8 Trade policy instruments 186 9 The political economy of trade policy 218 10 Trade policy in developing countries 255 1 1 Controversies in trade policy 276. Economic growth: A shift of the RS curve 99 Growth and the production possibility frontier 100 Relative supply and the terms of trade.
Exchange Rates and Open-Economy
Macroeconomics 293
Supply and Demand 362 Equilibrium in the Money Market 362 Interest Rates and the Money Supply 365 Production and the Interest Rate 366 Money Supply and the Exchange Rate in the Short Run 366 Money Links, the Interest Rate and the Exchange Rate 367 Supply US. and the dollar/euro exchange rate 369 Europe's money supply and the dollar/euro exchange rate 370 Money, the price level, and the exchange rate in the long run 373 Money and money prices 373 The long-run effects of changes in the money supply 374 Empirical Evidence on Money Supplies and Price Levels 375.
The IS-LM Model and the DD-AA Model 470 Appendix II: Intertemporal Trade and Consumption
Central Bank Balance Sheet and Money Supply 486 Foreign Exchange Interventions and Money Supply 487 Sterilization 488 Balance of Payments and Money Supply 489 How the Central Bank Fixes the Exchange Rate 490. Exchange Rate 491 Money Market Equilibrium at a Fixed Exchange Rate 491 Diagrammatic Analysis 492 Stabilization Policies with a Fixed Exchange Rate 494 Monetary Policy 494 Fiscal Policy 495 Exchange Rate Changes 496 Adapting to Fiscal Policy and Exchange Rate Changes 498 Case Study: Fixing an Escape Exchange Rate.
Equilibrium in the Foreign Exchange
Substitutability of assets 508 Evidence on the effects of sterilized intervention 510 The signaling effect of intervention 510 Reserve currencies in the global monetary system 511 The operation of a reserve currency standard 512 The asymmetric position of the reserve center 512 The gold standard 513 The operation of a gold standard 513 Symmetric monetary adjustment under a Gold Standard 514 Advantages and disadvantages of the Gold Standard 515 The Bimetallic Standard 516 The Gold Exchange Standard 516 Summary 517.
The Monetary Approach to the Balance
International Macroeconomic Policy 53 I
695 Lessons from Developing Country Crises 697 Reforming the World's Financial "Architecture" 698 Capital Mobility and the Exchange Rate Regime Trilemma 699. Recent general developments in the world economy raise concerns that have preoccupied such international economists for more more than two centuries. such as the nature of the international regulatory mechanism and the merits of free trade versus protectionism.
The Place of This Book in the Economics Curriculum
Some Distinctive Features of International Economics: Theory and Policy
The main ingredient of the macroeconomic model we develop is the interest parity ratio (later supplemented by risk premia). A broad discussion of the world capital market is given in Chapter 21, which takes up the welfare implications of international portfolio diversification as well as problems of prudential supervision of foreign financial institutions.
New to the Sixth Edition
In addition to these structural changes, we have updated the book in other ways to maintain current relevance. Thus, we extend our coverage of the welfare effect of newly industrialized countries' exports on more advanced economies (Chapter 5); we update the discussion of Japanese policy toward the semiconductor industry (Chapter 11); we discuss Japan's liquidity trap (Chapter 17) and evidence for the effect of currency unions on trade volume (Chapter 20); and we report on the collapse of Argentina's currency in 2002 (Chapter 22).
Learning Features
Study Guide, Instructor's Manual, and Web Site
Acknowledgments
Wayne Nafziger, Unibersidad ti Estado ti Kansas Terutomo Ozawa, Unibersidad ti Estado ti Colorado Arvind Kingship, Unibersidad ti Maryland. Scott Taylor, Unibersidad ti Britaniko a Columbia Aileen Thompson, Unibersidad ti Carleton Sarah Tinkler, Unibersidad ti Estado ti Weber.
Introduction
C H A P T E R I Introduction Therefore, international economics is even more important to the rest of the world than it is to the United States. Much of the book is devoted to old ideas that are still as valid as ever: the nineteenth-century trade theory of David Ricardo and even the eighteenth-century monetary analysis of David Hume remain highly relevant to the twenty-first century world economy.
International trade also allows countries to specialize in the production of a narrower range of goods, giving them greater efficiency of large-scale production. International trade can adversely affect owners of resources that are "specific" to import-competing industries, that is, they cannot find alternative jobs in other industries (Chapter 3).
Introduction the pattern of international trade—who sells what to whom—have been a major preoccu-
And as the example of the euro-dollar exchange rate illustrates, the relative values of currencies can change over time, sometimes dramatically. For most of the twentieth century, exchange rates have been set by government action rather than by the market.
Introduction the debate over which system, fixed or floating rates, is better, and Chapter 20 to the eco-
The growing importance of international capital markets and their new problems demand greater attention than ever before. This book devotes two chapters to issues arising from international capital markets: one on the functioning of global asset markets (Chapter 21) and one on foreign borrowing by developing countries (Chapter 22).
Hpternational Economics: Trade and Money
Since the 1960s, large international capital markets have emerged, notably the prominent Eurodollar market in London, in which billions of dollars are exchanged daily without ever touching the United States. Another risk is that of national bankruptcy: A nation may simply refuse to pay its debts (perhaps because it cannot), and there may be no effective way for its creditors to bring it to court.
PART International Trade Theory
Labor Productivity and Comparative Advantage
The Ricardian Model
Labor Productivity and Comparative Advantage I I share of the market for winter roses in the United States is being supplied by imports
It seems extremely likely that the opportunity cost of those roses in terms of computers will be less than it would be in the United States. Will the United States and South America eventually produce the goods in which each has a comparative advantage.
One-Factor Economy
When the production possibility frontier is a straight line, the opportunity cost of a pound of cheese in terms of wine is constant. What is the significance of the number aLClaLWl We saw in the previous section that it is the opportunity cost of cheese in terms of wine.
Vade in a One-Factor World
Labor Productivity and Comparative Advantage 23 Notice that this wage rate lies between the ratios of the two countries' productivities in
Because of its lower wage rate, Foreign has a cost advantage in wine, even though it has lower productivity. Home has a cost advantage in cheese, despite its higher wage rate, because the higher wage is more than offset by its higher productivity.
In the numerical example we use to dispel common misconceptions about comparative advantage, we assume that the relative wage of the two countries reflects their relative productivity—specifically, that the ratio of domestic to foreign wages is in a range that gives each place a cost advantage in one of the two goods. In fact, as the third column of the table shows, South Korea's unit labor costs lagged slightly behind those of the United States, while Taiwan's rose faster.
The resulting relative demand for home labor will fall when the ratio of domestic to foreign wages rises, for two reasons. The result depends on the relative size of countries (which determines the position of RS) and the relative demand for goods (which determines the shape and position of RD).
Adding Transport Costs and Nontraded Goods
One unit of this good requires 6 hours of home labor or 12 hours of foreign labor to produce. At a relative wage of 3, 12 hours of foreign work costs only 4 hours of work at home; so in the absence of shipping costs Dates of imports at home.
Iptnpirical Evidence on the Ricardian Model
In the absence of trade, what would be the price of apples in terms of bananas? How do the gains from trade compare with those in the case described in problem 4.
Specific Factors and Income Distribution
C H A P T E R 3 Specific Factors and Income Distribution 39 those displaced by imports may find jobs in manufacturing or services as a whole in Japan. This chapter focuses on a particular model, known as the specific factor model, that captures the distribution of income over history in a particularly clear way.
First, although the wage rate rises, it rises less than the rise in the price of industrial products. Look again at Figure 3.7, which shows the effect of an increase in manufacturer prices.
Specific Factors and Income Distribution 51
We therefore conclude that an increase in the supply of capital will shift the relative supply curve to the right. Correspondingly, an increase in the supply of land will increase food output and decrease manufacturing output; the relative supply curve would shift to the left.
In Japan, the increase in the relative price of industrial products leads to an increase in food consumption relative to industrial production and a decrease in the relative production of food. In America, the post-trade decline in the relative price of industrial products leads to an increase in the consumption of industrial products relative to food and a decrease in the relative production of industrial products; America therefore becomes an importer of industrial products and an exporter of food.
We assume that in the absence of trade, Japan would have a lower relative price of products than the rest of the world. Thus, in the absence of trade, the economy's consumption should be a point on the production possibilities frontier.
In the real world, the presence of both losers and winners in trade is one of the main reasons why trade is not free. Calculate the effects of the price change on the income of the specific factors in sectors 1 and 2.
APPENDIX TO CHAPTER 3
Further Details on Specific Factors
We know that employers will hire labor up to the point where the real wage in terms of output, me / PM, equals marginal product. The real wage in terms of manufactures falls, leading to an increase in the income of the owners of capital.
Resources and Trade
The Heckscher-Ohlin Model
Model of a Two-Factor Economy
In each sector, the ratio of land to labor used in production depends on the cost of labor relative to the cost of land, w/r. As the PCIPF increases, the ratio of land to labor increases in both textile and food production.
That is, in the absence of trade the relative price of cloth would be lower in Home than in Foreign. Conversely, the fall in the relative price of cloth abroad results in it becoming an importer of cloth and an exporter of food.
CASE STUDY
North-South Trade and Income Inequality
So what is responsible for the widening gap between skilled and unskilled workers in the US. 5 Among the important entries in the debate about the impact of trade on the distribution of income were Robert Lawrence and Matthew Slaughter, "Trade and the U.S.
Empirical Evidence on the Heckscher-Ohlin Model
It can therefore be expected that the predictions of the Heckscher-Ohlin model may look much better when applied to North-South trade than to general international trade. Learner, and Leo Sveikauskas, "Multisite, Multifactor Tests of Factor Abundance Theory," American Economic Review 77 (December 1987), p.
HH Table 4-6
Resources and Trade: The Heckscher-Ohlin Model 89
APPENDIX TO CHAPTER 4
Factor Prices, Goods Prices, and Input Choices
The two isoquants CC and FF show the inputs required to produce one dollar worth of goods and food. Finally, now consider the effects of an increase in the price of goods on the wage-rent ratio.
The Standard Trade Model
Because of these general features, the models we studied can be considered special cases of a more general model of a trading world economy. We develop a standard model of a trading world economy of which the models of Chapters 2,3 and 4 can be considered special cases and use this model to ask how a variety of changes in underlying parameters affect the world economy.
Standard Model of a Trading Economy
The Standard Trade Model 99 vorld Relative Supply and Demand
The consequences of economic growth in a trading world economy are a constant source of concern and controversy. Biased growth occurs when the production possibility frontier shifts more in one direction than the other.
This means that growth in the industrialized world would be import oriented, while growth in the less developed world would be export oriented. Some analysts believed that growth in poorer countries would actually be disastrous.
The Standard Trade Model 103 are, however, extreme: Strongly export-biased growth must be combined with very steep
Has the Growth of Newly Industrializing Countries Hurt Advanced Nations?
Since advanced countries spend on average about 20 percent of their income on imports, a 1 percent decline in the terms of trade would reduce real income by only about 0.2 percent. What we actually see is that the advanced countries' terms of trade improved between 1983 and 1992 and showed little change thereafter.
The Standard Trade Model 105 defeated Japan and Germany as well as to its wartime allies to help them rebuild. Since the
The RD curve will not move and trading conditions will not be affected. If the donor has a lower marginal propensity to spend on its exports, its terms of trade will actually improve.
The Standard Trade Model 107 A paradoxical possibility is implied by this analysis. A transfer payment—say foreign
The transfer of income from the United States to the rest of the world reduces the demand for non-tradable goods in the United States, freeing up resources that can be used for US production. An increase in the demand for non-marketable goods in the rest of the world draws foreign resources away from exports and reduces the supply of foreign exports (which are US imports).
ASE STUDY
Non-tradable goods may give rise to what appears to be a national preference for all domestically produced goods. At the same time, the transfer of income from the United States to the rest of the world increases the rest of the world's demand for non-tradables because some of that income is spent on haircuts and other non-tradables.
The Transfer Problem and the Asian Crisis
The Standard Trade Model 109
What seems to have saved Asia from a serious transmission problem was that other things were happening at the same time. So there was probably a transmission problem for Asia, but its effects were masked by other forces.
The direction of the terms of trade effects depends on the nature of the growth. Growth that is export-oriented (growth that expands an economy's ability to produce the goods it originally exported more than it expands the ability to produce goods that compete with imports) deteriorates the terms of trade.
APPENDIX TO CHAPTER 5
Representing International
Equilibrium with Offer Curves
On the vertical axis we draw (Qf — Df) the desired foreign export of food, while on the horizontal axis we draw (D* — Q*) the desired import of goods. A foreign supply curve shows how that country's desired imports of goods and exports of food change with relative price.
Economies of Scale,
Imperfect Competition, and International Trade
International trade plays a crucial role: it makes it possible for each country to produce a limited range of goods and benefit from economies of scale without sacrificing variety in consumption. Our example, then, suggests how reciprocal trade can arise as a result of economies of scale.
C H A P T E R 6 Economies of scale, imperfect competition and international trade 123 Both external and internal economies of scale are important causes of international. However, as we have just argued, internal economies of scale lead to a breakdown of perfect competition.
We therefore conclude that average costs depend on the size of the market and the number of companies in the sector. Meanwhile, the price the typical firm charges also depends on the number of firms in the industry.
Economies of Scale, Imperfect Competition, and International Trade 139 The Significance of Intraindustry Trade
The measure shown is intraindustry trade/total trade.5 The measure ranges from 0.99 for inorganic chemicals—an industry in which U.S. Industries are ranked by the relative importance of intraindustry trade, those with higher intraindustry trade first.
Intraindustry Trade in Action: The North American Auto Pact of 1964
In 1957, the main countries of continental Europe established an area of free trade in industrial products, the common market or the European Economic Community (EEC). The UK joined the EEC later, in 1973.) The result was rapid growth in trade. Canada's auto industry had roughly 30 percent lower labor productivity than America's.
To maximize profits, the firm must equate marginal revenue in each market with marginal cost. In Figure 6.8, we assume that the firm can increase exports without lowering price, so that marginal revenues and prices coincide in the export market.
CASE STUDY Antidumping as Protectionism
If both firms do this, the result will be trade, even though (by assumption) there was no initial difference in the price of the good in the two markets, and even though there are some transportation costs. A situation where dumping results in two-way trade in the same product is known as reciprocal dumping.9.
Economies of Scale, Imperfect Competition, and International Trade 149 Again, these advantages have been documented for Silicon Valley, where it is common
Or put differently, external economies can give rise to increasing returns to scale at the level of the national industry. While in practice the details of external economies are often quite subtle and complex (as the example of Silicon Valley shows), it can be useful to abstract from the details and represent external economies simply by assuming that an industry's costs are lower the larger the industry.
External economies are economies of scale that occur at the industry level rather than the firm level. Explain this tendency of industrial clusters to break up in terms of the theory of external economies.
APPENDIX TO CHAPTER 6
Determining Marginal Revenue
International Factor Movements
We then turn to an analysis of international borrowing and lending, in which we show that over time this lending can be interpreted as trade: The lending country now gives up resources to receive repayment in the future, while the borrower does the reverse .
International Labor Mobility
An Economy s Production Function
We now immediately show how the marginal product of labor depends on the amount of labor employed. We also indicate that the real wage earned by each unit of labor is equal to the marginal product of labor.
International Factor Movements 163
Labor migrates from the home country to abroad until OL2 workers are deployed in the home country, and L20* are deployed abroad, and wages are equalized. If this were to happen, it would obviously remove any incentive for labor to move from home to abroad.
International Factor Movements 165
Wage Convergence in the Age of Mass Migration
Immigration and the U.S. Economy
In the absence of international borrowing and lending, we would expect the relative price of future consumption to be higher in Home than in Foreign, and so if we open up the possibility of trade over time, we would expect Home to export current consumption and in the future import consumption. A country that has a comparative advantage in future production of consumer goods is one that, in the absence of international borrowing and lending, will give a low relative price of future consumption, that is, a high real interest rate.
International Factor Movements 171
