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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