International Economics

International Economics Definition

What is the definition of international economics?

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.

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.

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.

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.

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.

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.