Unit VII--Part 3: Comparative & Absolute Advantage

Absolute Advantage
-faster, more, more efficient
Comparative Advantage
-lower opportunity cost
-no 2 countries have same comparative advantage in making same products

EX) David Ricardo bakes 2 cakes per hour and 6 pizzas per hour. Ricky Ricardo bakes 4 cakes per hour and 8 pizzas per hour. This is represented in the chart below.

	David Ricardo	Ricky Ricardo
Cakes	2	4
Pizzas	6	8

1. Who has the comparative advantage in baking cakes? (**the smallest #)
6/2=3
8/4=2
3 to 2 cakes
Answer=Ricky

2. Who has the comparative advantage in making pizza?
2/6=0.33
4/8=0.5
0.33 to 0.5
Answer=David

**Bible:

Foreign Exchange Market Graph Examples

Foreign Exchange Market

Changes in Exchange Rates:
-Exchange rates (e) are a function of the supply and demand for currency

• an ↑ in supply of a currency will ↓ the exchange rate of a currency
• a ↓ in supply of a currency will ↑ the exchange rate of a currency
• an ↑ in demand for a currency will ↑ the exchange rate of a currency
• an ↑ in demand for a currency will ↓ the exchange rate of a currency

Appreciation & Depreciation:

• appreciation→of a currency occurs when exchange rate of that currency increases (e↑), meaning prices will go up
• depreciation→of a currency occurs when the exchange rate of that currency decreases (e↓)
• EX) If German tourists flock to America to go shopping, then supply of Euros will ↑ and demand for $ will ↑. This will cause the Euro to depreciate and the $ to appreciate. 

Exchange Rate Determinants (4):

1. consumer tastes
2. relative income
3. relative PL
4. speculation (stocks, interests, bonds)

**TIPS (cheat-sheet):

• always change the D line on one currency graph and the S line on the other currency graph
• move lines of 2 currency graphs in same direction (R or L) and you will have correct answer

 Flexible Exchange Rate→determines by market forces w/ little/no govt intervention

Fixed Exchange Rate→determined by govt policy (U.S.→$ doesn't fluctuate; stays same no matter what)