Explain the mechanism which restores the balance of payments equilibrium when it is disturbed under the gold standard.
Answer: The adjustment mechanism within the gold standard is considered to as the price-specie-flow method expounded by David Hume. Within the gold standard, a balance of payment disequilibrium will be corrected through a counter-flow of gold. Assume that the U.S. imports much more from the U.K. than it exports to the latter. Within the classical gold standard, gold that is the only means of international payments, will flow from the U.S. to the U.K. The result of it is the U.S. (U.K.) will experience a decrease (increase) in money supply. As result the price level will tend to fall in the U.S. and rise in the U.K. As a result, the U.S. products become much more competitive in the export market, whereas U.K. products become less competitive. This change will enhance U.S. balance of payments and at similar time hurt the U.K. balance of payments, eventually eliminating the basic BOP disequilibrium.