Page 27 - DMGT545_INTERNATIONAL_BUSINESS

International Business

notes The principle assertion of Mercantilism was that ‘a nation’s wealth and prosperity reflects in
its stock of precious metals such as, gold and silver’, as at that time gold and silver, were the
currency of trading nations. The basic tenet of Mercantilism is to maintain a trade balance where
exports are greater than imports. Consistent with this belief, the Mercantilist doctrine advocated
the government intervention. It means that their policy was to maximize exports and minimize
imports. It means that imports were to be restricted, by means of tariff and quotas, whereas,
exports were to be restricted by subsidies.

criticism

1. The theory viewed trade as a zero sum game, a gain by one results in a loss by another. Adam
Smith and David Ricardo showed the short-sightedness of the approach and demonstrated
that trade is a positive sum game or a situation where all the countries benefit.
2. Mercantilists measured the wealth of a nation by the stock of precious metals it possessed.
In contrast, today we measure the wealth of a nation by its stock of human man-made and
natural resources, available for producing goods and services. The greater the stock of
useful resources, the greater is the flow of goods and services to satisfy human wants and
increase the standard of living of the nation.

2.2 theory of absolute cost advantage

According to Adam Smith, trade between two nations is based on absolute advantage. When one
nation is more efficient than (or has an absolute advantage over) another in the production of one
commodity but is less efficient than (or has an absolute disadvantage with respect to) the other
nations in producing a second commodity than both the nation can gain by each specializing in
the production of the commodity of its absolute advantage and exchanging part of its output
with the other nation for the commodity of its absolute disadvantage. By this process resources
are utilized in the more efficient way and the output of both commodities will rise. According to
Smith, “whether advantage which one country has over another by natural or acquired, is in this respect
of no consequence”.

assumption

Adam Smith believed that all nations would gain from free trade and strongly advocated a policy
of laissez faire (i.e. As little government interference with the economic system as possible) To
illustrate, let there be two countries A and B having absolute differences in costs in producing a
commodity each, X and Y respectively, at an absolute lower cost of production than the other.
The absolute cost differences are given below:
country commodity x commodity y
A 10 5
B 5 10
From the above, Country A can produce 10X or 5Y with one unit of labour and country B can
produce 5X or 10Y with one unit of labour.
In the above case, country A has an absolute advantage in the production of X (For 10X is greater
than 5X) and country B has an absolute advantage in the production of Y (for 10Y is greater than
5Y). This can be expressed as

(10X of A)/ (5X of B) >1> (5Y of A)/ (10Y of B).
Trade between two countries will benefit both if A specializes in the production of X and B in the
production of Y as is shown below:

22 lovely Professional university