An economics field of study that applies both macroeconomic and microeconomic principles to international trade, which is the flow of trade among nations, and to international finance, which is the means of making payment for the exchange of goods among nations. International economics studies the economic interactions among the different nations that make up the global economy. Often this interaction is viewed in terms of the domestic economy and the foreign sector. The key economic principle underlying international economics is the law of comparative advantage.
International economics is the study of how the production of one nation is purchased by another nation and how the currency of one nation is exchanged for the currency of another nation to pay for this production. In one sense, international economics is the application of standard economic principles with one key qualification — the buyers are in one nation and the sellers are in another.
This key qualification, however, a couple of important topics. One is the need to exchange the currency of one nation for the currency of another. Another is the inevitable involvement of the government sector. The first topic is captured by the foreign exchange market. The second topic highlights government trade policies and the politics of protectionism.
Trade and Finance
International economics is a broad field of study that is divided between two subfields — international trade and international finance. Economists can and do spend their entire careers in either subfield, but usually have a keen understanding of both.
- International Trade: This is the study of the flow of goods and services among the nations of the globe. The primary focus is on how and why goods are traded, especially the identification of key principles such as the law of comparative advantage.
- International Finance: This is the study of the payment for the goods and services traded among nations. This subfield is concerned with identifying the principles important to the exchange of the currencies used to pay for the traded goods, with particular focus on the foreign exchange market.
A Macro-Micro Bridge
The study of international economics bridges the divide between the two primary branches of economics — macroeconomics and microeconomics.
- Macroeconomics: This is the study of the aggregate economy, with particular emphasis on business-cycle instability that triggers problems of unemployment and inflation. While macroeconomics is primarily concerned with domestic production that is purchased by the domestic sector, trade with the foreign sector can also play a pivotal role. Net exports are a small, but potentially volatile, component of aggregate demand that can contribute to economy-wide business-cycle instability. Changes in net exports can affect the production, income, and living standards of the domestic economy.
- Microeconomics: This is the study of parts of the economy, with particular emphasis on the efficiency of market exchanges. While a wide range of issues, applications, and topics are studied under the heading of microeconomics, important applications of market principles apply to international trade and international finance. The result of such applications provides insight into a number of extremely important issues, both within and beyond the venue of international economics. Some of these issues include migration of the population, competition among oligopoly firms, and wage differentials in labor markets.
The Trading Game
The starting point for the study of international economics is the trade than takes place among nations, termed either international trade or foreign trade. The international trade term is the more generic of the two, taking a more global view of the trading process. And in so doing it focuses on the essential principles of trade among nations, such as the law of comparative advantage.
The foreign trade term is a bit more specific, taking a domestic view of the trading process. And it so doing it emphasizes the interaction between the domestic economy and the foreign sector, especially assorted trading policies.
The study of foreign trade also gives rise to three related terms — exports, imports, and net exports.
- Exports: Exports are goods (or services) produced by the domestic economy and purchased by the foreign sector. These are goods that flow out of a domestic economy.
- Imports: Imports are goods (or services) produced by the foreign sector and purchased by the domestic economy. These are goods (or services) that flow into a domestic economy.
- Net Exports: Net exports are the difference between exports and imports. This is the difference between goods flowing out of the domestic economy and goods flowing into a domestic economy.
From the domestic view of foreign trade, the goal of a given nation is usually to promote exports, restrict imports, and thus create the biggest possible net exports difference between exports and imports. This difference between exports and imports is indicated by what is termed a nation’s balance of trade.
From the global view of international trade, the exports of one nation are the imports of another. When one nation exports another nation imports. The global sum of exports necessarily equals the global sum of imports. For the global economy, net exports are zero.
The central economic principle underlying the study of international trade is the law of comparative advantage.
- This law states that every nation has a production activity that incurs a lower opportunity cost than that of another nation, which means that trade between the two nations can be beneficial to both if each specializes in the production of a good with lower relative opportunity cost.
The law of comparative advantage indicates why it is that technologically advanced nations, nations that could produce all sorts of goods, find it beneficial to purchase some of those goods from less advanced nations. In the same way the exchanges among buyers and sellers within a nation can be beneficial to both sides, international trade among nations can also be beneficial to both sides.
Those who study international economics also spend a great deal of time studying how payment is made for the goods traded among nations, that is international finance. Because international trade occurs among nations that typically use different currencies, such trade inevitably requires the exchange of currencies.
The trading of currency is captured in what is termed the foreign exchange market. When one nation buys goods produced by another it also needs a bit of the currency of the other nation to make the payment. It “buys” this currency through the foreign exchange market. However, when it “buys” the currency of another nation, it simultaneously “sells” its own currency. In other words, one currency is exchanged for another.
While international trade is a primary that nations exchange currency it is not the only reason. Currency is also exchanged when one nation investments in the physical or financial assets of another. Or when the government of one nation provides aid or assistance to another nation. Comparable to the balance of trade, an accounting of the assorted currency flows from one nation to others is termed the balance of payments.
Policies and Politics
Another focus of the study of international economics is the assorted policies that governments undertake to either promote exports or restrict imports. With the goal of increasing net exports and “improving” their domestic balance of trade, three of the most common trade polices are:
- Tariffs: Tariffs are simply taxes on imports. By taxing imports, the price of imports increases relative to domestic production, which discourages imports and thus increases net exports.
- Import Quotas: Quotas are legal restrictions on the quantities of goods imported. By limiting the quantity of imports, imports are obviously discouraged and net exports increase.
- Export Subsidies: Subsidies are payments from the government to individuals or businesses without any expectations of receiving any production in exchange. Subsidy payment to export producers encourages exports and thus increases net exports.
In addition to increasing net exports, these policies inevitably benefit domestic producers with higher prices and/or greater profits. However, these policies also tend to hurt domestic consumers with higher prices and fewer choices.
While politics are always lurking nearby when government policies are involved, this is particularly true for foreign trade policies. Because trade policies create winners and losers, those affected are motivated to action. Those with the most political clout (which more often than note is the domestic producers) are usually able to convince government policy makers to undertake beneficial actions. While such actions might be beneficial to some, they are not necessarily beneficial to all.