Absolute advantage A country is said to have an absolute advantage over other

Absolute advantage a country is said to have an

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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
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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
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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
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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
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