Question

Describe the relative price effect of the price specie flow mechanism

Answer 1

Price specie flow mechanism is an argument which was developed by David Hume which analyzes how trade functions between countries on gold standard. This was argument made by david Hume against the statement that favourable balance of Trade is always good public policy.

This mechanism states that Under a Gold Standard a countries which import Gold against the Exports made by them which result in the Positive Trade Balances. On the other hand countries which export gold against the imports made by them will result in Negative Trade Balances.

In the former model i.e positive Trade balance due to import of gold against the exports made by them therefore the gold in the country will increase which will increase the Inflation rate which makes Rise in prices and makes Import more competative.

In the latter Model i.e Negative Trade Balances due to export of gold against the imports made by them which will result in decrease in the gold in the country which will result in deflation ,which will make fall in prices and make exports more competative internationally.

This Causes the balance of trade to shift in both countries and thus David Hume argued that a Trade balance is relatively Un Importatnt because in Long Term it Balances out Itself .

However this model assumes only gold or money flow from one country to another with considering the other Capital Flows which leads Hume's Model to be less applicable in the developed International ma