Why Do People Trade? Unequal Distribution of Resources: Natural Resources: Ex. America fertile soil=economy based on agriculture; Southwest Asia= large oil and natural gas reserves=economy based on income from sale of these resources

Specialization People / countries focus (specialize) on producing / trading the product (s) that they have more of / produce more efficiently than other people countries

Absolute Advantage A person or nation has an absolute advantage when it can produce more of a given product using a given amount of resources ex. Pete can produce 6 shirts per hour and Tom can produce 3 shirts per hour; Pete has an absolute advantage in producing shirts

Comparative Advantage The country that has the lower opportunity cost in producing a certain good has a comparative advantage in the product that it can produce most efficiently given all the products it could choose to produce

Example of Comparative Advantage Two Countries, A and B, produce bananas and sugar If A must sacrifice 2 tons of sugar to produce a ton of bananas, the opportunity cost of a ton of bananas is 2 tons of sugar If the o.c. of a ton of bananas in B=3 tons of sugar, A has a c.a. in producing bananas because its o.c. (2 tons of sugar) is lower

Foreign Exchange

To engage in world trade, countries must have a way of exchanging one type of currency for another. Foreign exchange markets allow quick and easy conversions of one currency to another.

Exchange Rate The price of one country’s currency in terms of another country’s currency. The ratio at which two currencies are traded for each other.

Exchange Rates and the U.S. Dollar “Strong Dollar”=strong in value; more foreign currency (euros, pesos, yuan) for each U.S. dollar. $1=200 pesos is a stronger dollar than $1=100 pesos. A strong dollar means IMPORTED goods are cheaper to buy, but EXPORTED goods are more expensive for foreign countries to buy. Result: Americans buy more imports; foreigners buy less U.S. products.

Exchange Rates and the U.S. Dollar… “Weak Dollar”=weaker in value, devalued dollar; less foreign currency for every U.S. dollar. $1=24 euros is a weaker dollar than $1=48 euros. A weak dollar means IMPORTED goods are more expensive to buy, but EXPORTED goods are less expensive for foreign countries to buy. Result: Americans buy fewer imports; Foreigners buy more U.S. products.