2a. State the difference between
Absolute Advantage and Comparative Advantage
Both absolute advantage and comparative advantage are important for international trade that helps countries to make decision regarding resource allocation, production of goods along with export and imports. The significant difference between absolute advantage and comparative advantage are as follows:
Definition: Absolute advantage is the basic ability of a country that helps it to produce specific goods at a lower marginal cost and in an efficient manner. Whereas, comparative advantage is the capability that a country requires to produce a good at a lower marginal rate along with maintaining opportunity cost to other countries.
Basic Concept: Absolute advantage deals with lower marginal cost of production as compare to the competitor country. Whereas, comparative advantage deals with both comparative advantage and opportunity cost of a specific good along with a comparison to other competitors country.
Trade Benefits: Not always, absolute cost advantage is beneficial for both the countries that are involved in trade transaction (Eaton et al., 2016). In case of comparative advantage, both the countries that are engaged in trade are mutually benefited from this.
Cost of Production: Absolute advantage helps in lowering the production cost in comparison to competitors. Whereas, comparative advantage specific helps in lowering opportunity cost along with maintain opportunity cost in comparison to other competitors.
Production of Goods: Absolute advantage helps nations having a flat out favorable position of delivering a decent produces a higher volume of that great with the equivalent accessible assets. Comparative advantage helps nations with near favorable position consider the creation of various merchandise in a nation while choosing the generation of a particular decent and asset portion for the equivalent.
Resource Allocation: An outright bit of leeway may not be extremely powerful in choosing the asset designation by a Country for creation of a decent, as it doesn't accept into record the open door cost of generation. Similar preferred position accepts into record the open door cost of creation, it is increasingly successful in choices for asset allotment, local generation, and import of explicit merchandise.
Benefits to Economies: In case of absolute advantage exchanges, the setting of supreme bit of leeway is not commonly useful in nature. On the other hand, comparative advantage exchanges choices dependent on relative favorable position are commonly valuable in nature.
Effectiveness for Economy: In case of absolute advantage exchanges, the idea of total favorable position may not be powerful as it centers on amplifying creation with the equivalent accessible assets without considering the open door cost of generation. On the other hand, comparative advantage the idea of total favorable position may not be powerful as it centers around amplifying creation with the equivalent accessible assets without considering the open door cost of generation.
The Terms of Trade and the Exchange Rate
The Terms of Trade is the normal cost of fares/by the normal cost of imports. It is a proportion of a nations relative intensity.
Terms of Trade (TOT) = (Index of average export prices / Index of average import prices)x 100
On the off chance that fare costs rise in respect to import costs, we state there has been an improvement in the terms of exchange. – A unit of fare purchases moderately more imports. For the most part, this prompts an improvement in expectations for everyday comforts as imported merchandise seem less expensive to shoppers.
On the off chance that import costs rise in respect to fare costs we state there has been a crumbling in the terms of exchange (Christiano et al., 2015). For the most part, this prompts a decrease in expectations for everyday comforts as remote money profit are moderately less and imported shopper merchandise increasingly costly.
On the other hand, an exchange rate is the value of one nation’s currency that is linked with the currency with another nation or other economic region. Various types of exchange rate is available such as free floating exchange rate, foreign exchange rate and others.
A Demand Side Shock and a Supply Side Shock
Shocks are events that are by and large unexpected and bring out changes in real economic growth, inflation and unemployment. All countries are exposed to some degree to external economic shocks. There is evidence that lower and middle-income developing nations are more vulnerable partly because they have a less diversified economy with a narrow range of production and export industries.
Demand side shocks
Demand side shocks generally affect various components of aggregate demand, for examples,
1. Economic downturn is a major trading partner of demand side shocks
2. Demand side shocks are unexpected and it increases or decreases tax for welfare purpose
3. It leads to financial crisis and that causes bank lending or fall in credit
4. Unemployment rate increases rapidly due to demand side shocks
5. Negative demand side shock can lead to negative multiplier effects and can induce negative accelerator effect on the amount of investment spending.
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