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Economic Development of Central America Econ. 4200 - Spring 2004 – Dr. Taylor - page 17 / 153

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Concepts to Define & Understand at the Beginning…

1. Comparative advantage - def: A nation has a comparative advantage over a trading partner in the production of an item if it can produce that item at a lower unit cost than its partner.

Implications...

a.Any country can increase its income by trading, because the world market provides an opportunity to buy some goods at relative prices that are lower than those which would prevail at home in the absence of trade.

b.The smaller the country the greater this potential gain from trade, but all countries benefit to some extent.

c.A country will gain most by exporting commodities that it produces using its abundant factors of production most intensively, while importing those goods whose production would require more of the scarcer factors of production.

2.Exchange rates - def: The price of one nation's monetary unit in terms of the monetary unit of another country.

a.Foreign exchange market: A market in which buyers and sellers of bank deposits denominated in the monetary unit of many nations exchange their funds.

- Exchange rates can be allowed to fluctuate freely, can be "managed" or can be pegged to the currency of a major trading partner. => Graph

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