Econ theme 4 Flashcards
What is the definition of absolute advantage?
Absolute advantage is the ability of an individual, company, or country to produce more of a good or service with the same amount of resources than another entity.
Fill in the blank: Absolute advantage focuses on the ________ of production.
efficiency
Who is the economist associated with the concept of absolute advantage?
Adam Smith
What does it mean for a country to have an absolute advantage in a particular good?
It means that the country can produce that good using fewer resources than another country.
Multiple Choice: Which of the following best describes absolute advantage? A) Producing at a lower opportunity cost B) Producing more with the same resources C) Trading goods internationally
B) Producing more with the same resources
What is the primary benefit of absolute advantage?
Increased efficiency in production and potential for higher output.
What is a key limitation of the absolute advantage theory?
It does not consider opportunity costs in production.
Multiple Choice: Which scenario illustrates absolute advantage? A) Country A can produce 10 cars with 5 workers, while Country B can produce 5 cars with the same number of workers. B) Country A can produce 5 cars with 3 workers, while Country B can produce 4 cars with 2 workers.
A) Country A can produce 10 cars with 5 workers, while Country B can produce 5 cars with the same number of workers.
Who benefits from trade based on absolute advantage?
Both countries involved in the trade can benefit by specializing in the production of goods where they have an absolute advantage.
What is the relationship between absolute advantage and specialization?
Countries tend to specialize in the production of goods for which they have an absolute advantage.
Fill in the blank: The concept of absolute advantage supports the idea of ________ in international trade.
specialization
What happens to production efficiency when countries specialize based on absolute advantage?
Production efficiency increases as resources are allocated to their most productive uses.
What role does technology play in absolute advantage?
Technology can enhance a country’s absolute advantage by increasing the efficiency of production.
Multiple Choice: Which of the following can diminish a country’s absolute advantage? A) Improved technology in another country B) Increased resource costs C) Both A and B
C) Both A and B
What is the impact of absolute advantage on domestic production?
It encourages domestic producers to focus on goods they can produce more efficiently.
Comparative advantage
When a country can produce a good with a lower opportunity cost than another country
benefits of specialisation and trade
-lower prices
-more choice (consumers and firms)
-economies of scale
-higher standard of living
-increased competition
-spread of tech and new ideas
-scept
financial markets
Places where buyers and sellers trade financial assets (shares)
costs of specialisation and trade
-risk of current account deficit
-export dependence
-increased exposure to external shocks
-structual unemployment
-global monopolies
-infant industries unable to compete
-aggressive, anti-competitive prices
Comparative advantages laws
-constant returns to scale
-ignores transport cost
-ignores barriers to trade
-perfect mobility of FOP between different uses
-externalities ignored
limitations of the law of comparative advantage
-free trade not necessarily fair trade (rich countries exert monopsony power to force producers in developing countries to accept low prices)
-law of comparative advantage is based on unrealistic assumptions
-if OC were the same, there would be no benefit from specialisation and trade
Terms of Trade formula
(index of export prices/ index of import prices) x 100
factors influencing country’s TOT
-country’s rate of inflation relative to other countries
-country’s produciviyt relative to that of other countries
-tariffs
-country’s exchange rate
effect of increase in TOT
-higher living standards =country can import more for a given quantity of exports
-deterioraion in CA of the balance of payments = cause decline in competitiveness of products
Role of Financial Markets (Facilitate saving)
-provide an opportunity for individuals/ firms to save money
-put money in a bank (get IR on it)
-put money into a pension fund (can access when you’re older)
Role of Financial Markets (Facilitate Lending)
-Lend money to businesses/individuals who need more cash
-personal/business loan from a bank (pay IR when you pay back)
-mortgage for a house
Role of Financial Market (Facilitate exchange)
-Provide opportunity for individuals/firms to exchange
-having bank account to transfer money to friends/pay for g/s
-makes it easier for trade
Role of Financial Markets (Provide market for equity)
- Provide market in which equity can be bought and sold
-businesses sell a percentage of their company to investors who want a share of companies profits so they dont have to pay IR on a loan- sell their company in shares and raise money to invest
- businesses will go to an international bank so they can sell the shares for them to willing investors (providing equity market)
Role of Financal Market (provide forward markets)
forward contracts - contract that guarantees that a trade happens at a later date at a certain place
- fixed price + future date of future transaction
- used usually for commodities/currencies (they have price instability)
-businesses ask bank to create forward contract as its complicated
Financial Crisis
bonuses/profits
2. Decide to start givng out subprime mortages (loans issued to borrowes with low credit card ratings carrying a hiigh IR)
3.House prices shoot up
4. creating housing bubble (steep run up in house prices, and that ‘bursts’ when what is driving demand collapses, leaving a high supply of houses leading to decline in house prices)
5 . 2008 - american economy collapses banks lose lots of money
6. global effects
subprime mortgages - adjustable rates
-teaser rate = 1% IR for one year then 5% for the next 10 yrs
- would help with getting high risk borrowers getting loans and then bank gets lots of money in the future
- borrowers fooled by ‘teaser rates’ and the asymmetric information (banks knew they would increase IR a lot and borrowers didn’t)
Financial Crisis = win-win formula
- bankers selling their subprime mortgages with adjustable rates
- they got high IR rate back from those repayments
- or if the borrowers defaulted the bank got the house and with the increasing house prices they would even get profit
- so banks could not lose with this scheme
Financial Crisis - the Housing bubble
- so increase in house prices( if borrowers defualt higher profit for bankers)
- so banks sell more of these subprime mortgages = more demand for houses = inflation in house prices (cycle)
-by 2007 house prices doubled so homeowners worried about crashing prices started selling
-this increase in supply decreased prices - so more homeowners were selling their houses
- house prices plummented
- bubble popped
Financial crisis - housing bubble popped
would lose money when someone defaulted on their mortgage
- now that years have passed the teaser rates of some of the subprime mortgages were jumping up to very high IR so more ppl defaulting on them
– banks lost lots of money
-since banks were connected to other banks globally everyone felt the devastating effects
-lehman brothers = bankrupt
-banks couldnt loan money = businesses had to cut costs = increase in unemployement
-gov. had to step in and give financial support
Types of financial market failure
- Asymmetric information
- Speculation and market bubbles
- Negative externalites
- Moral hazard
Market failure - Asymmetric information
-when one party knows more than another in a
transaction
-e.g. bankers selling subprime mortgages with adjustable rates
-financial regulators, monitor banks but didnt realise what banks were during before GFC as banks would complicate and repackage these deals
absolute poverty
unable to afford basic necessities like food, clean water, shelter
measuring absolute poverty
the world bank measures it - poverty line at $2.15 a day (2017 prices) adjusted for PPP
relative poverty
relatively poor compared to the rest of your country
measuring relative poverty (UK)
60% below median household income in your country
What does the Gini coefficient measure?
Income inequality within a population.
What is the range of the Gini coefficient?
0 to 1, where 0 represents perfect equality and 1 represents perfect inequality.
What is the formula for calculating the Gini coefficient?
G = A / (A + B), where A is the area between the line of equality and the Lorenz curve, and B is the area under the Lorenz curve.
What is the Lorenz curve?
A graphical representation of income distribution.
