We present results of a numerical calculation of lattice QCD with two degenerate flavors of dynamical quarks, identified with up and down quarks, and with a strange quark treated in the quenched approximation. The lattice action and simulation parameters are chosen with a view to carrying out an extrapolation to the continuum limit as well as chiral extrapolations in dynamical up and down quark masses. Gauge configurations are generated with a renormalization-group improved gauge action and a mean field improved clover quark action at three values of β=6/g2, corresponding to lattice spacings of a≈0.22, 0.16 and 0.11 fm, and four sea quark masses corresponding to mPS/mV≈0.8, 0.75, 0.7 and 0.6. The sizes of lattice are chosen to be 123×24, 163×32 and 243×48 so that the physical spatial size is kept constant at La≈2.5 fm. Hadron masses, light quark masses and meson decay constants are measured at five valence quark masses corresponding to mPS/mV≈0.8, 0.75, 0.7, 0.6 and 0.5. We also carry out complementary quenched simulations with the same improved actions. The quenched spectrum from this analysis agrees well in the continuum limit with the one of our earlier work using the standard action, quantitatively confirming the systematic deviation of the quenched spectrum from experiment. We find the two-flavor full QCD meson masses in the continuum limit to be much closer to experimental meson masses than those from quenched QCD. When using the K meson mass to fix the strange quark mass, the difference between quenched QCD and experiment of 2.6-0.9+0.3% for the K* meson mass and of 4.1-1.6+0.5% for the φ meson mass is reduced to 0.7-1.7+1.1% and 1.3-2.5+1.8% in full QCD, where the errors include estimates of systematic errors of the continuum extrapolation as well as statistical errors. Analyses of the J parameter yield a similar trend in that the quenched estimate in the continuum limit J=0.375-0.009+0.039 increases to J=0.440-0.031+0.061 in two-flavor full QCD, approaching the experimental value J≈0.48. We take these results as manifestations of sea quark effects in two-flavor full QCD. For baryon masses full QCD values for strange baryons such as Ξ and Ω are in agreement with experiment, while they differ increasingly with decreasing strange quark content, resulting in a nucleon mass higher than experiment by 10% and a Δ mass by 13%. The pattern suggests finite size effects as a possible origin for this deviation. For light quark masses in the continuum limit we obtain mudMS̅(2 GeV)=3.44-0.22+0.14 MeV and msMS̅(2 GeV)=88-6+4 MeV (K-input) and msMS̅(2 GeV)=90-11+5 MeV (φ-input), which are reduced by about 25% compared to the values in quenched QCD. We also present results for decay constants where large scaling violations obstruct a continuum extrapolation. The need for a nonperturbative estimate of renormalization factors is discussed.