, CHAPTER 2
EARLY TRADE THEORIES:
Mercantilism and the Transition to the Classical World of David Ricardo
A. Essay Questions
1. Explain how the price-specie-flow mechanism operates to maintain balanced trade
between countries. What are the assumptions that are critical to the mechanism’s
successful operation?
Answer: A trade surplus (or deficit) automatically produces internal repercussions that work to
remove that surplus (or deficit). The movement of specie between countries serves as an
automatic adjustment mechanism that always seeks to equalize the value of exports and
imports. The key assumptions are that all currencies are pegged to gold and hence to
each other, all currencies are freely convertible into gold, gold can be bought and sold at
will, and governments do not offset the impact of the gold flows on the money supply.
Also, it is crucial that prices and wages be flexible.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
2. Why was a positive trade balance so important to Mercantilists? In Mercantilist thinking,
why did a positive trade balance not result in domestic inflation and a loss of
international competitiveness?
Answer: The inflow of specie came from foreigners who paid for the excess purchases from the
home country with gold and silver. For Mercantilists, a positive trade balance did not
result in domestic inflation because of the belief that the economy was operating at less
than full employment; therefore, the increase in the money supply stimulated the
economy instead of creating inflation.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
3. What were the critical foundations of Mercantilist thought? What trade policies resulted
from this way of thinking?
Answer: The acquisition of precious metals was seen as the means for increasing wealth and
well-being. Mercantilists saw the enhancement of state power as being critical to the
growth process. The Mercantilists employed a labor theory of value in their analysis and
1
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
, stressed the need to maintain an excess of exports over imports. Finally, one of the most
important pillars of Mercantilist thought was the static view of world resources.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
4. Explain what is meant by a zero-sum game, and why it was central to Mercantilist
thinking. Then, explain how Smith’s idea of absolute advantage altered the nature of the
“game.”
Answer: A zero-sum game is a game such as poker where one person’s winnings are matched by
the losses of the other players. The Mercantilists held a static view of world resources, so
that one country’s economic gain was at the expense of another.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
5. (a) Why did the Mercantilists think that a situation where a country’s exports exceed its
imports is a “favorable” situation for the country? Briefly, what policies would a
Mercantilist recommend in order to generate such a “favorable” situation?
Answer: A positive trade balance generated specie from foreigners who paid for their excess
purchases from the home country with gold and silver. Governments attempted to control
international trade with specific policies to maximize the likelihood of a positive trade
balance and the resulting inflow of specie. Exports were subsidized and quotas and high
tariffs were placed on imports of consumption goods. Tariffs on imports of raw materials
that could be transformed by domestic labor into exportables were, however, low or
nonexistent.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
(b) What was the “price-specie-flow doctrine” and how did it undermine Mercantilist
thinking? Why would a situation where the demands for traded goods are “inelastic”
with respect to price changes pose a problem for the “price-specie-flow doctrine” in its
attack on Mercantilist thinking?
2
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
, Answer: The price-specie-flow doctrine asserted that a trade surplus (or deficit) automatically
produces internal repercussions that work to remove that surplus (or deficit). The
movement of specie between countries serves as an automatic adjustment mechanism
that always seeks to equalize the value of exports and imports. Inelastic demands for
traded goods would cast doubt on the adjustment process.
Difficulty: 03 Hard
Topic: The Challenge to Mercantilism by Early Classical Writers
AACSB: Analytic
Blooms: Apply
Learning Objective: 01-02
6. During the 2016 campaigns for nomination for president of the United States, the point
was frequently made that the United States was losing from trade with any given country
if the United States had a trade deficit with that country. Using material from this
chapter, assess this position.
Answer: To argue that the United States was losing from trade with any given country if the
United States had a trade deficit with that country is to display a gross misunderstanding
of reality.
Difficulty: 03 Hard
Topic: The Challenge to Mercantilism by Early Classical Writers
AACSB: Analytic
Blooms: Evaluate
Learning Objective: 01-02
B. Multiple-Choice Questions
7. In Adam Smith’s view, international trade
a. benefited both trading countries.
b. was based on absolute cost differences.
c. reflected the resource base of the countries in question.
d. all of the above.
Answer: d
Difficulty: 01 Easy
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Remember
Learning Objective: 01-01
8. In the price-specie-flow doctrine, a deficit country will __________ gold, and this gold
flow will ultimately lead to __________ in the deficit country’s exports.
a. lose; a decrease
3
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
EARLY TRADE THEORIES:
Mercantilism and the Transition to the Classical World of David Ricardo
A. Essay Questions
1. Explain how the price-specie-flow mechanism operates to maintain balanced trade
between countries. What are the assumptions that are critical to the mechanism’s
successful operation?
Answer: A trade surplus (or deficit) automatically produces internal repercussions that work to
remove that surplus (or deficit). The movement of specie between countries serves as an
automatic adjustment mechanism that always seeks to equalize the value of exports and
imports. The key assumptions are that all currencies are pegged to gold and hence to
each other, all currencies are freely convertible into gold, gold can be bought and sold at
will, and governments do not offset the impact of the gold flows on the money supply.
Also, it is crucial that prices and wages be flexible.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
2. Why was a positive trade balance so important to Mercantilists? In Mercantilist thinking,
why did a positive trade balance not result in domestic inflation and a loss of
international competitiveness?
Answer: The inflow of specie came from foreigners who paid for the excess purchases from the
home country with gold and silver. For Mercantilists, a positive trade balance did not
result in domestic inflation because of the belief that the economy was operating at less
than full employment; therefore, the increase in the money supply stimulated the
economy instead of creating inflation.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
3. What were the critical foundations of Mercantilist thought? What trade policies resulted
from this way of thinking?
Answer: The acquisition of precious metals was seen as the means for increasing wealth and
well-being. Mercantilists saw the enhancement of state power as being critical to the
growth process. The Mercantilists employed a labor theory of value in their analysis and
1
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
, stressed the need to maintain an excess of exports over imports. Finally, one of the most
important pillars of Mercantilist thought was the static view of world resources.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
4. Explain what is meant by a zero-sum game, and why it was central to Mercantilist
thinking. Then, explain how Smith’s idea of absolute advantage altered the nature of the
“game.”
Answer: A zero-sum game is a game such as poker where one person’s winnings are matched by
the losses of the other players. The Mercantilists held a static view of world resources, so
that one country’s economic gain was at the expense of another.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
5. (a) Why did the Mercantilists think that a situation where a country’s exports exceed its
imports is a “favorable” situation for the country? Briefly, what policies would a
Mercantilist recommend in order to generate such a “favorable” situation?
Answer: A positive trade balance generated specie from foreigners who paid for their excess
purchases from the home country with gold and silver. Governments attempted to control
international trade with specific policies to maximize the likelihood of a positive trade
balance and the resulting inflow of specie. Exports were subsidized and quotas and high
tariffs were placed on imports of consumption goods. Tariffs on imports of raw materials
that could be transformed by domestic labor into exportables were, however, low or
nonexistent.
Difficulty: 02 Medium
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Understand
Learning Objective: 01-01
(b) What was the “price-specie-flow doctrine” and how did it undermine Mercantilist
thinking? Why would a situation where the demands for traded goods are “inelastic”
with respect to price changes pose a problem for the “price-specie-flow doctrine” in its
attack on Mercantilist thinking?
2
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
, Answer: The price-specie-flow doctrine asserted that a trade surplus (or deficit) automatically
produces internal repercussions that work to remove that surplus (or deficit). The
movement of specie between countries serves as an automatic adjustment mechanism
that always seeks to equalize the value of exports and imports. Inelastic demands for
traded goods would cast doubt on the adjustment process.
Difficulty: 03 Hard
Topic: The Challenge to Mercantilism by Early Classical Writers
AACSB: Analytic
Blooms: Apply
Learning Objective: 01-02
6. During the 2016 campaigns for nomination for president of the United States, the point
was frequently made that the United States was losing from trade with any given country
if the United States had a trade deficit with that country. Using material from this
chapter, assess this position.
Answer: To argue that the United States was losing from trade with any given country if the
United States had a trade deficit with that country is to display a gross misunderstanding
of reality.
Difficulty: 03 Hard
Topic: The Challenge to Mercantilism by Early Classical Writers
AACSB: Analytic
Blooms: Evaluate
Learning Objective: 01-02
B. Multiple-Choice Questions
7. In Adam Smith’s view, international trade
a. benefited both trading countries.
b. was based on absolute cost differences.
c. reflected the resource base of the countries in question.
d. all of the above.
Answer: d
Difficulty: 01 Easy
Topic: Mercantilism
AACSB: Reflective Thinking
Blooms: Remember
Learning Objective: 01-01
8. In the price-specie-flow doctrine, a deficit country will __________ gold, and this gold
flow will ultimately lead to __________ in the deficit country’s exports.
a. lose; a decrease
3
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
