Home Midterm Eco54 Spring 2008

Summarize the central beliefs of the mercantilist school.

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The mercantilist school of economic thought believed that the self-sufficiency of the nation state was the key to a country securing economic success and assuming political dominance in wars against its foes. A nation’s reserves of gold and silver were the means by which economic power ought to be measured. Also, because nations would inevitably be at war, or planning for war, having large reserves of the internationally valuable monies of gold and silver meant that mercenary soldiers would always be available, making the nation strong. Dominating other nations by accumulating precious metals, either through the colonization of nations rich in those metals, or gaining wealth by exporting more goods and services than the nation imported was essential for nations desiring dominance. For mercantilists, the balance of trade of a nation should always be positive (“Economics,” Microsoft Encarta® Online Encyclopedia, 2007).

Mercantilist domestic policy stressed that wages should be low but the population should be large to populate the army. Large reserves of labor were required to work, pay high taxes, and thus enrich the nation. Children of the working class should labor as soon as possible, and only be educated as much as their labor required, and the populace should not have enough money to afford “extravagances” to make more goods available for export (“Economics,” Microsoft Encarta® Online Encyclopedia, 2007). It did not matter if the populace was well-educated or focused on creating new technology and enterprise, provided the nation was rich.

To what extent can these beliefs be said to have arisen out of the political history of the mercantilist era, such as the rise of nation states in Europe and the ‘Voyages of Discovery’ that led to the opening up of new trade links to South America and Asia?

Colonialism made additional resources of gold and silver available to the nations of Europe. The Voyages of Discovery, funded by newly powerful rulers, created a race between the major powers to see which nation could establish dominance over the New World and its seemingly vast supply of resources and goods. With new goods, and new sources of gold and silver, the nation-state could have additional resources to war against its neighbors.

Describe the nature of and the effects of the mercantilist policies of Colbert, finance minister under Louis XIV of France

Although historians are critical of Louis XIV’s excessive spending on luxuries, his efficient finance minister Colbert reduced the expenses collecting taxes, minimized patronage and corruption, and created an accurate system of bookkeeping for the government. Colbert tried to make the rates of taxation more equitable between the different French provinces. “Industry and agriculture were encouraged, and efforts were made to create free trade between the interior provinces of the kingdom” (Rempel 2008).

What was the nature of the theoretical reaction to such policies from economists such as Boisguilbert and the physiocrats?

Boisguilbert and the physiocrats reacted against the protectionist policies of mercantilism. Mercantilists saw high tariffs and trade barriers as a source of strength. Instead, the physiocrats believed that agriculture should be the focus of all economic policy, that taxes should be low, direct, and based on the land, and that free trade and commerce should be encouraged within the nation (“Economics,” Microsoft Encarta® Online Encyclopedia, 2007).


Discuss Adam Smith’s views on the proper role of the government. In Smith’s view, what should the government do and what should it not do?

Despite the current, popular caricature of Adam Smith as someone who believed that the government who governs best governs least, Smith’s primary interest was in creating a level economic playing field, not in prohibiting all government influence upon the economy. Smith actually believed that governments had a vital role to play in economic life. At times, the government could be essential to create a level playing field for economic actors, if certain entities were becoming too large. Also the government could prevent underhanded actions. “Like most modern believers in free markets, Smith believed that the government should enforce contracts and grant patents and copyrights to encourage inventions and new ideas. He also thought that the government should provide public works, such as roads and bridges, that, he assumed, would not be worthwhile for individuals to provide,” and which would spur commerce and make opportunities for entrepreneurship greater for everyone (“Adam Smith (1723-90),” the Concise Encyclopedia of Economics, 1999). Smith even believed that the users of such public works should pay in proportion to their use, in a modern version of tolls (“Adam Smith (1723-90),” the Concise Encyclopedia of Economics, 1999). This was a great and positive advancement upon the prohibitive taxation of an abject populace, as advocated by the mercantilists.

Of course, the historical environment in which Smith wrote must always be emphasized. “One definite difference between Smith and most modern believers in free markets is that Smith favored retaliatory tariffs,” against nations that abused free market policies, but given the preponderance of nations that still believed in mercantilism, and protectionism, this seems like a more rational policy even for a free market thinker like Smith than one might assume (“Adam Smith (1723-90),” the Concise Encyclopedia of Economics, 1999).

Explain the meaning of Robert Heilbroner’s comment in the Worldly Philosophers that “The great enemy to Adam Smith’s system is not so much government per se as monopoly in any form.”

In short, Smith wished to create a state in which every person could explore his or her desires and talents to the greatest degree. He hated what the monopoly state of mercantilism did to the soul of a nation, driving potentially talented members of the lower classes into penury simply to enrich the state, and preventing citizens from keeping most of their honestly-won gains. He frowned upon controls and limits upon commerce written into law that threatened competition, but he also recognized that monopoles could form in an entirely unregulated environment, and thus would have supported current attempts to curtail monopolies by the federal government through anti-trust statutes. Any monopoly, whether created by pubic or private enterprise, was dangerous in Smith’s view because it was a block to economic efficiency and growth.

In general, Smith did not see anti-trust legislation perhaps as necessary as we might today because Smith had a “benign” or even naive view of economic self-interest, and hoped that self-interest would naturally channel people to pursue aims that would result in the benefit of all humankind through the invisible hand of the marketplace (“Adam Smith (1723-90),” the Concise Encyclopedia of Economics, 1999).


Read Chapters I, II and III of Adam Smith’s Wealth of Nations. (a) Summarize Smith’s ideas on the division of labor.

Smith believed in the salutary effects of the division of labor, arguing that the main cause of prosperity was the new specialization of labor in the wake of industrialization. “Smith gave the famous example of pins. He asserted that ten workers could produce 48,000 pins per day if each of eighteen specialized tasks was assigned to particular workers. Average productivity: 4,800 pins per worker per day. But absent the division of labor, a worker would be lucky to produce even one pin per day” (“Adam Smith (1723-90),” the Concise Encyclopedia of Economics, 1999). Long before the modern ideas of standardized parts and factory labor was conceived of and implemented on a mass scale, the inherent efficiency of standardized labor in a factory, and the speculation of professions was conceived of by Smith.

In what ways has the concept of division of labor changed economic thinking? Which topics in economic theory have been affected the most? What role did the division of labor play in Smith’s theory of economic development?

Smith claimed that an individual would invest a resource, for example, land or labor, so as to earn the highest possible return on it. Consequently, all uses of the resource must yield an equal rate of return (adjusted for the relative riskiness of each enterprise). Otherwise reallocation would result” (“Adam Smith (1723-90),” the Concise Encyclopedia of Economics, 1999). In other words, rather than forcing people to pursue the same profession as their grandfather against their own good sense and self-interest, allowing people to rationally decide what particular way they wished to allocate their resources, including their talent as well as their land and money, was the best way to economically structure a society.

To what extent were Smith’s ideas on the division of labor anticipated in the writings of Xenophon, Plato, and William Petty?

Plato and Xenophon, who chronicled the life and words of Socrates, suggested like Smith in the Wealth of Nations that all human beings were divided into different classes of labor, those who ruled, those who fought, and those who labored by trade. If people with an inclination to philosophy were forced to become shoemakers, chaos and disharmony would result. Smith wrote in a more technologically sophisticated era, but had the same fears about the dangers of a nation or a person trying to do everything equally well, as advocated by the mercantilists. Smith believed this would lead to inefficiency.

However, unlike Plato, Smith did not believe that the ideal republic should decide from birth what occupation an individual should follow, rather that the individual must freely choose by his or her own will, how to direct his or her energies and labor in the most efficient and self-interested fashion, which would ultimately result in the advancement of the nation as a whole. Plato’s social structure, although not based upon birth, was still based upon a monopoly of philosophers dictating the lives of others according to their state-generated power, unlike Smith’s more democratic ideals. Smith’s analysis more perfectly echoes that of William Petty, who stressed how breaking down tasks, like Smith’s pin-manufacturing plant, could generate higher levels of efficiency in economic production. Petty also placed a strong emphasis, as did Smith, upon the vital need of a nation to practice free trade.


Discuss David Ricardo’s ‘Theory of Comparative Costs,’ its history, and its strengths and weaknesses as a theory of international trade.

David Ricardo argued that a nation should do best, what it can do best, and most cheaply, and because economics is a study in scarcity. For a nation to be entirely self-sufficient, the mercantilists argued, is militarily and economically foolish, leaving it vulnerable to dependency and attack. But Ricardo countered that obtain its goods a nation should trade with other powers that could produce such goods more efficiently relative to the other goods produced within each nation’s respective borders. Thus, a nation should specialize in certain types of production. “Using his famous example of two nations (Portugal and England) and two commodities (wine and cloth), Ricardo argued that trade would be beneficial even if Portugal held an absolute cost advantage over England in both commodities. Ricardo’s argument was that there are gains from trade if each nation specializes completely in the production of the good in which it has a ‘comparative’ cost advantage in producing, and then trades with the other nation for the other good” (“David Ricardo,” the New School, 2008). In other words, even if a nation can produce everything more efficiently than any other nation, it is still better off specializing in what it can produce at the least expensive cost and engaging in international trade with other nations. “Ricardo’s simple analysis demonstrated that even when one country is technologically superior in both goods; it could still be advantageous for countries to trade. In this circumstance, a comparative advantage is present for those products that the country can produce most-best in comparison to other countries, even if the most best product is produced less productively than in the other country. For example, suppose the U.S. is 10X more productive in corn and only 2X more productive in watches compared to Switzerland. In this case the U.S. is clearly most-best at producing corn (10x > 2x). At the same time though, Switzerland is 1/2X as productive in watches and (1/10) X as productive in corn. Thus, [watchers are] Switzerland’s most-best product and hence its comparative advantage” (Suranovic, 2007).

What did John Stuart Mill later add to Ricardo’s trade theory?

In his famous work the Principles of Political Economy, Mill wrote that to prohibit imports or impose heavy duties upon imported goods creates waste both for the labor of the manufacturer and also for the laborers of the home nation, who must make more goods of the same kind, and thus protectionist tariffs conspire to “render the labor and capital of the country less efficient in production than they would otherwise be; and compel a waste of the difference between the labor and capital necessary for the home production of the commodity and that which is required for producing the things with which it can be purchased from abroad” (V.X).

The result is in a national loss “measured by the excess of the price at which the commodity is produced, over that at which it could be imported. In the case of manufactured goods, the whole difference between the two prices is absorbed in indemnifying the producers for waste of labor, or of the capital which supports that labor. Those who are supposed to be benefited, namely, the makers of the protected articles, (unless they form an exclusive company, and have a monopoly against their own countrymen as well as against foreigners,) do not obtain higher profits than other people. All is sheer loss, to the country as well as to the consumer” (V.10.5).

Works Cited

Adam Smith (1723-90).” The Concise Encyclopedia of Economics. 1999. 8 Mar 2008. http://www.econlib.org/library/Enc/bios/Smith.html

David Ricardo.” The New School. 8 Mar 2008. http://cepa.newschool.edu/het/profiles/ricardo.htm

Economics.” Microsoft® Encarta® Online Encyclopedia. 2007. 8 Mar 2008. http://encarta.msn.com.

Mill, John Stuart. Principles of Political Economy. Library of Economics and Liberty.

2005. 8 Mar 2008.

E-text http://www.econlib.org/library/Mill/mlP.html

Rempel, G. “Louis XIV.” Western New England College. 8 Mar 2008. http://mars.wnec.edu/~grempel/courses/wc2/lectures/louisxiv.html

Suranovic, Steve. “Lesson on Comparative Advantage.” George Washington University. Oct 2007. 8 Mar 2008. http://stevesuranovic.blogspot.com/2007/10/lesson-on-comparative-advantage.html