1. 1 Comparative Advantage, Exchange Rates, and Globalization 9 9-1 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) 100 0 1,0000 80 2008080020 60 4006060040 6004040060 20 8002020080 001,00000100 Who has comparative advantage in production of oil? Food?

2. 1 Comparative Advantage, Exchange Rates, and Globalization 9 9-2 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 20 60 400200 40 80 100 600 1,000 800 Oil Food 200 600 4020 400 800 1,000 60 100 80 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

3. 1 Comparative Advantage, Exchange Rates, and Globalization 9 9-3 Application: The Gains from Trade ProductionConsumption U.S.Saudi ArabiaU.S.Saudi ArabiaI.T. Oil (barrels)01,000120500380 Food (tons)1,0000500120380  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

4. 1 Comparative Advantage, Exchange Rates, and Globalization 9 9-4 Application: The Gains from Trade Oil Food After trade, the U.S. can consume beyond its PPF 20 60 400200 40 80 100 600 1,000 800 Oil Food 200 600 4020 400 800 1,000 60 100 80 PPF : United StatesPPF : Saudi Arabia After trade, Saudi Arabia can consume beyond its PPF 120

5. 1 Comparative Advantage, Exchange Rates, and Globalization 9 9-5 0 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. S1S1 1.10 D1D1 If the supply of euros rises, and the demand for euros falls, the price decreases to $1.10, the new equilibrium.

6. 1 Comparative Advantage, Exchange Rates, and Globalization 9 9-6 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.