International Economics, Australia and New Zealand Edition

1 Introduction 1 1.1 The Globalization of the World Economy 1 1.2 International Trade and the Nation’s Standard of Living 4 1.3 The International Flow of Goods, Services, Labor, and Capital 8 1.4 International Economic Theories and Policies 12 1.5 Current International Economic Problems and Challenges 14 1.6 Organization and Methodology of the Text 16 Summary 18 Key Terms 19 Questions for Review 19 Problems 19 Appendix 20 A1.1 Basic International Trade Data 20 A1.2 Sources of Additional International Data and Information 24 Part 1 International Trade Theory 2 The Law of Comparative Advantage 29 2.1 Introduction 29 2.2 The Mercantilists’ Views on Trade 30 2.3 Trade Based on Absolute Advantage: Adam Smith 32 2.4 Trade Based on Comparative Advantage: David Ricardo 33 2.5 Comparative Advantage and Opportunity Costs 38 2.6 The Basis for and the Gains from Trade under Constant Costs 42 2.7 Empirical Tests of the Ricardian Model 44 Summary 47 Key Terms 48 Questions for Review 48 Problems 49 Appendix 50 A2.1 Comparative Advantage with More Than Two Commodities 50 A2.2 Comparative Advantage with More Than Two Nations 52 3 The Standard Theory of International Trade 53 3.1 Introduction 53 3.2 The Production Frontier with Increasing Costs 53 3.3 Community Indifference Curves 56 3.4 Equilibrium in Isolation 57 3.5 The Basis for and the Gains from Trade with Increasing Costs 60 3.6 Trade Based on Differences in Tastes 67 Summary 68 Key Terms 69 Questions for Review 69 Problems 69 Appendix 70 A3.1 Production Functions, Isoquants, Isocosts, and Equilibrium 71 A3.2 Production Theory with Two Nations, Two Commodities, and Two Factors 72 A3.3 Derivation of the Edgeworth Box Diagram and Production Frontiers 73 A3.4 Some Important Conclusions 76 4 Demand and Supply, Offer Curves, and The Terms of Trade 77 4.1 Introduction 77 4.2 The Equilibrium-Relative Commodity Price with Trade—Partial Equilibrium Analysis 77 4.3 Offer Curves 80 4.4 The Equilibrium-Relative Commodity Price with Trade—General Equilibrium Analysis 83 4.5 Relationship Between General and Partial Equilibrium Analyses 84 4.6 The Terms of Trade 86 Summary 88 Key Terms 89 Questions for Review 89 Problems 89 Appendix 90 A4.1 Derivation of a Trade Indifference Curve for Nation 1 90 A4.2 Derivation of Nation 1’s Trade Indifference Map 92 A4.3 Formal Derivation of Nation 1’s Offer Curve 92 A4.4 Outline of the Formal Derivation of Nation 2’s Offer Curve 94 A4.5 General Equilibrium of Production, Consumption, and Trade 96 A4.6 Multiple and Unstable Equilibria 96 5 Factor Endowments and The Heckscher–Ohlin Theory 99 5.1 Introduction 99 5.2 Assumptions of the Theory 100 5.3 Factor Intensity, Factor Abundance, and the Shape of the Production Frontier 101 5.4 Factor Endowments and the Heckscher–Ohlin Theory 107 5.5 Factor–Price Equalization and Income Distribution 112 5.6 Empirical Tests of the Heckscher–Ohlin Model 119 Summary 125 Key Terms 126 Questions for Review 127 Problems 127 Appendix 128 A5.1 The Edgeworth Box Diagram for Nation 1 and Nation 2 129 A5.2 Relative Factor–Price Equalization 130 A5.3 Absolute Factor–Price Equalization 132 A5.4 Effect of Trade on the Short-Run Distribution of Income: The Specific-Factors Model 132 A5.5 Illustration of Factor–Intensity Reversal 134 A5.6 The Elasticity of Substitution and Factor–Intensity Reversal 136 A5.7 Empirical Tests of Factor–Intensity Reversal 137 6 Economies of Scale, Imperfect Competition, and International Trade 138 6.1 Introduction 138 6.2 The Heckscher–Ohlin Model and New Trade Theories 138 6.3 Economies of Scale and International Trade 140 6.4 Imperfect Competition and International Trade 143 6.5 Trade Based on Dynamic Technological Differences 152 6.6 Costs of Transportation, Environmental Standards, and International Trade 156 Summary 160 Key Terms 161 Questions for Review 161 Problems 162 Appendix 162 A6.1 External Economies and the Pattern of Trade 162 A6.2 Dynamic External Economies and Specialization 164 7 Economic Growth and International Trade 166 7.1 Introduction 166 7.2 Growth of Factors of Production 167 7.3 Technical Progress 169 7.4 Growth and Trade: The Small-Country Case 172 7.5 Growth and Trade: The Large-Country Case 177 7.6 Growth, Change in Tastes, and Trade in Both Nations 182 Summary 184 Key Terms 185 Questions for Review 185 Problems 186 Appendix 187 A7.1 Formal Proof of the Rybczynski Theorem 187 A7.2 Growth with Factor Immobility 189 A7.3 Graphical Analysis of Hicksian Technical Progress 190 Part 2 International Trade Policy 8 Trade Restrictions: Tariffs 195 8.1 Introduction 195 8.2 Partial Equilibrium Analysis of a Tariff 197 8.3 The Theory of Tariff Structure 203 8.4 General Equilibrium Analysis of a Tariff in a Small Country 207 8.5 General Equilibrium Analysis of a Tariff in a Large Country 210 8.6 The Optimum Tariff 212 Summary 213 Key Terms 214 Questions for Review 214 Problems 215 Appendix 216 A8.1 Partial Equilibrium Effects of a Tariff in a Large Nation 216 A8.2 Derivation of the Formula for the Rate of Effective Protection 218 A8.3 The Stolper–Samuelson Theorem Graphically 219 A8.4 Exception to the Stolper–Samuelson Theorem—The Metzler Paradox 221 A8.5 Short-Run Effect of a Tariff on Factors’ Income 222 A8.6 Measurement of the Optimum Tariff 224 9 Nontariff Trade Barriers and the New Protectionism 226 9.1 Introduction 226 9.2 Import Quotas 226 9.3 Other Nontariff Barriers and the New Protectionism 229 9.4 The Political Economy of Protectionism 238 9.5 Strategic Trade and Industrial Policies 242 9.6 History of U.S. Commercial Policy 246 9.7 The Uruguay Round, the Failed Doha Round, and the Outstanding Trade Problems 250 Summary 255 Key Terms 256 Questions for Review 257 Problems 257 Appendix 258 A9.1 Centralized Cartels 258 A9.2 International Price Discrimination 259 A9.3 Tariffs, Subsidies, and Domestic Goals 260 10 Economic Integration: Customs Unions and Free Trade Areas 262 10.1 Introduction 262 10.2 Trade-Creating Customs Union 263 10.3 Trade-Diverting Customs Unions 264 10.4 The Theory of the Second Best and Other Static Welfare Effects of Customs Unions 266 10.5 Dynamic Benefits from Customs Unions 268 10.6 History of Attempts at Economic Integration 269 Summary 280 Key Terms 281 Questions for Review 281 Problems 281 Appendix 282 A10.1 General Equilibrium Analysis of the Static Effects of a Trade-Diverting Customs Union 282 A10.2 Regional Trade Agreements and Other Groups Around the World in June 2018 284 11 International Trade and Economic Development 289 11.1 Introduction 289 11.2 The Importance of Trade to Development 290 11.3 The Terms of Trade and Economic Development 295 11.4 Export Instability and Economic Development 300 11.5 Import Substitution versus Export Orientation 303 11.6 Current Problems Facing Developing Countries 307 Summary 313 Key Terms 313 Questions for Review 314 Problems 314 Appendix 315 A11.1 Income Inequalities by Traditional and Purchasing-Power Parity (PPP) Measures 315 A11.2 The World by Income 316 12 International Resource Movements and Multinational Corporations 319 12.1 Introduction 319 12.2 Some Data on International Capital Flows 320 12.3 Motives for International Capital Flows 323 12.4 Welfare Effects of International Capital Flows 326 12.5 Multinational Corporations 329 12.6 Motives for and Welfare Effects of International Labor Migration 334 Summary 338 Key Terms 339 Questions for Review 339 Problems 339 Appendix 340 A12.1 The Transfer Problem 340 A12.2 International Trade, Financial and Aid Flows, and Migration 341 Part 3 The Balance of Payments, Foreign Exchange Markets, and Exchange Rates 13 Balance of Payments 347 13.1 Introduction 347 13.2 Balance of Payments Accounting 348 13.3 The International Transactions of the United States 350 13.4 Accounting Balances and the U.S. Balance of Payments 353 13.5 The Postwar Balance of Payments of the United States 353 13.6 The Importance of the Current Account 356 13.7 The International Investment Position of the United States 357 Summary 360 Key Terms 361 Questions for Review 361 Problems 362 Appendix 362 A13.1 The IMF Method of Reporting International Transactions 362 14 Foreign Exchange Markets and Exchange Rates 366 14.1 Introduction 366 14.2 Functions of the Foreign Exchange Markets 366 14.3 Foreign Exchange Rates 370 14.4 Spot and Forward Rates, Currency Swaps, Futures, and Options 376 14.5 Foreign Exchange Risks, Hedging, and Speculation 379 14.6 Interest Arbitrage and the Efficiency of Foreign Exchange Markets 385 14.7 Eurocurrency or Offshore Financial Markets 392 Summary 396 Key Terms 397 Questions for Review 398 Problems 398 Appendix 399 A14.1 Derivation of the Formula for the Covered Interest Arbitrage Margin 399 15 Exchange Rate Determination 401 15.1 Introduction 401 15.2 Purchasing-Power Parity Theory 402 15.3 Monetary Approach to the Balance of Payments and Exchange Rates 407 15.4 Portfolio Balance Model and Exchange Rates 416 15.5 Exchange Rate Dynamics 421 15.6 Empirical Tests of the Monetary and Portfolio Balance Models and Exchange Rate Forecasting 425 Summary 428 Key Terms 429 Questions for Review 429 Problems 429 Appendix 431 A15.1 Formal Monetary Approach Model 431 A15.2 Formal Portfolio Balance Model and Exchange Rates 433 Part 4 Open-Economy Macroeconomics and the International Monetary System 16 The Price Adjustment Mechanism with Flexible and Fixed Exchange Rates 437 16.1 Introduction 437 16.2 Adjustment with Flexible Exchange Rates 438 16.3 Effect of Exchange Rate Changes on Domestic Prices and the Terms of Trade 441 16.4 Stability of Foreign Exchange Markets 443 16.5 Elasticities in the Real World 445 16.6 Adjustment under the Gold Standard 454 Summary 456 Key Terms 457 Questions for Review 457 Problems 458 Appendix 458 A16.1 The Effect of Exchange Rate Changes on Domestic Prices 458 A16.2 Derivation of the Marshall–Lerner Condition 460 A16.3 Derivation of the Gold Points and Gold Flows Under the Gold Standard 462 17 The Income Adjustment Mechanism and Synthesis of Automatic Adjustments 464 17.1 Introduction 464 17.2 Income Determination in a Closed Economy 465 17.3 Income Determination in a Small Open Economy 468 17.4 Foreign Repercussions 476 17.5 Absorption Approach 479 17.6 Monetary Adjustments and Synthesis of the Automatic Adjustments 481 Summary 484 Key Terms 485 Questions for Review 485 Problems 486 Appendix 487 A17.1 Derivation of Foreign Trade Multipliers with Foreign Repercussions 487 A17.2 The Transfer Problem Once Again 489 18 Open-Economy Macroeconomics: Adjustment Policies 491 18.1 Introduction 491 18.2 Internal and External Balance with Expenditure-Changing and Expenditure-Switching Policies 494 18.3 Equilibrium in the Goods Market, in the Money Market, and in the Balance of Payments 496 18.4 Fiscal and Monetary Policies for Internal and External Balance with Fixed Exchange Rates 498 18.5 The IS–LM–BP Model with Flexible Exchange Rates 506 18.6 Policy Mix and Price Changes 510 18.7 Direct Controls 516 Summary 519 Key Terms 520 Questions for Review 520 Problems 521 Appendix 522 A18.1 Derivation of the IS Curve 522 A18.2 Derivation of the LM Curve 524 A18.3 Derivation of the BP Curve 525 A18.4 Mathematical Summary 527 19 Prices and Output in an Open Economy: Aggregate Demand and Aggregate Supply 528 19.1 Introduction 528 19.2 Aggregate Demand, Aggregate Supply, and Equilibrium in a Closed Economy 528 19.3 Aggregate Demand in an Open Economy Under Fixed and Flexible Exchange Rates 534 19.4 Effect of Economic Shocks and Macroeconomic Policies on Aggregate Demand in Open Economies with Flexible Prices 536 19.5 Effect of Fiscal and Monetary Policies in Open Economies with Flexible Prices 539 19.6 Macroeconomic Policies to Stimulate Growth and Adjust to Supply Shocks 544 Summary 549 Key Terms 550 Questions for Review 550 Problems 551 20 Flexible Versus Fixed Exchange Rates, The European Monetary System, and Macroeconomic Policy Coordination 552 20.1 Introduction 552 20.2 The Case for Flexible Exchange Rates 553 20.3 The Case for Fixed Exchange Rates 555 20.4 Optimum Currency Areas, the European Monetary System, and the European Monetary Union 562 20.5 Currency Boards Arrangements and Dollarization 571 20.6 Exchange Rate Bands, Adjustable Pegs, Crawling Pegs, and Managed Floating 573 20.7 International Macroeconomic Policy Coordination 578 Summary 580 Key Terms 581 Questions for Review 581 Problems 581 Appendix 582 A20.1 Exchange Rate Arrangements 582 21 The International Monetary System: Past, Present, and Future 586 21.1 Introduction 586 21.2 The Gold Standard and the Interwar Experience 587 21.3 The Bretton Woods System 590 21.4 Operation and Evolution of the Bretton Woods System 592 21.5 U.S. Balance-of-Payments Deficits and Collapse of the Bretton Woods System 596 21.6 The International Monetary System: Present and Future 599 Summary 615 Key Terms 616 Questions for Review 617 Problems 617 Appendix 618 A21.1 International Reserves: 1950–2018 618 Glossary of Key Terms G-1 Name Index I-1 Subject Index I-5