International Economics
Over the last 20 years, the world has become an increasingly interdependent group of countries. The new buzzword
of the twenty-first century is globalization. Globalizationrefers to the interdependence of goods and resources that
belong to various countries. We realize more so now than ever before that no single country is self-sufficient. Countries
may be self-sufficient to a certain extent, but they would be better off with the existence of trade.
This chapter examines and reviews the impacts and benefits of world trade and the nature of connections between coun-
tries. Trade occurs because of specialization in production. No single individual or country can produce everything
better than others can. The result is specialization in production based on comparative advantage. Remember that com-
parative advantage is based on relative opportunity costs and how much a country has to “give up” to produce a good.
A country will specialize in the production of a good if the opportunity cost of producing that good is lower relative to
other countries. Nations then trade what they produce in excess of their own consumption to acquire new or needed
products.
The world price for goods and services is determined by the individual countries’ demand curves and supply curves. If the
world demand for coffee surpasses the world supply for coffee, then the price of coffee will be on a steady incline. Just
like an economy’s equilibrium price, the world’s equilibrium price is derived from the forces of supply and demand. Who
has what, how much of what, and at what price are all questions that depend on the world’s supply and demand for goods
and services.
Trade exists because people’s needs and wants are unlimited. Trade improves the condition of both people and countries
because it provides goods and services at lower opportunity costs. Because countries differ in their comparative advan-
tages, they export different goods. Countries also have different tastes and technological needs, and differ in what they
import. The existence of variety is the very reason for trade. Variety appeals to the human trait of self-interest. When the
world can provide a variety, individuals needs and wants have to be met. To meet the demand, countries trade to obtain
goods that would otherwise be unavailable to its citizens.
World Equilibrium
The world economy is complex because each country has a unique pattern of trade. A country’s trading partners and
types of goods traded vary from country to country. It’s almost as if you have to look at the world as one giant puzzle of
trade. Countries have to find other countries that have what they are looking for in terms of goods and services. That’s
just half the battle. The other half is finding a country that needs what you produce. While some countries trade a great
deal, the countries that trade very little are the ones that feed into the changing world equilibrium forces. The determi-
nants of world equilibrium shape the existences of comparative advantages in the world.
Comparative Advantage and Absolute Advantage
Comparative advantageis derived by examining the relative costs of production in each country. Economists measure
the costs of production through opportunity costs, which entails looking at what must be given up in order to produce a
certain good.
Absolute advantageis calculated by tallying the resource costs of producing a product. We derive absolute advantage
by comparing these resource costs to other countries producing the same good.
Suppose the United States and Canada are two isolated nations in our example. Each nation can produce both candy and
wheat. The difference is that each nation can produce each product at different opportunity costs. Figure 12-1 illustrates
the production possibilities for each country when producing wheat and candy.