International Economics

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1 International Economics 7th edition Theo S. Eicher, John H. Mutti, and Michelle H. Turnovsky O Routledge jjj^ Taylor & Francis Croup LONDON AND NEW YORK

2 List of Case Studies xiii List of Boxes %p List of figures %%i List of Tables Preface 1 Introduction: Life in an International Economy 1 Referenees and Suggestions for Further Rgadifig 7 PART I INTERNATIONAL TRADE AND TRADE POLICY 9 2 Why Do Nations Trade? Some Early Answers 13 Ji 14 W M 32

3 vi Contents - - '.";* ;.,v"..";:. >.?'i.-- ',..- '. «^'-f'i'i-" : " '~ff' 3 Why Do Nations Trade? Some Later Answers 34 Learning Objectives 34 Consumer Preferences and the Gains from Trade 35 Production Capabilities and the Gains from Trade 41 International Trade with Constant Costs 43 International Trade with Increasing Costs 49 The Division of the Gains from Trade 52 Summary of Key Concepts < _- 59 Case Study: Terms of Trade Changes and Australian Growth 59 Questions for Study and Review 61 References and Suggestions for Further Reading 63 Appendix: The Role of Money Prices 64 4 Trade and the Role of Factor Endowments 66 Learning Objectives 66 Factor Proportions as a Determinant of Trade 67 Trade and Changing Factor Endowments 78 Trade, the Distribution of Income and Factor Price Changes 82 Relaxing Some Assumptions of the H-O Model 89 Empirical Verification of the H-O Model 93 Summary of Key Concepts 97 Case Study: Trade Liberalization and the Distribution of Income in Brazil 97 Questions for Study and Review 99 References and Suggestions for Further Reading 101 Appendix: Mathematical Representations of Relationships in the H-O Model Scale, Competition and Trade 106 Learning Objectives 106 External Economies of Scale 108 Internal Economies of Scale 113 Economies of Scale and Monopolistic Competition 118 Trade with Other Forms of Imperfect Competition 126 Summary of Key Concepts. 132 Case Study: A Further Case of Intra-Industry Trade: Carrying Coals to Newcastle? 133 Questions for Study and Review 135 References and Suggestions for Further Reading 137 Appendix A: Monopolistic Competition and Trade 139 Appendix B: Oligopoly, the Cournot Model, and Trade 141

4 vii 6 The Theory of Protection Tariffs and Other Barriers to Trade 143 Learning Objectives 143 Partial Equilibrium Analysis of Trade Barriers 145 General Equilibrium Analysis of Trade Barriers 162 The Effective Rate of Protection 165 Intervention in Export Markets 170 Summary of Key Concepts. ' 174 Case Study: The Elimination of the MFA V 175 Questions for Study and Review 177 References and Suggestions for Further Reading Arguments for Protection and the Political Economy of Trade Policy 182 Learning Objectives 182 Arguments for Restricting Imports 184 Dumping 201 The Political Economy of Trade Policy 208 Summary of Key Concepts 211 Case Study: Are Chinese and Vietnamese Shoes Dumped in the E.U. Market? 212 Questions for Study and Review 213 References and Suggestions for Further Reading 216 Appendix: Optimum Tariffs: A Partial Equilibrium Perspective International Mobility of Labor and Capital 220 Learning Objectives 220 A Basic Model of Capital Mobility 224 Additional Issues Raised by Labor Mobility 228 Multinational Corporations 234 Summary of Key Concepts 244 Case Study: The Daimler Chrysler Marriage and Divorce 245 Questions for Study and Review 246 References and Suggestions for Further Reading Regional Blocs: Preferential Trade Liberalization 249 Learning Objectives 249 Alternative Forms of Preferential Trade Agreements 250 Efficiency Gains and Losses From Preferential Trade Agreements 251 Measuring the Economic Effects of a Preferential Trade Agreement 256 The European Union 258 NAFTA 264

5 viii Contents Summary of Key Concepts 268 Case Study: A Russia-EU Free Trade Agreement? 269 Questions for Study and Review 270 References and Suggestions for Further Reading Commercial Policy and the WTO 274 Learning Objectives 274 The Rationale for Multilateral Trade Liberalization 275 Precursors to Multilateral Trade Liberalization 276 Multilateral Trade Liberalization under the GATT 278 The Establishment of the WTO 284 Resolving Trade Disputes in the WTO 288 Developing Countries and the WTO 292 Summary of Key Concepts 295 Case Study: Discipline Over Agricultural Policies? The Case of U.S. Cotton Subsidies 296 Questions for Study and Review 297 References and Suggestions for Further Reading Trade and Growth 300 Learning Objectives 300 Building Blocks to Determine the Effects of Economic Growth on Trade 302 Large Countries and Changes in the Terms Of Trade 308 Developing-Country Perspectives and the Effects of Trade on Growth 312 Alternative Trade Policies and the Transition to Greater Manufactured Output 319 Growth and Environmental Externalities 324 Summary of Key Concepts 329 Case Study: China's Trade: Lessons to be Learned? 329 Questions for Study and Review 331 References and Suggestions for Further Reading * 332 Appendix: Demonstrating the Effects of Exogenous Technical Change 334 PART II INTERNATIONAL FINANCE AND OPEN ECONOMY MACROECONOMICS The Balance of Payments and the Exchange Rate 341 Learning Objectives 341 The Balance of Payments: International Transactions Accounts 342 The International Investment Position 352 The Exchange Rate 353 Summary of Key Concepts 360 Case Study I CSI: Trade Deficit 361

6 ix Case Study II "Dark Matter" Makes the US Deficit Disappear 362 Questions for Study and Review 364 References and Suggestions for Further Reading 365 Appendix Fundamentals of Exchange Rate Systems 374 Learning Objectives, 374 Flexible Exchange Rates: Adjustment through Market Forces 379 Fixed Exchange Rates: Adjustment through Central Bank Intervention 383 The Exchange Rate and Open-Economy National Income Accounting 390 The Marshall-Lerner Condition 392 The J-Curve Effect 395 Summary of Key Concepts 397 Case Study I: On Europe: Europe Feels Weight of Strong Euro 398 Case Study II: China Slightly Loosens the Reins on its Currency's Market Fluctuation 399 Questions for Study and Review 401 References and Suggestions for Further Reading 403 Appendix: The Marshall-Lerner Condition An Introduction to Modeling the Open Economy 406 Learning Objectives 406 Key Features of a Basic Open-Economy Model 407 A Small Open Economy with Fixed Exchange Rates 409 A Small Open Economy with Flexible Exchange Rates 422 Summary of Key Concepts 426 Case Study I: America is Borrowing Trouble 426 Case Study II: Greenspan Warns Against Raising Tariffs on China 428 Questions for Study and Review 430 References and Suggestions for Further Reading Extensions of the Basic Open-Economy Model: Policy Effectiveness and the Large Open Economy 435 Learning Objectives 435 Sterilization and Policies to Manage External Deficits 437 Internal and External Balance: The Policy Mix 445 The Large Open Economy 449 Summary of Key Concepts 460 Case Study I: Switching Engines: Global Economic Growth has become Less Dependent on American Spending 461 Case Study II: The Fiscal Fallacy of Decoupling from America 463 Questions for Study and Review 464 References and Suggestions for Further Reading 467

7 16 International Capital Markets 469 Learning Objectives 469 International Financial Flows 470 Financial Markets and Instruments 475 Various Agents and the Functions of the Markets 482 The Short-Term Exchange Rate Determination and Technical Analysis 486 Summary of Key Concepts 492 Case Study: Marking the Dealer's CardsNWhat.Economists Can Learn from Currency Traders 492 Questions for Study and Review 494 References and Suggestions for Further Reading Modeling International Capital Markets 497 -Learning Objectives 497 International Capital Market Arbitrage 498 Integrating Interest Arbitrage into the Open-Economy Model 507 Summary of Key Concepts 515 Case Study I: Carry On Speculating 516 Case Study II: The Domino Effect 518 Questions for Study and Review 520 References and Suggestions for Further Reading Policy Under Fixed Exchange Rates 524 Learning Objectives, 524 A Review of the Building Blocks: the IS, LM, and BP curves 526 Monetary Policy under Fixed Exchange Rates 529 Fiscal Policy under Fixed Exchange Rates 534 Exchange Rate Policy 541 The Policy Mix: Internal and External Balance 546 Summary of Key Concepts 552 Case Study I: The Petrodollar Peg 553 Case Study II: Don't Revalue the Yuan 555 Questions for Study and Review 556 References and Suggestions for Further Reading Policy under Flexible Exchange Rates and Extensions of the Mundell-Fleming Model 560 Learning Objectives 560 Monetary Policy under Flexible Exchange Rates 561 Fiscal Policy under Flexible Exchange Rates 566 The Large Open Economy under Flexible Exchange Rates 572

8 xi Price Adjustment in the Mundell-Fleming Model 578 Summary of Key Concepts 584 Case Study I: Insight: Currency Lessons Learned since the Upheaval 585 Case Study II: Preparing to Float 587 Questions for Study and Review 589 References and Suggestions for Further Reading 591 Appendix: The Policy Mix Revisited: Internal and External Balance 591 i 20 Perfectly Flexible Prices and Exchange Rate Dynamics 595 Learning Objectives 595 International Arbitrage and Purchasing Power Parity 596 Monetarist Approach to the Exchange Rate 610 Exchange Rate Dynamics - Overshooting 611 Summary of Key Concepts 616 Case Study I: Soft Currency 617 Case Study II: McCurrencies " 619 Questions for Study and Review 622 References and Suggestions for Further Reading 623 Appendix: Further Implications of the Monetarist or Long-Run Model The International Monetary System: A Brief History 626 Learning Objectives 626 The Gold Standard 628 Reconstruction and Exchange Rates after World War I 636 The Bretton Woods System 639 A Brief History of the Float after Bretton Woods 644 The New Financial Architecture: The Basel Accords 647 Summary of Key Concepts 650 Case Study I: Financial Reform - Reality Check at the IMF 651 Case Study II: IMF Quotas - Monetary Misquotations 653 Questions for Study and Review 655 References and Suggestions for Further Reading 656 Appendix: The IMF versus the World Bank - Differences and Recent Collaboration European Monetary Integration 659 Learning Objectives 659 European Issues with Bretton Woods and the Snake 660 The European Monetary System and its Exchange Rate Mechanism 665 The European Currency Crises 672 The European Economic and Monetary Union 675 Summary of Key Concepts 684

9 xii Contents Case Study: Beggar Thy Neighbour 685 Questions for Study and Review 687 References and Suggestions for Further Reading International Financial Crises 691 Learning Objectives 691 The 1970s Oil Shocks: Financial Flow Imbalances and the Origins of the Debt Crises 692 A Model of Currency Crises: Krugman'siModelof Speculative Attacks 694 The End of Capital Flows: Debt Crises in the 1980s 695 The Resurgence of Capital Flows to "Emerging Markets" in the 1990s 696 The Effect of Capital Inflows in the Mundell-Fleming Model 696 The End of Exuberant International Lending: The Asian Financial Crisis 699 Contagion 702 The Aftermath of the East Asian Crisis: The Economics of Reserve Accumulation 703 Reserve Accumulation and International Competitiveness Implications 705 Summary of Key Concepts 706 Case Study I: Guilt by Association 707 Case Study II: Who's in Charge of Determining U.S. Interest Rates? It May Be Beijing. 709 Questions for Study and Review 710 References and Suggestions for Further Reading 710 Glossary 712 Index 736

Contents. 1 Introduction. The Globalization of the World Economy 1 1.1A We Live in a Global Economy 1

Contents. 1 Introduction. The Globalization of the World Economy 1 1.1A We Live in a Global Economy 1 1 Introduction The Globalization of the World Economy 1 1.1A We Live in a Global Economy 1 The Globalization Challenge 3 The Dell PCs, iphones, and ipads Sold in the United States Are Anything but American!