Adam Smith

1. Adam Smith • Promoted laissez-faire approach by government • meaning • don’t create monopolies • don’t mandate low wages for workers • don’t force people into professions based on ancestry • don’t allow sub-groups to control the economy

2. Adam Smith • Moral philosopher • Described the capitalist system in detail • Changed the definition of “Wealth of Nations” • taught that economies work best when people are permitted to pursue own self-interest • taught that monopoly is dangerous to prosperity

3. Trade as a positive-sum game • taught that trade can create wealth for all partners, both sides could win at the same time • Example: where one country is better at producing one good and another is better at producing a second, • more is produced and consumed if each country specializes in production and trades than if each country produces only for its own market

4. Absolute Advantage: Example Absolute Advantage: Example Country Cloth Wine England 1 hr/yd 4 hrs/bbl Portugal 2 hrs/yd 3 hrs/bbl England has absolute advantage in production of cloth Portugal has absolute advantage in production of wine If England produces its own wine: Producers of cloth can buy wine at a ratio of 1W=4C Consumers of wine can buy cloth at ratio of 1W=4C

5. Country Cloth Wine England 1 hr/yd 4 hrs/bbl Portugal 2 hrs/yd 3 hrs/bbl If England produces its own wine: Producers of cloth can sell cloth at a ratio of 1C=1/4W Consumers of wine can buy wine at ratio of 1W=4C Assume trade with Portugal at price 1W=3C Producers of cloth can sell cloth at ratio of 1C=1/3 W Consumers of wine can buy wine at ratio of 1W=3C, save money Class: Reproduce example for Portugal

6. Absolute Advantage 300 hrs each country • England - produces and consumes either 300 cloth or 75 wine, or some combination • Portugal - produces and consumes 150 cloth or 100 wine, or some combination • with trade: • England: produces 300 cloth, consumes up to 100 wine • Portugal: produces 100 wine, consumes up to 300 cloth

7. Absolute Advantage 300 hrs each country • With trade: • England: produces 300 cloth, can buy up to 100 wine • Portugal: produces 100 wine, can buy up to 300 cloth • Assume country consumed half of its potential output / trade purchase for each good. • before trade, England produced 150 C and 37.5 W, consumes the same. • with trade produces 300 cloth, sells 150 to buy wine • consumes 150 cloth & 50W

8. David Ricardo • successful stockbroker • later became member of parliament • greatly influenced by “Wealth of Nations” • opposed Britain’s corn laws restricting imports of corn • wrote “The Principles of Political Economy and Taxation

9. Comparative Advantage • two countries can benefit from specialization and trade as long as one country is relatively better at producing a good relative to the second country • this is the principle of division of labour taken to an international context • Ricardo saw that Adam Smith’s analysis could extend to the case where one nation had absolute advantage in the production of both goods.

10. How does it work? • Simple example needs two countries, two goods, say Canada Mexico, cloth and wine • Assume Canada is absolutely more productive in the output of both goods, relatively more productive in wine-making

11. Canada should specialize in wine • Mexico should specialize in cloth • The two countries can trade to satisfy demand • NOTE: If wages were included, Canada would have higher buying power than Mexico with or without trade • because it is more productive, • NOT as a result of trade

12. Terminology • Autarky • no trade • Terms of trade • price of exports over price of imports • Complete specialization • country only produces one good, buys other good(s) through imports

13. C - A Example

14. C- A Example p. 2