Absolute advantage, comparative advantage, and foreign exchange rates in international trade

International Trade Concepts

Absolute and Comparative Advantage

Absolute Advantage

An absolute advantage is achieved when one country can produce a product at a lower cost than any other country, potentially gaining absolute control of the market for that good or service. Absolute advantage provides a country with leverage in international trade as it builds assets or wealth. Absolute advantage's can have a finite life as circumstances change. In the past French wine held absolute advantage, but recently, U.S., Australian, and New Zealand wines have started to become very competitive relative to French wines. In the United States, Ford Motor Company held absolute advantage, then General Motors, and finally other U.S. companies and foreign imports moved into the market. Absolute advantages are rare today, however some countries manage to approximate absolute advantages in some products. Climate differences can give some nations or regions an advantage in growing certain plants. Saffron is perhaps the world's most expensive spice at around $40 dollars an ounce. It is native to the Mediterranean, Asia Minor, and India. Today saffron is cultivated primarily in Spain, where the plant thrives in its soil and climate. Attempts to grow Saffron in other parts of the world have generally been unsuccessful (National American University, 2009).

Influences Affecting Foreign Exchange Rates

A nation's exchange rate is the rate at which its currency can be exchanged for the currencies of other nations. Foreign exchange rates are influenced by a number of factors, including domestic economic and political conditions, central bank intervention, balance of payment position, and speculation over future currency values. Currency values fluctuate depending on the supply and demand for each currency on the international market. In this system of floating exchange rates currency traders create a market for the world's currencies based on each countries relative trade and investment prospects. In theory, this market permits exchange rates to vary freely according to supply and demand. In practice, exchange rates do not float in total freedom as National governments often intervene in currency markets to adjust their exchange rates.

Nations influence exchange rates in other ways as well. They may form currency blocs by linking their exchange rates to each other. Many governments practice protectionist policies that seek to guard their economies against trade imbalances. For instance nations sometimes take deliberate action to devalue their currencies as a way to increase exports and stimulate foreign investment. For individual businesses the impact of currency devaluation depends on where that business buys its materials and where that business sells its products (Kurtz, 2010).