ECON102: Principles of Macroeconomics (2021.A.01)

Comparative Advantage

When it's cheaper for one nation to produce something than another. For example, if two products on the production possibilities curve are coffee and wheat, and the United States needs to spend 2 coffees to make a wheat, while Brazil only needs to spend 1.5 coffees, Brazil has a comparative advantage over the US in wheat (because it's relatively cheaper to make) and the US has a comparative advantage over Brazil in coffee.

Terms of Trade

The price of a good or service (the amount of one good or service which must be given up to obtain one unit of another good or service).

Exchange rates

Flexible exchange-rate system: rates at which national currencies are exchanged for one another are determined by demand and supply and in which no government intervention occurs.

Fixed exchange-rate system: governments determine rates at which currencies are exchanged and make necessary adjustments in their economies to ensure that these rates continue.

Appreciation/depreciation of money

When the currency depreciates, then American goods seem cheaper to foreigners, so they will buy more, increasing exports, and making the trade balance "more favorable". Likewise, when the currency appreciates, American goods seem more expensive to foreigners, and foreign goods seem cheaper to Americans, so imports increase and the trade balance becomes "less favorable".

Fiscal/Monetary policy

Fiscal

Expansionary policy → higher domestic interest rate → increased foreign demand for dollars → dollar appreciates → net exports decline → balance of trade becomes less "favorable"

Contractionary policy → lower domestic interest rate → decreased foreign demand for dollars → dollar depreciates → net exports increase → balance of trade becomes more "favorable"

Monetary

Easy money policy → decreased foreign demand for dollars → dollar depreciates net exports increase → balance of trade becomes more "favorable"

Tight money policy → increased foreign demand for dollars → dollar appreciates → net exports decrease → balance of trade becomes less "favorable"

Favorable/unfavorable trade balances

If exports exceed imports, you get a trade surplus which is considered a "favorable balance of trade". If imports exceed exports, you get a trade deficit which is considered an "unfavorable balance of trade".

A "favorable" balance of trade is not entirely good, however. We cannot buy as much foreign goods now (since our dollar is worth less) so foreign companies don't get as much business from us. However, when foreign prices rise, Americans turn to American companies to buy things from, helping American companies make more money.

Likewise, a "unfavorable" balance of trade isn't entirely bad either. Since our dollar has grown in value, we can buy more foreign goods, so foreign companies get more money. However, because of cheaper foreign goods, American companies won't get as much business (or they have to lower prices), so they don't get as much money.