1 Comparative Advantage, Exchange Rates, and Globalization Application: Comparative Advantage United StatesSaudi Arabia % of resources devoted to oil Oil produced (barrels) Food produced (tons) % of resources devoted to oil Oil produced (barrels) Food produced (tons) , , Who has comparative advantage in production of oil? Food?

1 Comparative Advantage, Exchange Rates, and Globalization Application: Comparative Advantage Oil Food The U.S. has comparative advantage in food because it has a lower opportunity cost (in terms of oil) to produce food , Oil Food , PPF : United StatesPPF : Saudi Arabia Saudi Arabia has comparative advantage in oil because it has a lower opportunity cost (in terms of food) to produce oil The U.S. should produce 1,000 tons of food Saudi Arabia should produce 1,000 barrels of oil

1 Comparative Advantage, Exchange Rates, and Globalization Application: The Gains from Trade ProductionConsumption U.S.Saudi ArabiaU.S.Saudi ArabiaI.T. Oil (barrels)01, Food (tons)1,  A trader, I.T., arranges for Saudi Arabia to trade 500 barrels of oil to the U.S. for 120 tons of food  The U.S. will trade 500 tons of food to Saudi Arabia for 120 barrels of oil  I.T. keeps 380 barrels of oil and 380 tons of food

1 Comparative Advantage, Exchange Rates, and Globalization Application: The Gains from Trade Oil Food After trade, the U.S. can consume beyond its PPF , Oil Food , PPF : United StatesPPF : Saudi Arabia After trade, Saudi Arabia can consume beyond its PPF 120

1 Comparative Advantage, Exchange Rates, and Globalization Price of euros (in dollars) The Supply of and Demand for Euros Determination of Exchange Rates and Trade Quantity of euros QDQD $1.30 S0S0 D0D0 In this figure, the supply of euros is equivalent to the demand for dollars, and equilibrium occurs at a dollar price of $1.30 for one euro. S1S D1D1 If the supply of euros rises, and the demand for euros falls, the price decreases to $1.10, the new equilibrium.

1 Comparative Advantage, Exchange Rates, and Globalization Determination of Exchange Rates and Trade 0 Q0Q0 Price Q1Q1 Q2Q2 P1P1 P0P0 Imports S W1 S W0 Domestic supply Domestic demand If the world price level is P 1, domestic producers will sell Q 1 and domestic consumers will demand Q 2. The difference is made up by imports shown by the difference between Q 2 and Q 1. A country will have a zero trade balance when the world price level equals the domestic price level, P 0.