"economics"exercise:Current account deficit

C is correct. A comparative advantage arises if one entity can produce an item at a lower opportunity cost than another. An absolute advantage in producing a good (or service) arises if one entity can produce that good at a lower cost or use fewer resources in its production than its trading partner. Even if a country does not have an absolute advantage in producing any of its goods, it can still gain from trade by exporting the goods in which it has a comparative advantage. The country with the lower opportunity cost (with the comparative advantage) should specialize and produce its low opportunity cost item, and the other country should produce the high opportunity cost item, trading the goods between each other to make both better off.

A is incorrect. Economies of scale or lower labor costs will likely result in a lower cost of production, but only a comparative advantage is necessary to benefit from trade.

B is incorrect. An absolute advantage in producing a good (or service) arises if one country is able to produce that good at a lower cost or use fewer resources in its production than its trading partner. It is the lower opportunity cost that one country has that is the reason that one country should specialize in order to gain from trade.

C is correct. A current account deficit must be offset by a capital account surplus. Only by borrowing money from foreigners can a country have a current account deficit and consume more output than it produces. An increase in net foreign liabilities is the result of borrowing from foreigners.

B is incorrect. Restricting foreign direct investment would have a negative effect on the capital account surplus and the country’s ability to increase its consumption.

A is incorrect. A current account deficit is consistent with low domestic savings. For the capital account to achieve a surplus, investments should exceed savings.