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International Economics

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International Economics

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!

Scope of International Economics

What is the scope of international economics? A big part of international economics is concerned with international trade. The first question we ask is why countries engage in trade in the first place. It's not necessarily because they are not able to produce everything themselves but that it is more efficient for countries to specialize in production in which they have a relatively lower cost. You will see trade-related topics such as absolute and comparative advantages, the balance of trade, trade barriers like tariffs and quotas, protectionism, and free trade agreements.

International Economics International Port StudySmarterFig. 1 - An international port.

International economics also deals with the issue of economic development in developing countries. What are some ways that can help developing countries catch up to their peers in the developed world? What are some of the obstacles that they face on the way there? How can assistance from international institutions like the World Bank and IMF or regional initiatives help development?

In addition, international economics asks questions about global economic challenges such as globalization, population growth, demand for resources, and pollution.

You can find out more about these categories by checking out these explanations:

- Internation Trade

- Developing Countries

- Global Economic Challenges

International Economics Definition

What is the definition of international economics?

International economics is the field of economics that is concerned with the economic interactions of different nations as well as the economic interactions between nations and international institutions.

A big part of international economics concerns trade between nations. Today, all nations import (buy) goods and services from other nations and export (sell) goods and services to other countries.

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 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!

Benefits of International Trade Economics

Economics theory says that international trade brings many benefits to countries around the world. This stems from the fact that countries can focus on producing the goods and services in which they have a comparative advantage. They can export these goods and services that they can produce relatively cheaply and import other goods and services from other countries.

International Economics Theory and Policy

David Ricardo is known for his contribution to 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. Absolute advantage means the ability to produce a larger output using the same amount of resources.

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 explanation of 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 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.

International Economics Examples

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.

Importance of International Economics

The importance of international economics cannot be understated. In terms of international trade alone, the importance of international trade has been underlined by the rise of free trade agreements (FTAs) 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 (EU) and the North American Free Trade Agreement (NAFTA).

The EU 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 EU enjoy zero tariffs between states and the convenience of using the same currency. 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 trade 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 - Key takeaways

  • International economics is the field of economics that is concerned with the economic interactions of different nations as well as the economic interactions between nations and international institutions.
  • International economics looks at factors influencing nations’ ability and willingness to import and export goods.
  • The law of comparative advantage says that specialization leads to increased skill and efficiency of production.

Frequently Asked Questions about International Economics

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

Final International Economics Quiz

Question

What is population growth?

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Answer

Population growth is the increase in the number of people in a given area

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What is a census?

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A census is the official count of the population in the country.

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What are the 3 factors that affect population growth?

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The three factors that affect population growth are fertility rate, life expectancy, and net migration. 

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What are the two types of population growth?

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Exponential and logistic growth.

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What is the fertility rate?

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The fertility rate is the number of births that 1,000 women are expected to go through in their lifetime.

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What is life expectancy?

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Life expectancy is the average lifespan that a person will reach.


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What is the net immigration rate?

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The net immigration rate is the total change in population from people moving in and out of the country.


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What do demographers study?

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Demographers study the growth, density, and other characteristics of the population

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True or False: population can cause positive AND negative effects on the economy?

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True

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True or False: the fertility rate is more important to population growth than the net immigration rate.

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False

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Which of the following is a positive economic outcome of population growth?

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More access to labor

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Which of the following is a negative economic outcome of population growth?

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Pollution

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In the United States, how often does the census occur?

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10 years

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Question

How would you define economic development?

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Economic Development focuses on improving the standard of living of the individuals of an economy through the implementation of policies, programs and socioeconomic goals.

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What are the 5 stages of economic development?

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  1. Traditional Society 
  2. Preconditions to Take-off
  3. Take-off
  4. Drive to Maturity
  5. Age of High Mass consumption

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An economy in the traditional society stage of economic development  will have which of the following characteristic:

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the economy is based on agriculture 

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An economy in the preconditions to take-off stage of economic development  will have which of the following characteristic:

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the economy develop and use manufacturing for its output

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An economy in the take-off stage of economic development will have which of the following characteristic:

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the economy has been introduced to industrialization 

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An economy in the preconditions to drive to maturity stage of economic development  will have which of the following characteristic:

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the economy is transitioning from a few key industries to more integrated and varying industries

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An economy in the age of high mass consumption stage of economic development will have which of the following characteristic:

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the economy is experiencing an increased amount of consumption 

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Developed countries have a higher GDP per capita as they tend to have a smaller population and a higher real GDP due to greater access to technology and investment. Whereas developing countries have a lower GDP per capita as they have a greater population and lower real GDP due to limited technology and investment available. 

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True

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The unemployment rate is an indicator that provides insights regarding the employed individuals in the labor force who are actively looking for employment


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False

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Higher inflation is indicative of lower purchasing power of the currency, in other words, fewer goods and services can be purchased for the same dollar value.


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True

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The national debt of a country is an indicator which provides insights into the net accumulation of the ------------------- of the government from domestic and foreign --------------------.


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borrowing; lenders

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The trade balance of a country is an indicator which provides insights into the -------------------  -------------------- of a country.


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net exports

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What are the three dimensions that the human development index takes into account?

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  1. Standard of living - measured by income per capita 
  2. Education - measured through literacy rate
  3. Longevity- measured through average life expectancy and infant mortality 

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What defines a developing country?


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Developing countries have developing economies and low average per capita income. Since their economies are not well developed, they have generally less developed infrastructure, education, and health care systems.


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Economic development focuses on the standard of living, it is inclusive of both qualitative and quantitive measures.


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True

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What are the 3 characteristics of developing countries?


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Typically, we consider a country as developing if its nation has a lower income, underdeveloped industrial structure, and lower level of welfare.

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How would you define economic growth? 

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Economic growth focuses on the increase in the output produced by an economy from one period to another.

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What is the difference between developed and developing countries?


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Economists use the GDP per capita as the development measure. The countries which are independent and have high income per capita are named developed countries whereas developing countries have a lower income per capita.

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Why economics is important in developing countries?


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Economics is the crucial element for a country to be developed. If there is enough funding in a country, the government can use it to improve the infrastructure, increase the quality of public goods, develop the health and education system and create jobs. 


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Why do developing countries usually have less variety in their economic activities?

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Because typically they even struggle with providing the basic needs for the nation. 

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Which of the following is not a 

developing country?


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US

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Which of the following are economic problems of developing countries? 


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High Population Growth


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What is a microloan?

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Microloans as part of microfinance is an economic way to support developing nations. A microloan is usually a small loan made to women to support their projects and encourage them to start small businesses. 


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Savings are one of the main resources to generate funds. In order to generate these internal funds, there should be more production than consumption. 


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True

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What is a Primitive Equilibrium?

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Primitive equilibrium is the first stage of economic development where the economy is stagnant and there is no formal monetary system. 


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There is no strict transition between the stages of development since countries may experience several stages of development at the same time.


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True

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United States, Australia, Canada, Japan, and West European countries are examples of developing countries. 


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False

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Why is population growth an economic problem for developing countries?


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The higher the number of people living in a country, the higher the demand for products, jobs as well as services such as education and health. Since the available income of the developing countries is limited, it is even harder to feed more and provide jobs and services for the increasing population. 


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Why external debt is an issue for developing countries?

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If countries need financial investment for these services and cannot afford it, they often take external debt from other countries to improve the conditions. However, sometimes some nations borrow so much money that they cannot repay the money and have to face higher interest rates. This affects the developing nations even more negatively.


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What is the Takeoff stage?

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Takeoff is the third stage of economic development and happens when the obstacles of primitive equilibrium have been resolved. At this stage, nations look for and adopt new technologies or techniques that outsiders bring to them. 


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What is a trade deficit?

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It is when a country imports more goods than it exports.

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What is a trade surplus?

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It is when a country exports more goods than it imports.

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What is a current account?

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A current account represents a country's total exports and imports of goods, services, income, and capital transfers.

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What does a positive net export mean?

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A country is in a trade surplus

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What does a negative net export mean?

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A country is in a trade deficit

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What makes up the largest portion of the current account?

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Net exports

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Question

What is the value of the dollar during a trade deficit?

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Answer

The value of the dollar is strong and will slowly become weaker

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