International Economics
Eleventh Edition
Dominick Salvatore
Fordham University
Contents
1 Introduction 1
1.1 The Globalization of the World Economy 1
1.1 A We Live in a Global Economy 1
• Case Study 1-1 The Dell PCs, iPhones, and iPads Sold in the
United States Are Anything but American! 2
• Case Study 1-2 What Is an “American” Car? 3 1.1B The Globalization Challenge 3
• Case Study 1-3 Is India’s Globalization Harming the United States? 5
1.2 International Trade and the Nation’s Standard of Living 6
• Case Study 1-4 Rising Importance of International Trade to the
United States 8
1.3 The International Flow of Goods, Services, Labor, and Capital 9
1.3 A The International Flow of Goods and Services: The Gravity Model 9 1.3B The International Flow of Labor and Capital 10
• Case Study 1-5 Major Net Exporters and Importers of Capital 11
1.4 International Economic Theories and Policies 11
1.4 A Purpose of International Economic Theories and Policies 11 1.4B The Subject Matter of International Economics 12
1.5 Current International Economic Problems and Challenges 13
1.6 Organization and Methodology of the Text 15 1.6A Organization of the Text 15
1.6B Methodology of the Text 16 Summary 17
A Look Ahead 18 Key Terms 18
Questions for Review 18 Problems 19
A1.1 Basic International Trade Data 20
A1.2 Sources of Additional International Data and Information 24 Selected Bibliography 26
INTERNet 28
Part 1 International Trade Theory
2 The Law of Comparative Advantage 31
2.1 Introduction 31
2.2 The Mercantilists’ Views on Trade 32
• Case Study 2-1 Munn’s Mercantilistic Views on Trade 33
• Case Study 2-2 Mercantilism Is Alive and Well in the
Twenty-first Century 33
2.3 Trade Based on Absolute Advantage: Adam Smith 34 2.3A Absolute Advantage 34
2.3 B Illustration of Absolute Advantage 35
2.4 Trade Based on Comparative Advantage: David Ricardo 36 2.4A The Law of Comparative Advantage 36
2.4B The Gains from Trade 37
2.4 C The Case of No Comparative Advantage 39 2.4D Comparative Advantage with Money 39
• Case Study 2-3 The Petition of the Candlemakers 41
2.5 Comparative Advantage and Opportunity Costs 41
2.5A Comparative Advantage and the Labor Theory of Value 41 2.5B The Opportunity Cost Theory 42
2.5 C The Production Possibility Frontier under Constant Costs 42 2.5D Opportunity Costs and Relative Commodity Prices 44
2.6 The Basis for and the Gains from Trade under Constant Costs 45 2.6A Illustration of the Gains from Trade 45
2.6 B Relative Commodity Prices with Trade 46
2.7 Empirical Tests of the Ricardian Model 47
• Case Study 2-4 Relative Unit Labor Costs and Relative
Exports—United States and Japan 49
Summary 50
A Look Ahead 51 Key Terms 51
Questions for Review 51 Problems 52
A2.1 Comparative Advantage with More Than Two Commodities 54 A2.2 Comparative Advantage with More Than Two Nations 55
3 The Standard Theory of International Trade 57
3.1 Introduction 57
3.2 The Production Frontier with Increasing Costs 58
3.2A Illustration of Increasing Costs 58
3.2B The Marginal Rate of Transformation 59
3.2 C Reasons for Increasing Opportunity Costs and Different Production Frontiers 59
3.3 Community Indifference Curves 60
3.3A Illustration of Community Indifference Curves 60 3.3B The Marginal Rate of Substitution 61
3.3 C Some Difficulties with Community Indifference Curves 61
3.4 Equilibrium in Isolation 62
3.4A Illustration of Equilibrium in Isolation 62
3.4 B Equilibrium-Relative Commodity Prices and Comparative Advantage 63
• Case Study 3-1 Comparative Advantage of the Largest Advanced and Emerging Economies 64
3.5 The Basis for and the Gains from Trade with Increasing Costs 64
3.5A Illustrations of the Basis for and the Gains from Trade with Increasing Costs 65
3.5 B Equilibrium-Relative Commodity Prices with Trade 66 3.5C Incomplete Specialization 67
• Case Study 3-2 Specialization and Export Concentration in
Selected Countries 67 3.5D Small-Country Case with Increasing Costs 69
3.5 E The Gains from Exchange and from Specialization 69
• Case Study 3-3 Job Losses in High U.S. Import-Competing
Industries 70
• Case Study 3-4 International Trade and Deindustrialization in the United States, the European Union, and Japan 71
3.6 Trade Based on Differences in Tastes 72
3.6A Illustration of Trade Based on Differences in Tastes 72 Summary 73
A Look Ahead 74 Key Terms 74
Questions for Review 74 Problems 75
A3.1 Production Functions, Isoquants, Isocosts, and Equilibrium 76 A3.2 Production Theory with Two Nations, Two Commodities, and
Two Factors 78
A3.3 Derivation of the Edgeworth Box Diagram and Production Frontiers 79
A3.4 Some Important Conclusions 82
Selected Bibliography 83
4 INTERNet 84
Demand and Supply, Offer Curves, and the Terms of Trade
85
4.1 Introduction 85
4.2 The Equilibrium-Relative Commodity Price with Trade — Partial Equilibrium Analysis 86
• Case Study 4-1 Demand, Supply, and the International
Price of Petroleum 87
• Case Study 4-2 The Index of Export to Import Prices for the
United States 88
4.3 Offer Curves 89
4.3A Origin and Definition of Offer Curves 89
4.3 B Derivation and Shape of the Offer Curve of Nation 1 89 4.3C Derivation and Shape of the Offer Curve of Nation 2 90
4.4 The Equilibrium-Relative Commodity Price with Trade — General Equilibrium Analysis 91
4.5 Relationship between General and Partial Equilibrium Analyses 93
4.6 The Terms of Trade 94
4.6 A Definition and Measurement of the Terms of Trade 94 4.6B Illustration of the Terms of Trade 95
• Case Study 4-3 The Terms of Trade of the G-7 Countries 95
• Case Study 4-4 The Terms of Trade of Advanced and
Developing Countries 96 4.6C Usefulness of the Model 96
Summary 97
A Look Ahead 98 Key Terms 98
Questions for Review 98 Problems 98
A4.1 Derivation of a Trade Indifference Curve for Nation 1 100 A4.2 Derivation of Nation 1’s Trade Indifference Map 100 A4.3 Formal Derivation of Nation 1’s Offer Curve 101
A4.4 Outline of the Formal Derivation of Nation 2’s Offer Curve 104 A4.5 General Equilibrium of Production, Consumption, and Trade 104 A4.6 Multiple and Unstable Equilibria 107
5 Factor Endowments and the Heckscher–Ohlin Theory 109
5.1 Introduction 109
5.2 Assumptions of the Theory 110
5.2A The Assumptions 110
5.2 B Meaning of the Assumptions 110
5.3 Factor Intensity, Factor Abundance, and the Shape of the Production Frontier 112
5.3A Factor Intensity 112 5.3B Factor Abundance 114
5.3 C Factor Abundance and the Shape of the Production Frontier 115
• Case Study 5-1 Relative Resource Endowments of Various Countries
116
• Case Study 5-2 Capital–Labor Ratios of Selected Countries 117
5.4 Factor Endowments and the Heckscher–Ohlin Theory 118 5.4A The Heckscher–Ohlin Theorem 118
5.4 B General Equilibrium Framework of the Heckscher–Ohlin Theory 119 5.4C Illustration of the Heckscher–Ohlin Theory 120
• Case Study 5-3 Classification of Major Product Categories in Terms of
Factor Intensity 122
• Case Study 5-4 The Factor Intensity of Trade of Various Countries
122
5.5 Factor–Price Equalization and Income Distribution 123 5.5A The Factor–Price Equalization Theorem 124
5.5 B Relative and Absolute Factor–Price Equalization 125 5.5C Effect of Trade on the Distribution of Income 126
• Case Study 5-5 Has International Trade Increased U.S. Wage
Inequalities? 127 5.5D The Specific-Factors Model 128
5.5 E Empirical Relevance 129
• Case Study 5-6 Convergence of Real Wages among Industrial
Countries 130
5.6 Empirical Tests of the Heckscher–Ohlin Model 131 5.6A Empirical Results — The Leontief Paradox 131
• Case Study 5-7 Capital and Labor Requirements in U.S. Trade 132
5.6 B Explanations of the Leontief Paradox and Other Empirical Tests of the H–O Model 133
• Case Study 5-8 The H–O Model with Skills and Land 135 5.6C Factor-Intensity Reversal 137
Summary 138
A Look Ahead 139 Key Terms 139
Questions for Review 139 Problems 140
A5.1 The Edgeworth Box Diagram for Nation 1 and Nation 2 142 A5.2 Relative Factor–Price Equalization 142
A5.3 Absolute Factor–Price Equalization 145
A5.4 Effect of Trade on the Short-Run Distribution of Income: The Specific-Factors Model 146
A5.5 Illustration of Factor-Intensity Reversal 148
A5.6 The Elasticity of Substitution and Factor-Intensity Reversal 150 A5.7 Empirical Tests of Factor-Intensity Reversal 151
Selected Bibliography 151
INTERNet 155
6 Economies of Scale, Imperfect Competition, and International Trade157
6.1 Introduction 157
6.2 The Heckscher–Ohlin Model and New Trade Theories 158
6.3 Economies of Scale and International Trade 159
• Case Study 6-1 The New International Economies of Scale 161
• Case Study 6-2 Job Loss Rates in U.S. Industries and Globalization
162
6.4 Imperfect Competition and International Trade 163 6.4A Trade Based on Product Differentiation 163
• Case Study 6-3 U.S. Intra-Industry Trade in Automotive Products 163
• Case Study 6-4 Variety Gains with International Trade 165 6.4B Measuring Intra-Industry Trade 167
• Case Study 6-5 Growth of Intra-Industry Trade 167
• Case Study 6-6 Intra-Industry Trade Indexes for G-20 Countries 168 6.4C Formal Model of Intra-Industry Trade 169
6.4 D Another Version of the Intra-Industry Trade Model 170
6.5 Trade Based on Dynamic Technological Differences 172 6.5A Technological Gap and Product Cycle Models 172 6.5B Illustration of the Product Cycle Model 173
• Case Study 6-7 The United States as the Most Competitive Economy
175
6.6 Costs of Transportation, Environmental Standards, and International Trade 175 6.6A Costs of Transportation and Nontraded Commodities 175
6.6B Costs of Transportation and the Location of Industry 177
6.6 C Environmental Standards, Industry Location, and International Trade 178
• Case Study 6-8 Environmental Performance Index 179 Summary 179
A Look Ahead 180
Key Terms 180
Questions for Review 181 Problems 181
A6.1 External Economies and the Pattern of Trade 182 A6.2 Dynamic External Economies and Specialization 184 Selected Bibliography 185
INTERNet 187
7 Economic Growth and International Trade 189
7.1 Introduction 189
7.2 Growth of Factors of Production 190
7.2A Labor Growth and Capital Accumulation over Time 190
7.2 B The Rybczynski Theorem 192
7.3 Technical Progress 193
7.3A Neutral, Labor-Saving, and Capital-Saving Technical Progress 193
7.3 B Technical Progress and the Nation’s Production Frontier 194
• Case Study 7-1 Growth in the Capital Stock per Worker of Selected Countries 195
7.4 Growth and Trade: The Small-Country Case 196 7.4A The Effect of Growth on Trade 196
7.4 B Illustration of Factor Growth, Trade, and Welfare 197 7.4C Technical Progress, Trade, and Welfare 199
• Case Study 7-2 Growth in Output per Worker from Capital Deepening,
Technological Change, and Improvements in Efficiency
200
7.5 Growth and Trade: The Large-Country Case 201
7.5A Growth and the Nation’s Terms of Trade and Welfare 201 7.5B Immiserizing Growth 202
7.5 C Illustration of Beneficial Growth and Trade 203
• Case Study 7-3 Growth and the Emergence of New Economic Giants
205
7.6 Growth, Change in Tastes, and Trade in Both Nations 206 7.6A Growth and Trade in Both Nations 206
7.6 B Change in Tastes and Trade in Both Nations 208
• Case Study 7-4 Growth, Trade, and Welfare in the Leading Industrial Countries 208
Summary 209
A Look Ahead 210 Key Terms 210
Questions for Review 211 Problems 211
A7.1 Formal Proof of the Rybczynski Theorem 212 A7.2 Growth with Factor Immobility 214
A7.3 Graphical Analysis of Hicksian Technical Progress 216 Selected Bibliography 217
INTERNet 218
Part 2 International Trade Policy
8 Trade Restrictions: Tariffs 221
8.1 Introduction 221
• Case Study 8-1 Average Tariff on Nonagricultural Products in Major Developed Countries 222
• Case Study 8-2 Average Tariffs on Nonagricultural Products in Some Major Developing Countries 223
8.2 Partial Equilibrium Analysis of a Tariff 223 8.2A Partial Equilibrium Effects of a Tariff 224
8.2 B Effect of a Tariff on Consumer and Producer Surplus 225 8.2C Costs and Benefits of a Tariff 226
• Case Study 8-3 The Welfare Effect of Liberalizing Trade on Some
U.S. Products 227
• Case Study 8-4 The Welfare Effect of Liberalizing Trade on Some EU Products 228
8.3 The Theory of Tariff Structure 229
8.3A The Rate of Effective Protection 229
8.3 B Generalization and Evaluation of the Theory of Effective Protection 231
• Case Study 8-5 Rising Tariff Rates with Degree of Domestic Processing
232
• Case Study 8-6 Structure of Tariffs on Industrial Products in the United States, the European Union, Japan,
and Canada 232
8.4 General Equilibrium Analysis of a Tariff in a Small Country 234 8.4A General Equilibrium Effects of a Tariff in a Small Country 234 8.4B Illustration of the Effects of a Tariff in a Small Country 235 8.4C The Stolper–Samuelson Theorem 236
8.5 General Equilibrium Analysis of a Tariff in a Large Country 237
8.5 A General Equilibrium Effects of a Tariff in a Large Country 237 8.5B Illustration of the Effects of a Tariff in a Large Country 238
8.6 The Optimum Tariff 239
8.6A The Meaning of the Concept of Optimum Tariff and Retaliation 239 8.6B Illustration of the Optimum Tariff and Retaliation 240
Summary 241
A Look Ahead 242 Key Terms 242
Questions for Review 243 Problems 243
Selected Bibliography 254
INTERNet 256
9 Nontariff Trade Barriers and the New Protectionism 257
9.1 Introduction 257
9.2 Import Quotas 258
9.2 A Effects of an Import Quota 258
• Case Study 9-1 The Economic Effects of the U.S. Quota on Sugar Imports 259
9.2 B Comparison of an Import Quota to an Import Tariff 260
9.3 Other Nontariff Barriers and the New Protectionism 260 9.3A Voluntary Export Restraints 261
• Case Study 9-2 Voluntary Export Restraints (VERs) on Japanese
Automobiles to the United States and Europe 261 9.3B Technical, Administrative, and Other Regulations 262
9.3C International Cartels 263
9.3D Dumping 264
9.3 E Export Subsidies 266
• Case Study 9-3 Antidumping Investigations by G20 Members 266
• Case Study 9-4 Agricultural Subsidies in OECD Countries 267
• Case Study 9-5 Pervasiveness of Nontariff Barriers 268 9.3F Analysis of Export Subsidies 269
9.4 The Political Economy of Protectionism 270
9.4A Fallacious and Questionable Arguments for Protection 270
9.4 B The Infant-Industry and Other Qualified Arguments for Protection 271 9.4C Who Gets Protected? 272
• Case Study 9-6 Benefits to the World Economy from Complete Trade
Liberalization 273
9.5 Strategic Trade and Industrial Policies 274 9.5A Strategic Trade Policy 274
9.5 B Strategic Trade and Industrial Policies with Game Theory 275 9.5C The U.S. Response to Foreign Industrial Targeting and
Strategic Trade Policies 277
9.6 History of U.S. Commercial Policy 278
9.6A The Trade Agreements Act of 1934 278
9.6 B The General Agreement on Tariffs and Trade (GATT) 279 9.6C The 1962 Trade Expansion Act and the Kennedy Round 280 9.6D The Trade Reform Act of 1974 and the Tokyo Round 280 9.6E The 1984 and 1988 Trade Acts 281
9.7 The Uruguay Round, Outstanding Trade Problems, and the Doha Round 282 9.7A The Uruguay Round 283
• Case Study 9-7 Gains from the Uruguay Round 285
• Case Study 9-8 The Multilateral Rounds of Trade Negotiations 286 9.7B Outstanding Trade Problems and the Doha Round 286
• Case Study 9-9 Benefits from a Likely Doha Scenario 288
Summary 288
A Look Ahead 290 Key Terms 290
Questions for Review 290 Problems 291
A9.1 Centralized Cartels 292
A9.2 International Price Discrimination 293 A9.3 Tariffs, Subsidies, and Domestic Goals 294 Selected Bibliography 295
INTERNet 299
10 Economic Integration: Customs Unions and Free Trade Areas 301
10.1 Introduction 301
10.2 Trade-Creating Customs Union 302
10.2 A Trade Creation 302
10.2 B Illustration of a Trade-Creating Customs Union 303
10.3 Trade-Diverting Customs Unions 304
10.3 A Trade Diversion 304
10.3 B Illustration of a Trade-Diverting Customs Union 304
10.4 The Theory of the Second Best and Other Static Welfare Effects of Customs Unions 306
10.4A The Theory of the Second Best 306
10.4 B Conditions More Likely to Lead to Increased Welfare 307 10.4C Other Static Welfare Effects of Customs Unions 307
10.5 Dynamic Benefits from Customs Unions 308
10.6 History of Attempts at Economic Integration 309 10.6A The European Union 309
• Case Study 10-1 Economic Profile of the EU, NAFTA, and Japan
310
• Case Study 10-2 Gains from the Single EU Market 311 10.6B The European Free Trade Association 312
10.6 C The North American and Other Free Trade Agreements 313
• Case Study 10-3 Mexico’s Gains from NAFTA—Expectations and
Outcome 315
10.6 D Attempts at Economic Integration among Developing Countries 316
• Case Study 10-4 Economic Profile of Mercosur 317
10.6 E Economic Integration in Central and Eastern Europe and in the Former Soviet Republics 318
• Case Study 10-5 Changes in Trade Patterns with Economic
Integration 319
Summary 321
A Look Ahead 322 Key Terms 322
Questions for Review 322 Problems 323
A10.1 General Equilibrium Analysis of the Static Effects of a Trade-Diverting Customs Union 324
A10.2 Regional Trade Agreements Around the World 325 Selected Bibliography 327
INTERNet 330
11 International Trade and Economic Development 331
11.1 Introduction 331
11.2 The Importance of Trade to Development 332
11.2A Trade Theory and Economic Development 332
11.2B Trade as an Engine of Growth 333
11.2C The Contributions of Trade to Development 335
11.2 D International Trade and Endogenous Growth Theory 336
• Case Study 11-1 The East Asian Miracle of Growth and Trade
337
11.3 The Terms of Trade and Economic Development 338 11.3A The Various Terms of Trade 338
11.3B Alleged Reasons for Deterioration in the Commodity Terms of Trade 339
11.3 C Historical Movement in the Commodity and Income Terms of Trade 340
• Case Study 11-2 Change in Commodity Prices over Time 342
11.4 Export Instability and Economic Development 343 11.4A Cause and Effects of Export Instability 343
11.4 B Measurements of Export Instability and Its Effect on Development 344 11.4C International Commodity Agreements 345
11.5 Import Substitution versus Export Orientation 346
11.5 A Development through Import Substitution versus Exports 346 11.5B Experience with Import Substitution 348
• Case Study 11-3 The Growth of GDP of Rich Countries,
Globalizers, and Nonglobalizers 348 11.5C Trade Liberalization and Growth in Developing Countries 349
• Case Study 11-4 Manufactures in Total Exports of Selected
Developing Countries 350
11.6 Current Problems Facing Developing Countries 351 11.6A Poverty in Developing Countries 351
11.6 B The Foreign Debt Problem of Developing Countries 353
• Case Study 11-5 The Foreign Debt Burden of Developing Countries
353
11.6 C Trade Problems of Developing Countries 354
• Case Study 11-6 Globalization and World Poverty 355 Summary 356
A Look Ahead 357
Key Terms 357
Questions for Review 357 Problems 358
A11.1 Income Inequalities by Traditional and Purchasing-Power Parity (PPP) Measures 359
Selected Bibliography 360
INTERNet 365
12 International Resource Movements and
Multinational Corporations 367
12.1 Introduction 367
12.2 Some Data on International Capital Flows 368
• Case Study 12-1 Fluctuations in Foreign Direct Investment Flows to the United States 370
12.3 Motives for International Capital Flows 371
12.3 A Motives for International Portfolio Investments 371 12.3B Motives for Direct Foreign Investments 373
12.4 Welfare Effects of International Capital Flows 374
• Case Study 12-2 The Stock of Foreign Direct Investments Around
the World 374
12.4A Effects on the Investing and Host Countries 375
12.4 B Other Effects on the Investing and Host Countries 377
12.5 Multinational Corporations 378
12.5 A Reasons for the Existence of Multinational Corporations 378 12.5B Problems Created by Multinational Corporations in the Home
Country 379
• Case Study 12-3 The World’s Largest Nonpetroleum, Industrial
Corporations 380
• Case Study 12-4 Employment of U.S. MNCs Abroad 381 12.5C Problems Created by Multinational Corporations in the
Host Country 382
12.6 Motives for and Welfare Effects of International Labor Migration 383 12.6A Motives for International Labor Migration 383
12.6B Welfare Effects of International Labor Migration 384
12.6 C Other Welfare Effects of International Labor Migration 385
• Case Study 12-5 U.S. Immigration and Debate over
Immigration Policy 387
Summary 388
A Look Ahead 389 Key Terms 389
Questions for Review 389 Problems 390
A12.1 The Transfer Problem 390 Selected Bibliography 391
INTERNet 393
Part 3 The Balance of Payments, Foreign Exchange Markets, and Exchange Rates
13 Balance of Payments 397
13.1 Introduction 397
13.2 Balance-of-Payments Accounting Principles 398
13.2A Credits and Debits 398
13.2 B Double-Entry Bookkeeping 399
13.3 The International Transactions of the United States 401
• Case Study 13-1 The Major Goods Exports and Imports of the
United States 403
13.4 Accounting Balances and the Balance of Payments 405
13.5 The Postwar Balance of Payments of the United States 407
• Case Study 13-2 The Major Trade Partners of the United States
409
• Case Study 13-3 The U.S. Trade Deficit with Japan 410
• Case Study 13-4 The Exploding U.S. Trade Deficit with China
411
13.6 The International Investment Position of the United States 412
• Case Study 13-5 The United States as a Debtor Nation 414 Summary 415
A Look Ahead 415 Key Terms 416
Questions for Review 416 Problems 417
A13.1 The IMF Method of Reporting International Transactions 418 Selected Bibliography 421
INTERNet 422
14 Foreign Exchange Markets and Exchange Rates 423
14.1 Introduction 423
14.2 Functions of the Foreign Exchange Markets 423
• Case Study 14-1 The U.S. Dollar as the Dominant International
Currency 425
• Case Study 14-2 The Birth of a New Currency: The Euro 427
14.3 Foreign Exchange Rates 427
14.3 A Equilibrium Foreign Exchange Rates 427
• Case Study 14-3 Foreign Exchange Quotations 430 14.3B Arbitrage 431
14.3 C The Exchange Rate and the Balance of Payments 432
14.4 Spot and Forward Rates, Currency Swaps, Futures, and Options 434 14.4A Spot and Forward Rates 434
14.4B Foreign Exchange Swaps 435
14.4 C Foreign Exchange Futures and Options 436
• Case Study 14-4 Size, Currency, and Geographic Distribution
of the Foreign Exchange Market 437
14.5 Foreign Exchange Risks, Hedging, and Speculation 438 14.5A Foreign Exchange Risks 438
14.5B Hedging 441
14.5 C Speculation 442
14.6 Interest Arbitrage and the Efficiency of Foreign Exchange Markets 444 14.6A Uncovered Interest Arbitrage 444
• Case Study 14-5 Carry Trade 445
14.6B Covered Interest Arbitrage 446
14.6C Covered Interest Arbitrage Parity 447 14.6D Covered Interest Arbitrage Margin 449
14.6 E Efficiency of Foreign Exchange Markets 450
14.7 Eurocurrency or Offshore Financial Markets 451
14.7 A Description and Size of the Eurocurrency Market 451 14.7B Reasons for the Development and Growth of the
Eurocurrency Market 452
• Case Study 14-6 Size and Growth of Eurocurrency Market 453 14.7C Operation and Effects of the Eurocurrency Market 454
14.7D Eurobond and Euronote Markets 455
Summary 456
A Look Ahead 457 Key Terms 457
Questions for Review 457 Problems 458
A14.1 Derivation of the Formula for the Covered Interest Arbitrage Margin 459
Selected Bibliography 461
INTERNet 462
15 Exchange Rate Determination 463
15.1 Introduction 463
15.2 Purchasing-Power Parity Theory 464
15.2A Absolute Purchasing-Power Parity Theory 464
15.2 B Relative Purchasing-Power Parity Theory 465
• Case Study 15-1 Absolute Purchasing-Power Parity in the Real World 466
• Case Study 15-2 The Big Mac Index and the Law of One Price
467
• Case Study 15-3 Relative Purchasing-Power Parity in the Real World 469
15.2 C Empirical Tests of the Purchasing-Power Parity Theory 470
15.3 Monetary Approach to the Balance of Payments and Exchange Rates 471 15.3A Monetary Approach under Fixed Exchange Rates 471
15.3 B Monetary Approach under Flexible Exchange Rates 473 15.3C Monetary Approach to Exchange Rate Determination 475
• Case Study 15-4 Monetary Growth and Inflation 476
• Case Study 15-5 Nominal and Real Exchange Rates, and the
Monetary Approach 477
15.3 D Expectations, Interest Differentials, and Exchange Rates 478
• Case Study 15-6 Interest Differentials, Exchange Rates, and the Monetary Approach 480
15.4 Portfolio Balance Model and Exchange Rates 480 15.4A Portfolio Balance Model 481
15.4B Extended Portfolio Balance Model 482
15.4 C Portfolio Adjustments and Exchange Rates 484
15.5 Exchange Rate Dynamics 486
15.5A Exchange Rate Overshooting 486
15.5 B Time Path to a New Equilibrium Exchange Rate 487
15.6 Empirical Tests of the Monetary and Portfolio Balance Models and Exchange Rate Forecasting 489
• Case Study 15-7 Exchange Rate Overshooting of the U.S. Dollar
490
• Case Study 15-8 The Euro Exchange Rate Defies Forecasts 491 Summary 493
A Look Ahead 494
Key Terms 494
Questions for Review 494 Problems 495
A15.1 Formal Monetary Approach Model 497
A15.2 Formal Portfolio Balance Model and Exchange Rates 498 Selected Bibliography 500
INTERNet 503
Part 4 Open-Economy Macroeconomics and the International Monetary System
16 The Price Adjustment Mechanism with Flexible and
Fixed Exchange Rates 507
16.1 Introduction 507
16.2 Adjustment with Flexible Exchange Rates 508
16.2A Balance-of-Payments Adjustments with Exchange Rate Changes 508
16.2B Derivation of the Demand Curve for Foreign Exchange 509
16.2 C Derivation of the Supply Curve for Foreign Exchange 511
16.3 Effect of Exchange Rate Changes on Domestic Prices and the Terms of Trade 512
• Case Study 16-1 Currency Depreciation and Inflation in
Developing Countries during the 1997–1998 East Asian Crisis 513
16.4 Stability of Foreign Exchange Markets 514
16.4 A Stable and Unstable Foreign Exchange Markets 514 16.4B The Marshall–Lerner Condition 516
16.5 Elasticities in the Real World 517 16.5A Elasticity Estimates 517
16.5 B The J-Curve Effect and Revised Elasticity Estimates 519
• Case Study 16-2 Estimated Price Elasticities in International Trade
520
• Case Study 16-3 Other Estimated Price Elasticities in International
Trade 521
• Case Study 16-4 Effective Exchange Rate of the Dollar and
U.S. Current Account Balance 521
• Case Study 16-5 Dollar Depreciation and the U.S. Current
Account Balance 523
• Case Study 16-6 Exchange Rates and Current Account Balances
during the European Financial Crisis of the Early 1990s 524
16.5 C Currency Pass-Through 524
• Case Study 16-7 Exchange Rate Pass-Through to Import Prices in Industrial Countries 525
16.6 Adjustment under the Gold Standard 526 16.6A The Gold Standard 526
16.6B The Price-Specie-Flow Mechanism 527
Summary 529
A Look Ahead 529 Key Terms 530
Questions for Review 530 Problems 530
A16.1 The Effect of Exchange Rate Changes on Domestic Prices 531 A16.2 Derivation of the Marshall–Lerner Condition 534
A16.3 Derivation of the Gold Points and Gold Flows under the Gold Standard 536 Selected Bibliography 537
INTERNet 539
17 The Income Adjustment Mechanism and Synthesis of
Automatic Adjustments 541
17.1 Introduction 541
17.2 Income Determination in a Closed Economy 542
17.2A Determination of the Equilibrium National Income in a Closed Economy 542
17.2 B Multiplier in a Closed Economy 545
17.3 Income Determination in a Small Open Economy 546
17.3 A Import Function 546
• Case Study 17-1 Income Elasticity of Imports 547
17.3 B Determination of the Equilibrium National Income in a Small Open Economy 548
• Case Study 17-2 Private Sector and Current Account Balances 549
17.3 C Graphical Determination of the Equilibrium National Income 549 17.3D Foreign Trade Multiplier 551
• Case Study 17-3 Growth in the United States and the World and
U.S. Current Account Deficits 553
• Case Study 17-4 Growth and Current Account Balance in
Developing Economies 554
17.4 Foreign Repercussions 555
• Case Study 17-5 Effect of the Asian Financial Crisis of the Late
1990s on OECD Countries 557
17.5 Absorption Approach 558
17.6 Monetary Adjustments and Synthesis of the Automatic Adjustments 559 17.6A Monetary Adjustments 559
17.6 B Synthesis of Automatic Adjustments 560
• Case Study 17-6 Interdependence in the World Economy 561 17.6C Disadvantages of Automatic Adjustments 562
Summary 563
A Look Ahead 564 Key Terms 564
Questions for Review 565 Problems 565
A17.1 Derivation of Foreign Trade Multipliers with Foreign Repercussions 566 A17.2 The Transfer Problem Once Again 568
Selected Bibliography 570
INTERNet 572
18 Open-Economy Macroeconomics: Adjustment Policies 573
18.1 Introduction 573
• Case Study 18-1 Government, Private-Sector, and Current Account
Balances in the G-7 Countries 574
18.2 Internal and External Balance with Expenditure-Changing and Expenditure-Switching Policies 576
18.3 Equilibrium in the Goods Market, in the Money Market, and in the Balance of Payments 578
18.4 Fiscal and Monetary Policies for Internal and External Balance with Fixed Exchange Rates 581
18.4A Fiscal and Monetary Policies from External Balance and Unemployment 581
18.4B Fiscal and Monetary Policies from External Deficit and Unemployment 583
18.4 C Fiscal and Monetary Policies with Elastic Capital Flows 584
• Case Study 18-2 Relationship between U.S. Current Account and
Budget Deficits 585
18.4 D Fiscal and Monetary Policies with Perfect Capital Mobility 586
• Case Study 18-3 Effect of U.S. Fiscal Policy in the United States
and Abroad 588
18.5 The IS–LM–BP Model with Flexible Exchange Rates 589 18.5A The IS–LM–BP Model with Flexible Exchange Rates and
Imperfect Capital Mobility 589
18.5 B The IS–LM–BP Model with Flexible Exchange Rates and Perfect Capital Mobility 591
• Case Study 18-4 Effect of Monetary Policy in the United States and Other OECD Countries 592
18.6 Policy Mix and Price Changes 594
18.6 A Policy Mix and Internal and External Balance 594 18.6B Evaluation of the Policy Mix with Price Changes 596 18.6C Policy Mix in the Real World 597
• Case Study 18-5 U.S. Monetary and Fiscal Policies during the
Past Decade 599
• Case Study 18-6 Deeper U.S. Recession without Strong Fiscal and Monetary Measures 600
18.7 Direct Controls 600 18.7A Trade Controls 601
18.7B Exchange Controls 601
18.7 C Other Direct Controls and International Cooperation 602
• Case Study 18-7 Direct Controls on International Transactions Around the World 603
Summary 604
A Look Ahead 605 Key Terms 605
Questions for Review 605 Problems 606
A18.1 Derivation of the IS Curve 608 A18.2 Derivation of the LM Curve 609 A18.3 Derivation of the BP Curve 611 A18.4 Mathematical Summary 611 Selected Bibliography 613
INTERNet 615
19 Prices and Output in an Open Economy: Aggregate Demand and Aggregate Supply 617
19.1 Introduction 617
19.2 Aggregate Demand, Aggregate Supply, and Equilibrium in a Closed Economy 618
19.2A Aggregate Demand in a Closed Economy 618
19.2 B Aggregate Supply in the Long Run and in the Short Run 619 19.2C Short-Run and Long-Run Equilibrium in a Closed Economy 621
• Case Study 19-1 Deviations of Short-Run Outputs from the Natural
Level in the United States 623
19.3 Aggregate Demand in an Open Economy under Fixed and Flexible Exchange Rates 623
19.3 A Aggregate Demand in an Open Economy under Fixed Exchange Rates 624
19.3 B Aggregate Demand in an Open Economy under Flexible Exchange Rates 625
19.4 Effect of Economic Shocks and Macroeconomic Policies on Aggregate Demand in Open Economies with Flexible Prices 626
19.4A Real-Sector Shocks and Aggregate Demand 627
19.4 B Monetary Shocks and Aggregate Demand 628
19.4 C Fiscal and Monetary Policies and Aggregate Demand in Open Economies 629
19.5 Effect of Fiscal and Monetary Policies in Open Economies with Flexible Prices 630
• Case Study 19-2 Central Bank Independence and Inflation in
Industrial Countries 632
• Case Study 19-3 Inflation Targeting—A New Approach to
Monetary Policy 633
19.6 Macroeconomic Policies to Stimulate Growth and Adjust to Supply Shocks 634
19.6A Macroeconomic Policies for Growth 634
19.6 B Macroeconomic Policies to Adjust to Supply Shocks 635
• Case Study 19-4 Petroleum Shocks and Stagflation in the United States 637
• Case Study 19-5 Impact of an Increase in the Price of Petroleum
638
• Case Study 19-6 Actual and Natural Unemployment Rates and
Inflation in the United States 639
Summary 640
A Look Ahead 641 Key Terms 641
Questions for Review 641 Problems 642
Selected Bibliography 642
INTERNet 644
20 Flexible versus Fixed Exchange Rates, the European Monetary System, and Macroeconomic Policy Coordination 645
20.1 Introduction 645
20.2 The Case for Flexible Exchange Rates 646
20.2A Market Efficiency 647
20.2 B Policy Advantages 647
20.3 The Case for Fixed Exchange Rates 649
20.3A Less Uncertainty 649
20.3B Stabilizing Speculation 650
20.3 C Price Discipline 652
• Case Study 20-1 Macroeconomic Performance under Fixed and
Flexible Exchange Rate Regimes 653 20.3D The Open-Economy Trilemma 654
20.4 Optimum Currency Areas, the European Monetary System, and the European Monetary Union 655
20.4A Optimum Currency Areas 656
20.4 B European Monetary System (1979–1998) 657
• Case Study 20-2 The 1992–1993 Currency Crisis in the
European Monetary System 658 20.4C Transition to Monetary Union 658
20.4 D Creation of the Euro 660
• Case Study 20-3 Maastricht Convergence Indicators 660
• Case Study 20-4 Benefits and Costs of the Euro 663
20.4 E The European Central Bank and the Common Monetary Policy 663
• Case Study 20-5 The Eurozone Crisis 664
20.5 Currency Boards Arrangements and Dollarization 665 20.5A Currency Board Arrangements 665
20.5 B Dollarization 666
• Case Study 20-6 Argentina’s Currency Board Arrangements
and Crisis 666
20.6 Exchange Rate Bands, Adjustable Pegs, Crawling Pegs, and Managed Floating 667
20.6A Exchange Rate Bands 667 20.6B Adjustable Peg Systems 668 20.6C Crawling Pegs 670
20.6 D Managed Floating 670
• Case Study 20-7 Exchange Rate Arrangements of IMF Members
672
20.7 International Macroeconomic Policy Coordination 673
Summary 675
A Look Ahead 676 Key Terms 676
Questions for Review 676 Problems 677
A20.1 Exchange Rate Arrangements 678 Selected Bibliography 683
INTERNet 686
21 The International Monetary System: Past, Present, and Future 687
21.1 Introduction 687
21.2 The Gold Standard and the Interwar Experience 688 21.2A The Gold Standard Period (1880–1914) 689 21.2B The Interwar Experience 690
21.3 The Bretton Woods System 691
21.3A The Gold-Exchange Standard (1947–1971) 692
21.3 B Borrowing from the International Monetary Fund 693
21.4 Operation and Evolution of the Bretton Woods System 694 21.4A Operation of the Bretton Woods System 694
21.4 B Evolution of the Bretton Woods System 695
• Case Study 21-1 Macroeconomic Performance under Different
Exchange Rate Regimes 697
21.5 U.S. Balance-of-Payments Deficits and Collapse of the Bretton Woods System 698
21.5 A U.S. Balance-of-Payments Deficits 698 21.5B Collapse of the Bretton Woods System 700
21.6 The International Monetary System: Present and Future 702 21.6A Operation of the Present System 702
21.6B Current IMF Operation 703
21.6C Problems with Present Exchange Rate Arrangements 706
21.6 D Proposals for Reforming Present Exchange Rate Arrangements 707 21.6E Financial Crises in Emerging Market Economies 709
• Case Study 21-2 The Anatomy of a Currency Crisis: The Collapse
of the Mexican Peso 709
• Case Study 21-3 Chronology of Economic Crises in Emerging
Markets: From Asia to Argentina 710
• Case Study 21-4 The Financial Crisis in the United States and
Other Advanced Economies 713 21.6F Other Current International Economic Problems 714
• Case Study 21-5 Trade Imbalances of the Leading Industrial
Nations 716
Summary 718
Key Terms 720
Questions for Review 720 Problems 721
A21.1 International Reserves: 1950–2011 722
Selected Bibliography 724
INTERNet 728
Glossary of Key Terms 729
Name Index 743
Subject Index 751
Download here