International trade is guided by the principle of comparative advantage: a country benefits by specializing in goods it can produce at a lower opportunity cost than its trading partners, then exchanging them for goods others produce more cheaply. This differs from absolute advantage, which refers to producing more of a good using the same resources. A country can hold a comparative advantage in producing a good even when it has no absolute advantage in any activity, which is why mutually beneficial trade is possible between economies of vastly different productivity levels.
Exchange rates translate prices across currencies. Under floating exchange rate systems, currency values are determined by supply and demand, influenced by trade balances, interest rate differentials, and speculation. Shifts in these underlying forces cause currencies to appreciate or depreciate, with significant consequences for exports, imports, and the broader economy.
Markets sometimes fail to allocate resources efficiently because externalities, the unintended side effects of production or consumption on third parties, are not reflected in prices. Negative externalities, such as pollution, lead to overproduction, while positive externalities, such as vaccinations, lead to underproduction. Public goods present a related problem: they are non-excludable and non-rivalrous, meaning no one can be effectively barred from using them and one person's use does not diminish another's. National defense and street lighting are classic examples; markets underprovide them, justifying government intervention. The tragedy of the commons describes a similar dynamic in which shared resources, such as fisheries or grazing land, are overused because individuals lack private incentives to conserve what is collectively owned.