Comparative_Advantage__Lesson_1_

Comparative_Advantage__Lesson_1_ - E.g let X represent cars...

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1 Lesson 1 1 Prices in a Market Economy • Adam Smith’s “Invisible Hand” • Prices function as signals • Decoding prices Lesson 1 2 Relative Prices or Money Prices? $0.80 $20.00 Lesson 1 3 Relative Prices or Money Prices? One month of XM-Radio service is 25 times as expensive as one cup of yogurt The value of one month of XM-Radio service equals the value of 25 cups of yogurt
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2 Lesson 1 4 = Lesson 1 5 00 . 20 $ = X P 80 . 0 $ = Y P 80 . 0 $ 00 . 20 $ = Y X P P 80 . 0 00 . 20 = Y X P P 25 = Y X P P Lesson 1 6 …The price of (good) X is 25 times the price of (good) Y …The price of (good) X in terms of (good) Y is 25 We call the good by which the prices of other goods are measured the numeraire good
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3 Lesson 1 7 In this example, Yogurt was the numeraire That choice was arbitrary We could just as easily choose XM-Radio as numeraire Yogurt is 1/25 th as expensive as XM-Radio 25 1 00 . 20 $ 80 . 0 $ = = X Y P P Lesson 1 8 The measure of relative price does not depend on the units in which money prices are measured Easy to make cross-country comparisons in relative price despite differences in currencies Let “ X ”and“ Y ” represent any two goods
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Unformatted text preview: E.g., let X represent cars and Y represent automatic dishwashing machines Lesson 1 9 Country: USA England Currency: $ £ X P £18,000 $25,000 Y P £300 $500 Y X P P 50 500 000 , 25 = 60 300 000 , 18 = X Y P P 50 1 00 , 25 500 = 60 1 000 , 18 300 = 4 Lesson 1 10 When compared with England, cars (good X ) are relatively cheap in America Alternatively, we might say that automatic dishwashing machines (good Y ) are relatively expensive in America when compared with England These two statements are equivalent to each other Lesson 1 11 The Importance of Relative Prices • We will see that cross-country differences in relative prices motivate a large share of world trade • If relative prices are different across countries, trade among the countries can benefit all of them – While all countries may benefit from trade, some individuals (people and businesses) within each country may be harmed...
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Comparative_Advantage__Lesson_1_ - E.g let X represent cars...

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