Question

(International Trade & Finance)

Page 2:

2.a. Xanadu has had an overall trade surplus with the rest of the world for many years. How would a Mercantilist view this surplus? Explain! What would David Hume's argument be regarding surplus? Explain!

2. b. Dismalia is a country with an unproductive labor force. It requires more units of labor to produce a unit of any good in Dismalia than in other country. Dismalia's leaders have decided that the country cannot gain from international trade. Are they correct or incorrect? Briefly explain!

Answer 1

2a) Mercantilism is a economic theory of trade which believes in promoting exports of a country to accumulate wealth If Xanadu has overall trade surplus with rest of the world, then a Mercantilist would view this surplus as wealth created through exports of goods and services, or export wealth. David Hume was a well-known Monetarist, who believed that money supply changes prices. As per him, if Xanadu has a trade surplus, it means it is exporting more than imports i.e. their net exports are positive. This means there is an inflow of gold in the country as export income, which will lead to an increase in the prices in the economy, leading to inflation. 2b) They are incorrect. This is because trade patterns are determined in relative sense and not absolute sense. It does not matter how much a country is producing, it matters how it is producing as compared to other countries and what are their opportunity cost of production. The country can always gain from trade by producing and exporting goods in which it has lower opportunity cost or comparative advantage.