Question

1. Explain the principle of comparative advantage. Does it tell us how the gains from trade will be distributed?

2. What is meant by the dollar-euro exchange rate? In what market is this rate determined? What factors will cause the dollar value of the euro to rise? What factors will cause the dollar value of the euro to fall?

Answer 1

According to comparative advantage theory the nation should specialise in the production of commodities s in which it's absolute disadvantage is small and import the commodity in which it's absolute disadvantage is greater. No it only tells us the limits within which commodities will be exchanged and amount of gain to both nations but not how gains from trade will be distributed

Dollar euro exchange rate shows how much units of dollar can be exchanged per euro. This rate is determined in foreign exchange market. Greater demand for euros in relation to supply and smaller demand for dollars causes the dollar value of euro to rise. Smaller demand for euros compared to supply and greater demand for dollars cause dollar value of euro to fall. Note demand and supply in turn depend on imports, exports, capital movements etc