Next Chapter: A Simple Model of Aggregate Demand: Equilibrium
From the first, economists have been concerned to understand international trade, both in terms of the monetary flows and national currencies and in terms of flows of real goods and services.
When we think of flows of real goods and services, the first question is: why do nations trade? Why should each nation not be self-sufficient, producing for itself all the goods and services it needs? For two hundred years, most economists have answered this question with the concept of comparative advantage. Different nations have different comparative advantages, and by exporting the good in which the country has a comparative advantage, each country obtains the goods it uses at a lower cost than would be the case if they were self-sufficient. The surprise is that, even if one country has the absolute advantage -- that is, the higher productivity -- in each product, the other country will have a comparative advantage in some product, and will be able to export it. That is so because comparative advantage arises from the relative prices within the country. And while the country with the lower productivity will remain poorer than the other country, it will (at least) be less poor with trade than without.
When we think of monetary flows, there has been somewhat less agreement in the long Reasonable Dialog of economics. Early economists, and their predecessors in philosophy, believed that the "price-specie-flow" mechanism would regulate the price level in each country so that the purchasing power of national currencies would be comparable. Twentieth century economists have preferred to rely on the supply and demand in markets for international currencies to do that. This means that the market would devalue a currency with a low purchasing power until its purchasing power would correspond to the rate of exchange and imports and exports would be balanced.
In a world in which nations grow closer together thanks to progress in communications and transportation, international trade grows more important to all countries. This "globalization" of the market economy seems from some points of view to be new, but economists have envisioned the market economy as a global system from the beginnings of our science. Monetary systems and details will change, but the fundamentals of supply, demand, and comparative advantage only grow more important.
Next Chapter: A Simple Model of Aggregate Demand: Equilibrium
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