Absolute Advantage
- Individual: exists when a person can produce more of a certain good/service than someone else in the same amount of time (or can produce a good using the least amount of resources.)
- National: exist when a country can produce more of a good/service than another country in the same time period.
Comparative Advantage
- A person or a nation has a comparative advantage in the production of a product when it can produce the product at a lower domestic opportunity cost than can a trading partner.
- Ex. for input: number of hours to do a job, number of acres to feed a horse, number of gallons of paint to paint a house.
- Ex. for output:
Specialization and Trade
- Gains from trade are based on comparative advantage, not absolute or advantage.
Mechanics of Foreign Exchange (FOREX)
- Foreign Exchange (FOREX)
- The buying and selling of currency
- Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell their Dollars and buy Euros.
- Any transaction that occurs in the balance of Payments necessitates foreign exchange.
- The exchange rate (e) is determined in the foreign currency market.
- Changes in Exchange Rates
- Exchange rates (e) are a function of the supply and demand for currency.
- An increase in the supply of a currency will decrease the exchange rate of a currency.
- An decrease in the supply of a currency will increase the exchange rate of a currency.
- An increase in the demand of a currency will increase the exchange rate of a currency.
- An decrease in the demand of a currency will decrease the exchange rate of a currency.
- Appreciation and Depreciation
- Appreciation of a currency occurs when the exchange rate of that currency increase (e↑)
- Depreciation of a currency occurs when the exchange rate of that currency decrease (e↓)
- Exchange Rate Determinants
- Consumer Tastes
- Relative Income
- Relative Price Level
- Speculation
- Exports and Imports
- The exchange rate is a determinants of both exports and imports.
- Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports.
- Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports.
- Floating/Flexible Rates
- Depends on demand and supply of that currency vs. other currencies.
- It is very sensitive to the business cycle
- Provide options for investment
- Fixed Rates
- Based upon a country's willingness to distribute currency and the ability to control the amounts.
