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You go to an Apple store and find that the AirPods have become expensive. You go to Amazon and order a new pair of headphones from China, which are much cheaper. Have you ever wondered what the economic impact of this is? What happens when countries trade with one another? How does international economics view the trade between countries, and what are some policies we can use to improve our economies? You'll be able to answer all this and much more once you reach the bottom of this article!
What is the definition of international economics? In macroeconomics, international economics refers to trade between nations. Today, all nations import (buy) goods and services from other nations and export (sell) goods and services to other countries.
International economics is the field of economics that is concerned with how nations interact with one another on economic basis.
The balance of exports minus imports, called net exports (XN), is one of the four sectors of gross domestic product (GDP). Thus, nations that export more than they import, known as net exporters, add to their GDP - the value of all final goods and services produced within their borders - for the year.
Net importers, which import more than they export, see a reduction in their annual GDP. Factors that increase net exports will increase a nation’s output.
International and global economics looks at factors influencing nations’ ability and willingness to import and export goods. This includes conditions that make international trade beneficial for countries, which is explained using the Law of Comparative Advantage and further explored by looking at economic systems and free trade organizations.
It also looks at limits on imports and exports, collectively known as trade barriers. As one of the four sectors of GDP, it is essential to learn about international economics to understand a nation’s economic health and stability.
Check out our Barriers to Trade for a more detailed explanation!
International port, pixabay
David Ricardo is known for his contribution to the international economics theory and policy. He created the Law of Comparative Advantage, which states that nations should produce and export goods in which they have a lower opportunity cost than another nation. Previously, countries tried to make and sell all goods they had an absolute advantage in, which meant the ability to create a more significant total amount.
At the time, Britain, thanks to the Industrial Revolution, had an absolute advantage in most goods. Ricardo realized that, although Britain could make the most of many goods, it had to sacrifice lots of one valuable good to make more of another valuable good.
The amount of one thing you must give up to produce more of another thing is the opportunity cost - literally, the cost (in terms of good Y) of the opportunity to create one more unit of good X. While Britain could make more units of good X than any other country, it had to give up many units of good Y to do so.
It was discovered that other nations, such as Portugal, could make a unit of good X and give up less good Y to do it! If Portugal was allowed to focus on making good X, and Britain was allowed to focus on making good Y, there would be more total goods available for both countries.
The Law of Comparative Advantage leads to specialization (focus on a few goods), which leads to increased skill and efficiency of production. Over time, this further increases the gains from trade, represented by the increased number of goods a nation can consume after specializing and trading internationally versus the number of goods it could consume only using domestic production.
Check out our Comparative Advantage and Trade to learn more about Ricardo's theory.
A country's economic system heavily influences how freely a nation engages in specialization and international trade. An economic system is composed of the laws, rules, and traditions that determine who is allowed to produce and consume which goods. In the modern era, especially in non-rural areas, economic systems exist on a spectrum between free market (also known as capitalism) and command (also known as socialism or communism). During the era from 1920 to the mid-1980s, many nations under communism used central planning to determine economic production.
We have detailed explanations on Command Economy and Market Economy. Check them out!
Today, few command economies remain, except countries like Cuba and North Korea. Most economies, including the United States, are mixed economies that use the laws of supply and demand and government regulations to determine production. They trade with other countries, and their economies are open to foreigners.
Let us look at a hypothetical international economics example of comparative advantage between two producers: Britain and Portugal.
Using all of its factors of production (resources), Britain can produce either 100 units of Good X or 100 units of Good Y. Britain can make any combination of Goods X and Y.
Using all of its available resources, Portugal can produce either 90 units of Good X or 50 units of Good Y. Clearly, Britain can make more of both X and Y, giving it an absolute advantage in both goods.
Suppose one seeks to maximize the total amount of both X and Y available between countries. In that case, it makes sense for Portugal to focus entirely on making X and Britain to focus entirely on making Y as it must only give up 50 units of Y to make 90 units of X.
In comparison, Britain would have to give up 100 units of Y to make the same amount of X (since the ratio between Y and X for Britain is 1:1). Britain should make all the units of Y since it can produce twice as much as Portugal and sacrifice 100 units of X.
Proportionally, Portugal would have to give up 180 units of X to make 100 units of Y (doubling both of its values on the PPC)! Portugal has the lower opportunity cost in terms of Y (50 vs. 90) to make an equal amount of X. In contrast, Britain has the lower opportunity cost in terms of Y (100 vs. 180) to make an equal amount of Y. Portugal has the comparative advantage in Good X. In contrast, Britain has the comparative advantage in Good Y.
Now specializing, Portugal makes 90 units of X, and Britain makes 100 units of Y. Both would enjoy more consumption from trading with one another.
The scope of international economics is now global, thanks to the rise of free trade agreements and free trade organizations (FTOs) after World War II. Today, most nations belong to the World Trade Organization (WTO) and seek to trade regularly with other countries. There are also regional trade agreements and organizations, like the European Union (E.U.) and the North American Free Trade Agreement (NAFTA).
The E.U. has gone so far as to create a market using a common currency - the euro. Similar to states within the United States, members of the E.U. enjoy zero tariffs between states and the convenience of using the same coin. Rules and regulations on commerce are also the same, which reduces confusion. Altogether, free trade agreements and moving closer to a common market has increased economic efficiency by reducing transaction costs.
These are the costs incurred in transactions, ranging from time to negotiation to expense in exchanging currency. Consumers enjoy lower prices by reducing transaction costs through trade agreements and modern technology.
International economics also affects nations domestically. While most economists support global free trade because it benefits all consumers (through lower prices) and some producers (those with comparative advantage), there is usually some degree of domestic support for trade barriers to protect struggling domestic producers.
Applying a tariff (tax) to imports raises the price, helping some domestic producers remain in business. However, the nations whose imports have been limited may retaliate with their own tariffs.
Reciprocal trade agreements require nations to not raise tariffs on each other’s goods, as doing so often results in a “trade war” whereby two countries raise taxes on each other, try to artificially adjust their currency values, or produce other harmful actions.
Fortunately, most countries now use tariffs and quotas sparingly, preferring to let the supply-and-demand market forces determine which domestic firms are competitive against foreign suppliers.
International economics is the field of economics that is concerned with how nations interact with one another on economic basis. An example of international economics would be: analyzing how net exports affect the economy.
International trade agreements, trade barriers, free trade organizations, etc.
Trade between nations affects GDP, which makes international economics important.
Some of the components include net exports, foreign exchange market, balance of payments, etc.
International Trade and International Finance
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