1. Distinguish between comparative advantage and absolute advantage in international trade.
Absolute advantage and comparative advantage are two basic concepts to international trade. Under absolute advantage, one country can produce more output per unit of productive input than another. With comparative advantage, if one country has an absolute (dis)advantage in every type of output, the other might benefit from specializing in and exporting those products, if any exist.
A country has an absolute advantage economically over another, in a particular good, when it can produce that good at a lower cost. Using the same input of resources a country with an absolute advantage will have greater output. Assuming this one good is the only item in the market, beneficial trade is impossible. An absolute advantage is one where trade is not mutually beneficial, as opposed to a comparative advantage where trade is mutually beneficial.
A country has a comparative advantage in the production of a good if it can produce that good at a lower opportunity cost relative to another country. The theory of comparative advantage explains why it can be beneficial for two parties (countries, regions, individuals and so on) to trade if one has a lower relative cost of producing some good. What matters is not the absolute cost of production but the opportunity cost, which measures how much production of one good, is reduced to produce one more unit of the other good.
2. How Do Shifts in Demand and Supply Affect the Exchange Rate?
Week 2 3
In the same way that supply and demand for products shift to change the prices of those products, the constant shifts in the supply and demand for foreign currency result in changing prices of currency. As a result, the “price” of money changes as demand for foreign currencies changes. This “price” of foreign currency, in terms of U.S. currency, is known as the foreign exchange rate. It simply tells you how many American dollars it will...