1. International trade is of growing importance to the United States and of even greater importance to most other countries. International trade, like trade among individuals, arises from comparative advantage: the opportunity cost of producing an additional unit of a good is lower in some countries than in others. Goods and services purchased from abroad are imports; those sold abroad are exports. Foreign trade, like other economic linkages between countries, has been growing rapidly, a phenomenon called globalization. Hyperglobalization, the phenomenon of extremely high levels of international trade, has occurred as advances in communication and transportation technology have allowed supply chains of production to span the globe.

  2. The Ricardian model of international trade assumes that opportunity costs are constant. It shows that there are gains from trade: two countries are better off with trade than in autarky.

  3. In practice, comparative advantage reflects differences between countries in climate, factor endowments, and technology. The Heckscher–Ohlin model shows how differences in factor endowments determine comparative advantage: goods differ in factor intensity, and countries tend to export goods that are intensive in the factors they have in abundance.

  4. The domestic demand curve and the domestic supply curve determine the price of a good in autarky. When international trade occurs, the domestic price is driven to equality with the world price, the price at which the good is bought and sold abroad.

  5. If the world price is below the autarky price, a good is imported. This leads to an increase in consumer surplus, a fall in producer surplus, and a gain in total surplus. If the world price is above the autarky price, a good is exported. This leads to an increase in producer surplus, a fall in consumer surplus, and a gain in total surplus.

  6. International trade leads to expansion in exporting industries and contraction in import-competing industries. This raises the domestic demand for abundant factors of production, reduces the demand for scarce factors, and so affects factor prices, such as wages.

  7. Most economists advocate free trade, but in practice many governments engage in trade protection. The two most common forms of protection are tariffs and quotas. In rare occasions, export industries are subsidized.

  8. A tariff is a tax levied on imports. It raises the domestic price above the world price, hurting consumers, benefiting domestic producers, and generating government revenue. As a result, total surplus falls. An import quota is a legal limit on the quantity of a good that can be imported. It has the same effects as a tariff, except that the revenue goes not to the government but to those who receive import licenses.

  9. A country’s balance of payments accounts summarize its transactions with the rest of the world. The balance of payments on current account, or current account, includes the balance of payments on goods and services together with balances on factor income and transfers. The merchandise trade balance, or trade balance, is a frequently cited component of the balance of payments on goods and services. The balance of payments on financial account, or financial account, measures capital flows. By definition, the balance of payments on current account plus the balance of payments on financial account is zero.

  10. Capital flows respond to international differences in interest rates and other rates of return; they can be usefully analyzed using an international version of the loanable funds model, which shows how a country where the interest rate would be low in the absence of capital flows sends funds to a country where the interest rate would be high in the absence of capital flows. The underlying determinants of capital flows are international differences in savings and opportunities for investment spending.

  11. Currencies are traded in the foreign exchange market; the prices at which they are traded are exchange rates. When a currency rises against another currency, it appreciates; when it falls, it depreciates. The equilibrium exchange rate matches the quantity of that currency supplied to the foreign exchange market to the quantity demanded.

  12. To correct for international differences in inflation rates, economists calculate real exchange rates, which multiply the exchange rate between two countries’ currencies by the ratio of the countries’ price levels. The current account responds only to changes in the real exchange rate, not the nominal exchange rate. Purchasing power parity is the exchange rate that makes the cost of a basket of goods and services equal in two countries. While purchasing power parity and the nominal exchange rate almost always differ, purchasing power parity is a good predictor of actual changes in the nominal exchange rate.