The Basic Idea Underlying Purchasing Power Parity

International trade affects the economy by increasing the Aggregate Demand (AD), and by becoming a source of inputs for production. International trade based on the theory of comparative advantage will improve efficiency in allocating resources, as well as allow businesses to reach economies of scale - "the situation in which costs per unit of output fall as output increases", consequently reaching competitive prices of international markets (Colander, 2004, p. 428). When an economy involves itself in trade, under the right circumstances, it is able to shift the Production Possibility Curve (PPC) curve outward, and achieve greater levels of output. This increase in production can be achieved through the use of more resources

“Bertrand's theory describes a duopoly market in which two firms are competing with each other through a price war. As per the assumptions made, if the price of a good from 'Firm 1' is less than the price charged by 'Firm 2' then, all the consumers will buy goods only from Firm 1. And, Firm 1 will be able to cater to all the consumer demands. However, if Firm 2 also reduces its price making it equal to the equal to the price charged by Firm 1, then, the total demand and the total sale will be equally divided between the two firms. If the price war continues, then firms eventually will reach a point where they will charge a 'Marginal Price'. After reaching this point none of the firms can further lower their prices and will reach a point of stagnancy.”

One needs to have a base level understanding of what defines an exchange rate. According to Investopedia, a foreign exchange rate is “The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another.”(Investopedia, 2012) The process by which foreign exchange rates are determined is really not any different than any other

Due to the differences between the countries in its profitable fundamentals; the International Trade occurs. The contracts between the countries consider as the primary driver of the global exchange. These contracts concluded on the basis of the countries beneficial elements and advantages. Each international trade between the countries depends on numerous focal points of this exchange process. The economics and producers effectiveness measured by absolute advantage for these economics/producers. For example; if the producer needs lesser amount of contributions/inputs to provide specific product, then this producer has an absolute advantage in producing

Imagine initially that the two countries are not trading and that they are each producing at point ‘c’ and keeping all their produce for themselves. Do you think the two nations can benefit from specialization and trade? Explain your answer using the concept of comparative advantage and opportunity costs. First, identify the opportunity cost for each country in each good, and then say which country has a comparative advantage in which good. Note if both countries fully specialize at point e there will be less teacups in the market than prior to trade. Note that Ying at point d and Tai at point e in fact guarantees a gain from trade. Drawing and recognizing the PPF correctly also counts. 4. Using the appropriate diagrams, detail the impact on the

Exchange rates play a pivotal role in the relationships between individual economies and the global economy. Almost all financial flows are processed through the exchange rate, as a result the movements and fluctuations of the exchange have a significant impact on international competitiveness, trade flows, investment decisions and many other factors within the economy. Due to the increasing globalisation of the world economy, trade and financial flows are becoming more accessible

A price escalation strategy consists of using the price has been determined for the domestic market and then adding the costs of shipping, duties and markups to come up with a final retail price. This strategy ensures that the company not only recovers the cost of the export venture, but also includes a built in profit per item. Because they begin with charging the amount that they would otherwise sell for in the United States – one that brings with it a profit – they are promising themselves returns at least equal to that which they would receive if they continued to sell domestically. The price is ultimately higher than that which is derived from a cost escalation strategy, but with a higher end product – like those produced by Polyprin – a higher price is not at all detrimental to the likelihood of its success.

If the scales should go out of balance then trade and international relations are damaged. If this happens the trading partners will counter with tariffs and quotas of their own. (Colander, 2010)

Surpluses put pressure on prices to fall. Hence, the new market equilibrium will be at a price that is lower than P*.

This opportunity provides a gain from exchange as domestic consumers buy cheaper imported goods and producers can export goods at higher foreign prices.

The American dollar rate can reveal the value of dollar compared to other countries. For example,

As consumers, we all live in a society where our needs and wants are the drive for our consumption of certain goods and services. At this point elements of supply and demand are factored into the equation: in order to supply some goods and services that are being demanded countries rely on importing and exporting. To obtain these goods and services some form of compensation/ incentive is needed. Conducting trade by means of barter is not very practical in most circumstances and today’s society. So we use money. Different countries use different forms of money: the Dollar in the United States of America, the Euro in Europe, the Pound in The United Kingdom and in China the Renminbi .What happens when countries who want to trade with each other use different forms of money, when their units of monetary exchange are not the same? Common sense would tell the buyer to exchange their currency to match that of the sellers, and so they do so.

Example: China is able to make toys more inexpensively than the United States because the wages/earnings, cost of living, cost of operations, skilled labor costs, etc. are not as high in that country as it is in the United States. Let’s say a toy cost $30 in the store - to make that toy in the U.S. it will cost $20/toy and in China the toy can be made at the cost of $5/toy. Of manufacturing company is going to want to go with China making the toy because they can make a $25 profit; whereas, if the U.S. made toy they would only make a $10 profit.

It is the most remarkable conclusion of the Heckscher-Olin theory that trade can equalize the price of each factor of production across countries. Nevertheless, the long-term effect didn’t complete in the real world, especially in China. On majoy

Price discrimination can be analysed using the concept of MC and MR. The firms need to allocate production between the two markets so that the MR is identical for each market if it is to maximise profit.MR in market A is higher than MR in market B. By switching products from B to A, the firms can increase its revenue from a given output.MR in market B will now rise because it can charge a higher price if it sells less.MR in market A will fall because it has to lower price to sell more. For example, if MR in