LEARNING UNIT 2

Mercantilists and
the Classical theorists
 PRESCRIBED READING:
What
should I
Chapter 2 of the textbook is
study? prescribed.

11th edition :29-53;

13th edition: 29 – 52.

Study Sections: 2.1, 2.2

(and case study 2-2), 2.3
(2.3A, 2.3B) 2.4 (2.4A, 2.4B,
2.4C), 2.5 (2.5A,
2.5B, 2.5C, 2.5D) 2.6(2.6A),
2.7, 2.8

Why should I learn this content?

THE AIM OF THE LEARNING UNIT:

This topic introduces you to the classical theories

of international trade.
HOW TO USE THESE SLIDES?
While working through these slides:

 Keep your study guide and textbook

open next to you and read the
sections stipulated by the study
guide.
 These slides do not cover the entire

chapter, only the important points.

 Make sure you also study the

other parts as stipulated by your

study guide.
 Remember to make notes!
FOLLOW THE WORK IN YOUR
TEXTBOOK…

11th ed. page 29- 48

13th ed. Page 29 - 52

2.1 INTRODUCTION
 The section on trade theory looks at the
early and classical trade theories.

 Trade theories try to explain why and how

countries trade.

 In order words, the patterns and gains from

trade.

 We focus first on the mercantilists and then

classical theorists (Adam Smith and David
Ricardo).
2.1 CONTINUE

 Why do countries trade?

 To benefit from specialisation

 Since 1 country cannot produce all goods

efficiently, it is better off producing that
which it can produce efficiently and
importing that which it cannot.
 Countries therefore trade to increase their
consumption.
2.2. MERCANTILISTS’ VIEWS ON
TRADE
 Mercantilists were a group of European men
between 1700 and 1800s who wrote on
international trade that became the economic
philosophy known as mercantilism
 Believed that for a nation to be rich and powerful it
should export more than it imported.
 Having a trade surplus in the form of bullion ensured
riches and power.
 Advocated for protectionism by government in the
form of tariff and other trade barriers.
2.2 CONTINUE
 Trade was seen to be a zero sum game since for
a nation to gain, another has to lose.
 Believed trade was driven by self interest.
 Limitations of the mercantilist theory
 They failed to consider the impact having a surplus will
have on an economy.
 Theory also fails to explain
welfare effects of trade policy.
Watch the following video about mercantilism
Copy the URL and paste in your browser.

https://www.youtube.com/watch?v=oiwvvNMOjCE

(Internet connection required)

PAUSE: ANSWER THESE TRUE OR FALSE
QUESTIONS.
1. For the mercantilists, international
trade was a zero sum game.

2. Hume, Smith and Ricardo were

followers of the mercantilist doctrine.

3. According to the mercantilists,

national economic welfare can only be
increased if the government
encourages exports and imports.
2 MINUTES QUICK CHECK IN: WRITE YOUR
ANSWERS DOWN.
1. According to the Mercantilists, trade is a ------------------

[1] positive sum game

[2] negative sum game
[3] zero sum game

1. The economic theory of Mercantilism suggests that a nation’s wealth

could be calculated by------------------

[1] the amount of actual notes and coins in supply

[2] the amount of gold and silver accumulated
[3] the amount of raw materials the nation owned

1. According to mercantilists, economic welfare can be enhanced if

government prioritised

[1] imports
[2] government spending
[3] exports over imports
CASE STUDY 2-2:
MERCANTILISM IS ALIVE AND
WELL IN THE 21ST CENTURY

 Verbally, most countries support free trade.

 However, in practice many impose trade
restrictions:
 European Union (EU) put restrictions on hormone fed
beef from the USA.
 The EU has preference for bananas from Africa above
Central American plantations.
 Developing nations are also highly protective of their
domestic industries

 Why implement trade restrictions?

EXAMPLES OF TRADE BARRIERS IN
AFRICAN COUNTRIES
 South Africa: Example of non-tariff barriers
 Tariff-ratequota agreement with the USA to allow
the import of 65000 tons of bone-in chicken leg
quarters free of anti dumping duties.
 Import permit needed for used or second-hand
goods
Meltzer, S., Smith, C., Bubu, C., and Wentzel, W. (2020). International trade in goods and services in South
Africa: Overview

 Nigeria: Example of trade restrictions

 Country has politically mandated restrictions on
imports and exports of e.g. meat products, bagged
cement. Furniture and footwear
 Imports of rice have a levy of 20 percent (World
Economic Forum (WEF)
https://reports.weforum.org/enabling-trade-increasing-the-potential-of-trade-reforms/enabling-trade-barriers-to-

importsexports-in-nigeria /
2.3. CLASSICAL THEORISTS
Trade based on absolute advantage (Adam Smith)

 Assumptions of the theory:

 Producers and consumers are rational.
 There are 2 countries and 2 commodities.
 Labour is the only factor of production.
 Each nation has a fixed endowment of resources
 Perfect competition exists.
 Free mobility of labour between the 2 goods in each
country but not between nations.
 No barriers to trade.
 Constant returns to scale in production.
 No transport costs
 Technology level is fixed in both countries, though it
may differ between the countries
FUNDAMENTALS OF THE THEORY
 No country will trade if it does not benefit
 For countries to trade with each other voluntarily, they all have to
gain

 According to Adam Smith, a nation has absolute advantage

in the production of a commodity if it can produce a
commodity more efficiently (less inputs) than the other
nation.

 Having absolute advantage in the production

of 1 commodity is a prerequisite for
trade to occur.

 Countries gain from trade by specializing

in producing the product of their absolute
advantage.
CONTINUE
 Specialization (division of labour) leads to
increased output of both commodities.

 The gains from specialization is the increased

output and maximized individual welfare.

 If one nation had absolute advantage in

producing both goods, then trade will not
occur.

 Because each country produces and exports

its commodity of absolute advantage, the
theory suggests that there is complete
specialization.
ABSOLUTE ADVANTAGE: CASE OF ABSOLUTE
ADVANTAGE

South
Output per hour

Namibia
Africa

GOLD
8 1
Fish 2 5
ABSOLUTE ADVANTAGE: THE CASE OF NO TRADE

South
Output per hour

Namibia
Africa

Gold (tons/hr)
5 2

Fish (tons/hr)
4 1
THE GAIN FROM TRADE BASED ON THE THEORY OF ABSOLUTE ADVANTAGE

South
Output per hour

Namibia
Africa

GOLD (tons/hr)
8 1
Fish(tons/hr) 2 5
EXPLANATION
 SA has an absolute advantage in gold
 Namibia has an absolute advantage in fish
 Let’s use an arbitrary rate of exchange, let SA
exchange 8G for 8F from Namibia.
 (i) South Africa will gain 6F OR saves 4 labour hours.
 The 8G Namibia gets in the exchange from SA would
have taken it 8hrs to produce.
 If Namibia decides to use those 8hours to produce only
its product of absolute advantage (Fish) it can produce
40F
 Namibia, then gives SA 8G in exchange and it gains 32F
or saves 6.4hrs
 Using the exchange above (8G for 8F), both countries
gain. SA gains 6F and Namibia gains 32F.
 Since SA could exchange 8G for 2F domestically, SA
benefits from trade if it can exchange 8G for more than
2F from Namibia and for Namibia, 8G = 40F. Therefore,
the range of mutually beneficial trade is 2F<8G<40F
 QUICK QUESTIONS: WRITE YOUR ANSWERS
DOWN
Output per labour hour
South Africa Lesotho
Wheat 20 bushels 50 bushels
Gold 80 tonnes 20 tonnes

 In which commodity does Lesotho's absolute

advantage lie?
 In which commodity does South Africa's absolute

advantage lie?
 According to Smith, who should specialise in

producing wheat?
 According to Smith , who should specialise in

producing gold?
CLASSICAL THEORISTS
Ricardian theory of comparative advantage (David
Ricardo)
 Assumptions of the theory:
 Producers and consumers are rational.
 There are 2 countries and 2 commodities.
 Labour is the only factor of production.
 Each nation has a fixed endowment of resources
 Perfect competition exists.
 Free mobility of labour between the 2 goods in each
country but not between nations.
 No barriers to trade.
 Constant returns to scale in production.
 No transport costs
 Technology level is fixed in both countries, though it may
differ between the countries
FUNDAMENTALS OF THE THEORY
 According to Ricardo, mutually beneficial trade
is possible even if one nation has absolute
advantage in the production of both goods
 or a nation has an absolute disadvantage over the
other nation in the production of both goods.
 Mutually beneficial trade will only be possible if
each nation has a comparative advantage in the
production of one of the two goods.
 What is important is the degree of the
advantage (opportunity cost).
CONTINUE
 A nation will export the commodity for which the
opportunity cost is lowest and import that for
which the opportunity cost is higher.

The case of no trade/equal advantage:

 If the opportunity costs of producing the 2 goods is

the same in both nations, this implies that neither

of the two nations have comparative advantage in
the production of any of the commodities

 In this case, trade will not be possible

 This thus means that for trade to occur, the

opportunity cost must be different in both nations.
COMPARATIVE ADVANTAGE

OUTPUT PER HOUR

Japan Kenya

Electronics
12 1
Tea
8 2
EXPLANATION
 From the above, Japan has an absolute
advantage in the production of both
commodities.
 But they can still both benefit from trade

based on the principle of comparative

advantage.
 To see how, determine the opportunity cost

of producing each good in each country.

 From first and second year, remember the

definition of opportunity cost?

Opportunity cost is the amount of one commodity that must
be forgone in order to produce one more unit of the first
commodity.
OPPORTUNITY COST OF PRODUCING
ELECTRONICS AND TEA
Opportunity Japan Kenya
cost of
producing
electronics
12 E = 8T 1 E = 2T
1E = X

Cross Multiply
8TE = 12E X

Divide both sides by 12 E

8TE /12E= 12E X/12E

0.66T = X
IE = 0.66T
Opportunity 8T =12 E 2T=1E
cost of IT=X IT=X
producing
Tea Cross multiply: Cross multiply
12 ET = 8TX I ET = 2 TX

Divide both sides by 8T Divide both sides by 2T

12 ET /8T = 8TX /8T 1 ET / 2 T = 2 TX / 2 T

1.5E = X 0.5 E = X
IT =1.5E 1T = 0.5 E

Conclusion
Japan has a comparative advantage in producing electronics and Kenya has a
comparative advantage in producing Tea.
THE GAIN FROM TRADE BASED ON THE THEORY OF COMPARATIVE ADVANTAGE: USING SAME EXAMPLE FROM ABSOLUTE ADVANTAGE.

South
Output per hour

Namibia
Africa

GOLD (tons/hr)
8 1
Fish(tons/hr) 2 5
EXPLANATION
 SA has an absolute advantage in gold
 Namibia has an absolute advantage in fish
 Let’s use an arbitrary rate of exchange, let SA exchange 8G for
8F from Namibia.
 (i) South Africa will gain 6F OR saves 3 labour hours.
 The 8G Namibia gets in the exchange from SA would have taken it
8hrs to produce.
 If Namibia decides to use those 8hours to produce only its product
of absolute advantage (Fish) it can produce 40F
 Namibia, then gives SA 8G in exchange and it gains 32F or saves
6.4hrs
 Using the exchange above (8G for 8F), both countries gain. SA
gains 6F and Namibia gains 32F.
 The arbitrary exchange rate is not the only possible one
 Domestically, SA could exchange 8G for 2F, therefore it means SA
will gain if it exchanges 8G for anything more than 2F.
 Anything less than 40F that Namibia has to give up to get 8G is a
gain for it
 Therefore, the range of mutually beneficial trade is 2F<8G<40F.
3 MINUTES: WORK THROUGH THIS
EXAMPLE

South Africa Namibia

Gold [ ton/hr] 8 4

Fish [ ton /hr] 4 2

1. In which product does South Africa and Namibia have an

absolute advantage? An absolute disadvantage?

2. In which commodity does South Africa and Namibia have a

comparative advantage and comparative disadvantage in?
DO THE FOLLOWING QUESTIONS SHARE YOUR ANSWERS ON THE
DISCUSSION FORUM UNDER “DISCUSSION CLASS ANSWERS”

Consider the following scenarios:

Scenario A
Nigeria Ghana

Crude Oil [ ton/hr] 16 4

Cocoa [ ton /hr] 4 8

Scenario B
Nigeria Ghana

Crude Oil [ ton/hr] 16 8

Cocoa [ ton /hr] 8 4

(i) For Scenarios A and B, in which commodity does

Nigeria and Ghana have an absolute advantage
and absolute disadvantage? Explain.

[5]
CONTINUED
 For scenarios A and B, indicate the
commodity in which Nigeria and Ghana have
a comparative advantage and disadvantage.
[You must show your workings] [6
marks]

 In scenarios A and B, determine, using the

classical theories, whether trade is possible
between Nigeria and Ghana and explain the
pattern of trade. [8 marks]
CONTINUED:

 Use the table below to answer the following

questions
Good South Africa Namibia
(Output/hr)
Gold (tons)
12 3
Fish (tons)
9 6
If South Africa exchanges 12 tons of gold for 12 tons of fish with
Namibia

(i)How much does South Africa gain in terms of fish?

(ii)How much does Namibia gain in terms of fish?
(iii)What is the range of mutually beneficial trade? [6 marks]
TYPICAL ESSAY QUESTION ON MERCANTILISM,
ABSOLUTE AND COMPARATIVE ADVANTAGE
1. Given your knowledge of the classical theories,
evaluate the following statement:
“According to Adam Smith, mutually beneficial trade is only
possible if one nation has a comparative advantage in the
production of at least one of the commodities”.
Note: all assumptions and criticisms must be stated.
[25 marks]

2. Mercantilists believed that two nations can

gain from trade by trading according to each of
their absolute advantages. Is this a valid
statement? Explain.
[15 marks]
MORE EXAMPLES
Formore on absolute
advantage study table 2.1 in
your textbook

Formore on comparative
advantages study table 2.2 in
your textbook
 Still want to know more?
Watch the following video about absolute and
comparative advantage

https://www.youtube.com/watch?
v=Pd_qs8ueIWw

(Internet connection required)

END OF STUDY UNIT 2