Module 8: International Economics Module 8: International Economics 8.1 International Trade The foundational principles of specialization and comparative advantage are just as powerful when applied to nations as they are to individuals or firms.
International trade allows countries to specialize in producing what they do best and trade for the rest.
This global specialization leads to greater overall efficiency, increased world output, and enables countries to consume beyond their own domestic production possibilities, ultimately generating greater wealth for all participants.
The Basis for Trade The fundamental driver of international trade is comparative advantage.
A country will specialize in and export goods for which it has a lower opportunity cost of production, and it will import goods for which other countries have a lower opportunity cost.
Even if one country has an absolute advantage in producing all goods, it still benefits by specializing in the goods where its comparative advantage is greatest.
Through this process of specialization based on comparative advantage, the total output of the world economy increases.
Trade Barriers Despite the clear benefits of free trade, governments often impose restrictions to protect domestic industries from foreign competition.
The two most common forms of trade barriers are: Tariff: A tax levied on imported goods.
A tariff increases the price of the imported product for domestic consumers, making domestic substitutes more attractive.
The government collects revenue from the tax.
Quota: A legal limit on the quantity of a specific good that can be imported.
By restricting supply, a quota also drives up the domestic price of the good.
Both tariffs and quotas harm domestic consumers by forcing them to pay higher prices and reducing the quantity of goods available.
While these policies may protect specific domestic producers and jobs in the short term, they often lead to overall economic inefficiency.
The argument for protectionism often centers on “protecting domestic jobs,” but critics argue that this merely redistributes employment to less efficient industries at the expense of consumers and overall economic growth.
Trade involves the exchange of not only goods and services but also the currencies required to pay for them, which leads us to the topic of international finance.
8.2 International Finance International trade and investment would be impossible without a system for exchanging the currencies of different nations.
The foreign exchange market is the global marketplace where national currencies are bought and sold.
This market is the mechanism that determines the exchange rate—the value of one country’s currency in terms of another.