International trade is the exchange of goods and services between two (or more) countries. When goods (services) are brought in, it is called import and when goods are carried out its called export.
International trade is necessary, because the scare resources are distributed unevenly between different countries and thus some countries are better producing some products than other. Another, not so obvious and maybe arguable, uneven allocation .
The international trade helps to make the distribution of resources more even. The countries can specialise to work that they are best at. It also helps countries to obtain the products they otherwise might not get. Also, it increases the variety of goods. E.g. UK can produce cheese, but with international trade English are also able to enjoy French cheese etc.
If we take 2 countries, e.g. A and B, and assume that their economies produce only 2 things, food and cars, then, without international trade, both sectors would involve 50% of the resources and output might be:
A | B | |
Food(F) | 200 | 100 |
Cars(C) | 400 | 50 |
From here it is seen that A is better in producing F and C, but the opportunity cost for 1F=2C, whereas the opportunity cost for F in B is 1F=1/2C. The international trade is beneficial and possible always when the 2 goods have different opportunity costs in different countries. When one country is absolutely better of producing one good and the other country another, then it is called an absolute advantage, but as in example above when one country is relatively (in terms of opportunity costs) better of producing one good it is called a comparative advantage. So A has absolute comparative advantage of producing C and B has comparative advantage of producing F. In this case (and in real life) the specialisation is never complete. That means that B will not give up all production of C if it wants to increase both the quantities of F and C, and vice-versa. A diagram can be draw from this data showing the production possibility curves for both of the countries and finding the optimum allocation of resources.
There is also one thing that needs to be considered - the exchange rate. A would trade with B if it would get anything more than 1/2 of F for its C, the same way B would trade if it could get more than 1/2 of C for its F, so any exchange rate between 1/2F=C and 2F=C would be beneficial, let us assume that the exchange rate will be F=C. Also let us assume that countries want to exchange 25 units. Note, that the production possibility curve cannot be straight line, because if A would produce only C (so 800), the it cannot exchange all of them to F, because B is not able to produce 800 F. So these production possibility curves apply only if 25 units is exchanged, any other quantity would have different possibility curves.
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