theories of macro economics

8/6/2019 Theories of Macro Economics

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THEORIES OF MACRO

ECONOMICS

By:-

Sagar Sinha


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Mercantilism


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Evolution of Mercantilism

End of feudalism paved way for mercantilism.

Dominated Western Europe from 16th century to

late 18th century.

The word was taken from German in late 19th

century.

Thomas Mun is known to be a major creator of

mercantile system.


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Mercantilism

Mercantilism is the economic doctrine that says

government control of foreign trade is of

paramount importance for ensuring the prosperity

and security of a state.


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Goals of mercantilism

Favorable balance of trades

Encourage domestic production and export ,

discourage imports.

To become most powerful and wealthiest nation.

Become self sufficient in all areas.


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Manufactured Goods

Raw Products

Colonizing

CountriesColonies


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Tenets of Mercantilism

By Philip Wilhelm Von Hornick.

That every inch of a country's soil be utilized foragriculture, mining or manufacturing.

That all raw materials found in a country be used in

domestic manufacture, since finished goods have ahigher value than raw materials.

That a large, working population be encouraged.

That all export of gold and silver be prohibited

and all domestic money be kept in circulation That all imports of foreign goods be discouraged as

much as possible.


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Tenets of Mercantilism (Continued)

That where certain imports are indispensable theybe obtained at first hand, in exchange for otherdomestic goods instead of gold and silver.

That as much as possible, imports be confined to rawmaterials that can be finished [in the home country].

That opportunities be constantly sought for selling acountry's surplus manufactures to foreigners, so far

as necessary, for gold and silver. That no importation be allowed if such goods are

sufficiently and suitably supplied at home.


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Drawbacks of Mercantilism

Limited profits of colonists.

Restricted use of domestic products.

Foreign goods more expensive (taxes) Colonists became resentful.

Colonists treated as inferiors.

Increased warfare.

Increased exports lead to inflation.


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Theory of Absolute AdvantageBy Adam Smith

Theory says The ability of a party (an individual,

or firm, or country) to produce more of a good or

service than competitors, using the same amount of

resources.

Main agenda was to counter Mercantilism.

This was described in reference to international

trade. Labour was the only input used.


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Theory of Absolute Advantage

(Continued)

Export goods for which a country is more

productive.

Import those goods for which other countries are

more productive.


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Example of Absolute Advantage

Party A can produce 5 widgets per hour with 3 employees.

Party B can produce 10 widgets per hour with 3 employees.

Assuming that the employees of both parties are paid equally, PartyB has an absolute advantage over Party A in producing widgets per

hour. This is because Party B can produce twice as many widgets as

Party A can with the same number of employees.


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Drawbacks

No trade will happen if a country has absolute

advantage.

Absolute advantage theory does not take

opportunity cost under consideration.


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Theory of comparative AdvantageBy David Ricardo

Theory says two countries (or other kinds of

parties, such as individuals or firms) can both gain

from trade if, in the absence of trade, they

have different relative costs for producing the samegoods.

David Ricardo explained this theory in 1817 taking

example of England and Portugal


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An example of Comparative

Advantage between Two Countries

Days of Labor Required Countryto Produce Portugal EnglandWine (1 barrel) 3 2

Cloth (1 bolt) 10 4*England has absolute advantage in both. Less labor is

required to produce either good in England than inPortugal. However

Which has comparative advantage in Wine?

Which has comparative advantage in Cloth?**Comparative Advantage: The ability to produce a

specific product more efficiently than any otherproduct


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An example of Comparative

Advantage between Two Countries

Compare Opportunity Costs

England can produce either 2 barrels of wine or 1 bolt of cloth with thesame amount of labor (4 days) so (1c = 2 w or 1w = c)

By shifting labor from wine to cloth, England can transform 2 barrels ofwine into one bolt of cloth

Portugal can produce either 3.33 barrels of wine or one bolt of cloth withthe same labor (10 days) so (1w = 1/3 c or 1c = 3 1/3 w)

In comparative terms, cloth is inexpensive in England and expensive inPortugal, whereas wine is cheap in Portugal and expensive in England (1bolt of cloth costs only 2 barrels of wine in England, but the same bolt costs3.33 barrels of wine in Portugal)

The differences in relative cost of one good in terms of the other createPortugals comparative advantage in wine and Englands in cloth


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The Gain in Output from Trade with

Comparative Advantage

Portugal England Total

Wine (barrels) 20 -182

Cloth (bolts) -6 9 3*Total output of both goods rises when Portugal shifts

60 labor days from cloth to wine and England shifts36 labor days from wine to cloth

**Numbers obtained by dividing the following: ForPortugal, 60/3 = 20, 60/10 = 6 (negativebecause its a loss). For England, 36/2 = 18(negative because its a loss), 36/4 = 9

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