Unit 7- Absolute and Comparative Advantage

Absolute Advantage

• Individual- exists when a person can produce more of a certain good/service than someone else in the same amount of time or resources
• National- exists when a country can produce more a good/service than another country can in the same time period or using the same amount of resources

Comparative Advantage

• A person or a nation has a comparative advantage when it can produce the product at a lower domestic opportunity cost than can a trading partner.

         Examples of output problems

1.      meat produced in a day

2.      video games produced in a year

         Example of input problem

1.      hours to make a video game 

Specialization and trade

• Gains from trade are based on comparative advantage
• Country should import whichever product they do not have the advantage in producing

Unit 7- Balance of Payments

Balance of payments

•  Measures of money inflows and outflows between the united states and the rest of the world (ROW).
• Inflows are referred to as credits
• Outflows are referred to as debits

• The balance of payment is divided into three accounts:

1. Current account

2. Capital/financial account

3. Official reserves account

•  Double entry book keeping- Every transaction in the balance of payments is recorded twice

Current account

•  Balance of trade or Net exports

      -  Exports of goods/services- import of goods/services.

      -  Exports create a credit to the balance of payments.

      -  Imports create a debit to the balance of payments.

•  Net foreign income

      -   Income earned by the U.S. owned foreign assets

      -   Interest payments on U.S. owned foreign assets

      -   Net transfers are usually unilateral

      -    Foreign aid- a debit to the current account.

      

Capital Account

•  balance of capital ownership
• Includes the purchase of both real and financial assets
•  Direct investment in the United States is a credit to the capital account
• Direct investment by United States firms/individuals in a foreign country are a debit to the capital account- Ford factory in China
• Purchase of foreign financial assets represents a Debit to the capital account- Franco buys stock in Saudi Aramco
• Purchase of domestic financial assets by foreigners represents a credit to the capital account.

               

 Relationship between current and capital account

•  The current account and the capital account should zero each other out
•  if the current account has a negative balance (deficit) then the capital account should then have a positive balance (surplus).

 Official reserves

•  foreign currency holdings of the U.S. FED
• balance of payments surplus- the fed accumulates foreign currency and debits the balance of payments
•  When there is a balance of payments deficit- the fed depletes its reserves of foreign currency and credits the balance of payments. 
• The U.S. is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate
• China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the U.S.

Formulas

1. Balance of trade- Good exports + goods imports

2. Balance on goods and services- 

Goods exports + service exports + goods imports + service imports

3. Current Account-  Balance on goods and services + net investment + net transfers

4. Capital account- Foreign purchases + domestic purchases