (i.e.
produces it with higher cost than others).

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Adam Smith: Absolute Advantage

 Given the free trade policy, the international specialisation would

result in an increase in the world’s output which can be shared by
the trading nations. Thus, a nation needs not to gain at the expense of
other nations, all nations could gain from trade simultaneously.

Consider the following table:

US UK
Wheat (Bushels/Labour-Hour) 6 1
Cloth (Yards/Labour-Hour) 4 5

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Adam Smith: Absolute Advantage

From this table, it is clear that:

1. The US has an absolute advantage over the UK in the production of

Wheat (i.e. 6 bushels/labour-hour compared with 1 bushel/labour-
hour in the UK).

2. The UK has an absolute advantage over the US in the production of

Cloth (i.e. 5 yards/labour-hour compared with 4 yard/labour-hour in
the US).

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Adam Smith: Absolute Advantage

From this table, it is clear that:

3. If the US specialised in the production of wheat and the UK

specialised in the production of cloth, the total production of wheat
and cloth in the US and the UK will be greater than before the
specialisation and trade.

4. In the presence of free trade, the US and the UK can gain from the
international trade by sharing this increase in output in both
commodities.

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Adam Smith: Absolute Advantage

Gains from trade:

US UK
Wheat (Bushels/Labour-Hour) 6 1
Cloth (Yards/Labour-Hour) 4 5

If the US exchanges 6 bushels of wheat (6W) with 6 yards of the British

cloth (6C), the US gains 2C or saves 0.5 hour of labour time.

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Adam Smith: Absolute Advantage

Gains from trade:

US UK
Wheat (Bushels/Labour-Hour) 6 1
Cloth (Yards/Labour-Hour) 4 5

Similarly, the 6W that the UK receives from the US would require six
hours of labour time to produce in the UK. These six hours can produce
30C in the UK. By being able to exchange 6C for 6W with the US, the UK
gains 24C, or saves almost five labour - hours.

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Adam Smith: Absolute Advantage

Smith’s theory faced a lot of criticism such as labour homogeneity

between nations and commodities and the transportation cost.
However, one of the main questions that Smith’s trade theory could not
answer is that, if one nation has an absolute advantage over the
production of both commodities and the other nation has an absolute
disadvantage over both commodities, Does the trade between those two
nations exist? For example:

US UK
Wheat (Bushels/Labour-Hour) 6 1
Cloth (Yards/Labour-Hour) 4 2

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