THE CLASSICAL MODEL OF INTERNATIONAL TRADE
Topic 3.1
Mercantilism aimed to limit imports and promote exports.
Adam Smith developed his ideas to refute mercantilism.
We shall continue to develop a model of international trade.
Factors of production cannot move between countries.
This keeps the PPF fixed (with static technology) and it also prevents wage equalization
There are no barriers to trade in goods.
So there are no tariffs or quotas.
Exports pay for imports.
This is balanced trade.
There are no flows of money or bonds (there are no ‘capital flows’).
Labor is the only factor of production
This is the ‘labor theory of value’.
Production exhibits constant returns to scale between labor and output.
Proportional changes in imports lead to proportional changes in outputs when labor is the only factor of production this means that there is a fixed ratio of output to input.
The constant returns assumption allows us to derive formulas that are independent of the absolute level of output.
Absolute advantage can be illustrated by tables.
There are two variations of these tables. One version assumes that each country has the same amount of labor and then presents the maximum output of each good that is possible for each country. The other version holds the production levels the same for each country the same and then presents the different amounts of labor required within each country.
Both variations are equivalent – they are different approaches to presenting the same information. Tables are only useful for presenting linear PPFs.
Table 3.1 is the second type of table.
From table 3.1 we see than country A has an absolute advantage in producing S and country B has the absolute advantage in producing T.
Diagram 3.1
If each country had 12 hours of labor A has the absolute advantage in T (it can produce more units of T) and B has the absolute advantage of S (if can product more units of S).
In order to know where each country would be in autarky and where they would change production if trade was allowed we need information about consumption preferences (not in diagram 3.1).
Under reasonable consumption preferences (the best we can do without being given the ‘true’ CICs) and assuming that both countries consume both goods it is likely that A will specialize in T and B will specialize in S.
Table 3.3 represents a situation where A has the absolute advantage in both good.
Diagram 3.2
A has the absolute advantage in both goods, but its comparative advantage is S.
There is potential for A to specialize in production of S while B specializes in production of T.
