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

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

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

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

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

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

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

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

Contents xxi

Questions for Review 214

Problems 215

Appendix 216

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

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

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

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

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

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

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

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

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

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

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

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

Glossary of Key Terms G-1

Name Index I-1

Subject Index I-5

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