Absolute advantage ○ A country is said to have an absolute advantage over other producers of a product if it is the most efficient producer of that product ● Comparative advantage ○ A country is said to have a comparative advantage over other producers of a product if it can produce the product at a lower opportunity cost Specialization and Trade ● The basic principle ○ Specialization according to comparative advantage reduces costs ○ This is true even if a nation has an absolute advantage ● Specialization and comparative advantage ○ Example: two isolated nations (Canada and Brazil) ○ Constant costs ■ Straight-line production possibilities curves ○ Different costs ■ Different technology and resources Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
8 ○ Canada has absolute advantage in both steel and soybeans ● Specialization based on comparative advantage ○ Opportunity cost of 1 tonne of steel: ■ 1 tonne of soybeans in Canada (1St = 1Soy) ■ 2 tonnes of soybeans in Brazil (1St = 2Soy) ● Terms of trade ○ Canada 1St = 1Soy ■ Canada will sell 1St for more than 1Soy ○ Brazil 1St = 2Soy ■ Brazil will pay less than 2Soy for 1St ○ For trade to be mutually beneficial the terms of trade must be between each nation’s opportunity costs ● Gains from trade ○ Trading possibilities line ■ Slope equals terms of trade ■ The trading possibilities line shows that both countries end up better off with trade Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
9 Exchange rates and purchasing power parity ● Foreign exchange markets ○ International trade depends on the exchange rate ○ The exchange rate is the price of foreign currency ● Exchange rate systems: ○ Flexible (floating) exchange-rate system ○ Fixed exchange rate system ● Depreciation and appreciation ○ If the exchange rate increases, the Canadian dollar depreciates ○ If the exchange rate decreases, the Canadian dollar appreciates ● Determinants of exchange rate changes ○ Demand and supply analysis ● In flexible exchange rate systems, the price of foreign currency fluctuates according to the supply and demand ○ Example: the market for foreign currency (pounds) ● Determinants of exchange rates ○ Factors that shift demand/supply ■ Changes in tastes ■ Relative income changes Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
10 ■ Relative inflation rate changes ● Purchasing-power-parity theory ■ Relative interest rates ■ Relative expected returns on assets ■ Speculation Measuring Domestic Output and the Price Level Gross Domestic Product ● The main measure of the economy’s performance ● The total (aggregate) market value of all final goods and services produced within the borders of a country during a specific period of time ● GDP is a monetary measure ● Avoiding multiple counting ○ To avoid multiple counting, only final goods and services are counted ○ Final goods: goods and services purchased for final use and not for resale for further processing or manufacturing ○ Intermediate goods: products purchased for resale or further processing or
- Winter '08
- Inflation, Ryan L.