Absolute advantage
Absolute advantage is a concept where one country produces a similar good at a cheaper cost of production compared with another country (William, 2008). This means that the production costs of one country are likely to be higher compared with another country. Absolute advantage occurs when a country employs less labour resources compared with other countries in production. For instance, compare South Africa and Sudan involved in Sugar production. South Africa will have an absolute advantage over Sudan if it incurs fewer costs in producing sugar. This is contributed by factors like lower production costs in terms of labour and technology between the two countries. A country with fewer labour production costs is likely to produce more outputs with the same capital investments compared with another country (William, 2008). Absolute advantage is mainly influenced by the level of production of labour in a country. Labour scarcity in a country is likely to contribute to the cost of production being higher. Countries that are well endowed with resources are likely to have absolute advantage over those that lack these resources in producing a good. Division of labour and specialization in production contributes to a nation enjoying absolute advantage (William, 2008).
Comparative advantage
Comparative advantage is a concept in production where a firm or a country produces a good at lower foregone costs compared to other firms or countries. For instance, take a case where both Sweden and Germany are involved in Milk and Distilled water production respectively. If Sweden produces more Milk at the lower foregone cost of distilled water, then it will have a comparative advantage over Germany in milk production and vice versa (Melline, 2006). Comparative advantage is established not by the difference in values of labour productivity, instead by labour productivity ratios between two countries. This means that no particular nation will enjoy a comparative advantage in both products it produces.
Foreign Exchange Rates
The foreign exchange rate in a country is affected by the level of demand and supply of the foreign exchange currency. The foreign exchange rate is affected by several factors. Firstly, the rate of inflation in different countries affects foreign exchange rates. The ability of consumers to buy goods between countries due to inflation in a country can affect the rate of foreign exchange. Secondly, the interest rate of a country can also influence the rate of foreign exchange. The third reason of foreign exchange rates changes, is a shift in relative productivity in a country. For example, when a country’s production levels go down compared to another country, the former country becomes less competitive to the latter in international trade. This, leads to a decline in good exported from the country. Low exports can affect demand of foreign currency. Furthermore, consumers keep changing in the products consumed from different countries. For instance, in situations where Americans prefer products made in Canada, like clothes, this is likely to increase the demand for Canadian dollar in foreign-exchange markets. Lastly, the economic and political stability level of foreign investments in a country. Political and economic stability contribute to increased investment in an economy (Woodbury, 2007).
References
Melline, G. (2006). International Trade Theory and Policy. Web.
William, A. (2008). International Encyclopedia of the Social Sciences. Ed. Darity, Jr. Vol. 1. 2nd ed. Detroit: Macmillan Reference USA.
Woodbury, D. (2007). Currency Exchange: Encyclopedia of Business and Finance. Vol. 1. 2nd ed. Detroit: Macmillan Reference USA, 2007. HarperCollins College Publishers. NY, USA.