Unit 7 - Comparative and Absolute Advantage

Absolute advantage -  one country would have an absolute advantage over the other if it can produce same amount of goods with fewer resources.

• This is then the ability of country to produce more goods than its competitors using same or less resources.

Comparative advantage  - the production of a product  can produce the product at a lower domestic opportunity cost than can a trading partner.

• It is also the basis for all trade.
• If the two nations specialize according to comparative. advantage, then to get the other product, they must trade.

Terms of Trade - the rate of exchange of two products is be determined through negotiation

• Terms of trade - the outcome .
• Gains from trade are based on comparative advantage, not absolute advantage

Specialization and Trade

• Specialization based on comparative advantage improves global resource allocation.
• Specialization and trade - increase productivity and the standard of living within a nation.
• Because of specialization and trade, there will be a larger global output of goods and services.

Input and Output Approach

• Output problem - based on the most of an item producer can make if it specializes using a set amount of resources.
• Take B/A for comparative advantage and pick the highest amount for absolute advantage.
• Input problem approach -  based on the least resources producer needs to make a set amount of an item .
• Take A/B for comparative and pick lowest amount for absolute.

Unit 7 - Foreign Exchange Market

Foreign Exchange Market

• A market in which various national currencies are exchanged for one another. (this is the definition)
• The buying and selling of currency
• Ex: If you travel and want to buy souvenirs from Japan, you have to sell your Dollars to buy Yen.

Exchange rate - the equilibrium prices of currency in these markets, determined in foreign currency exchange.

• Ex: If you sell $1.00, then you can buy ¥102.185.

2 Points

1.  A competitive market - real-world foreign exchange markets characterized by large numbers of buyers and sellers dealing in standardized products such as American’s dollars, European’s Euro, British’s Pound and Japanese Yen.
2.  Linkages to all domestic and foreign prices - the market price or exchange rate of a nation’s currency is an unusual price; it links all domestic prices with all foreign prices. Enable consumers to translate prices of foreign goods into units of their own currency.

 Dollar-Yen Market

• U.S exports goods to Japan demand payment in dollar not Yen and vice-versa to Japan and they will exchange their currency in the foreign exchange market.
• Some U.S. importers need to pay the Japanese in exporters in Yen, so these people will demand for Yen.
• Because of the demand between two currency, we have “price” is in Dollars and the “product” is in Yen.
• If we show it on a graph of Supply and Demand the intersection of Demand Curve and Supply Curve establishes the equilibrium Dollar price of Yen.

Changing Rates : Depreciation and Appreciation

• Appreciation occurs when the exchange rate of a certain currency decreases.
• Depreciation occurs when the exchange rate of a certain currency increases.
• Ex: If the Japan products sell out more, then Yen will increases while the Dollars will decreases.

Unit 7 - Balance of Payments

Balance of Payments - the sum of all the transaction that takes place between its residents and the residents of all foreign nations.

Current Account - the US trade in currently produced goods and services.

• Export - credit (+)
• Import - debt (-)

A country's balance of trade on goods and services is the difference between the export and import of goods.

• Trade surplus = export > import.
• Trade deficit = export < import.

Official Reserves - the central banks of nations hold quantities of foreign currencies.

Balance of Payment Deficit and Surpluses - imbalance between current and capital accounts that causes a drawing down or building up of foreign currencies.