International economics theory and policy 6th edition

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International Economics Theory and Policy SIXTH EDITION Paul R Krugman Princeton University Maurice Obstfeld University of California, Berkeley BAD GUY NOTICE: I only scanned this book to help my fellow students If you like the book, go buy it However, if you can't afford it, or you're simply too tired to go to the library every time you need to read it or copy pages from it, then don't complain about the quality Dear Mr Krugman, dear Mr Obstfeld, I honestly advise you to offer us a downloadable PDF-Version of your book It would be a lot cheaper for you and us, and a lot easier to get Maybe for the next time Welcome to the new Millenium! Boston San Francisco New York London Toronto Sydney Tokyo Singapore Madrid Mexico City Munich Paris Cape Town Hong Kong Montreal Frete U n i v e r s a l Berlin Wlrtschaftswissenschatilicte Bibliothek For Robin and Leslie Ann Editor-in-Chief: Denise Clinton Executive Development Manager: Sylvia Mallory Development Editor: Jane Tufts Web Development: Melissa Honig Managing Editor: James Rigney Production Supervisor: Katherine Watson Design Manager: Regina Kolenda Text Design, Electronic Composition, and Project Management: Elm Street Publishing Services, Inc Cover Designer: Regina Kolenda Cover Image: © Digital Vision Ltd Supplements Editor: Andrea Basso Marketing Manager: Adrienne D'Ambrosio Manufacturing Coordinator: Hugh Crawford International Economics: Theory and Policy Copyright © 2003 by Paul R Krugman and Maurice Obstfeld All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written consent of the publisher For information on obtaining permission for the use of material from this work, please submit a written request to Pearson Education, Inc., Rights and Contracts Department, 75 Arlington St., Suite 300, Boston, MA 02116 or fax your request to (617) 848-7047 Printed in the United States of America ISBN: 0-321-11639-9 WORLD STUDENT SERIES This edition may be sold only in those countries to which it is consigned by Pearson Education International It is not to be re-exported and it is not for sale in the U.S.A or Canada 03 02 BRIEF CONTENTS Contents Preface Introduction Part I International Trade Theory Labor Productivity and Comparative Advantage: The Ricardian Model Specific Factors and Income Distribution Resources and Trade: The Heckscher-Ohlin Model The Standard Trade Model Economies of Scale, Imperfect Competition, and International Trade International Factor Movements Part International Trade Policy The Instruments of Trade Policy The Political Economy of Trade Policy 10 Trade Policy in Developing Countries 11 Controversies in Trade Policy Part Exchange Rates and Open-Economy Macroeconomics 12 National Income Accounting and the Balance of Payments Exchange Rates and the Foreign Exchange Market: An Asset Approach 14 Money, Interest Rates, and Exchange Rates 15 Price Levels and the Exchange Rate in the Long Run 16 Output and the Exchange Rate in the Short Run 17 Fixed Exchange Rates and Foreign Exchange Intervention Part International Macroeconomic Policy 18 The International Monetary System, 1870-1973 19 Macroeconomic Policy and Coordination under Floating Exchange Rates 20 Optimum Currency Areas and the European Experience The Global Capital Market: Performance and Policy Problems 2 Developing Countries: Growth, Crisis, and Reform vii xxii 10 38 67 93 120 160 185 186 218 255 276 293 294 324 357 388 433 481 53 I 532 568 604 636 665 vi Brief Contents Mathematical Postscripts Postscript to Chapter 3: The Specific Factors Model Postscript to Chapter 4: The Factor Proportions Model Postscript to Chapter 5: The Trading World Economy Postscript to Chapter 6: The Monopolistic Competition Model Postscript to Chapter 21: Risk Aversion and International Portfolio Diversification 707 708 714 717 Index 737 726 728 CONTENTS Preface Introduction What Is International Economics About? The Gains from Trade The Pattern of Trade How Much Trade? The Balance of Payments Exchange Rate Determination International Policy Coordination The International Capital Market International Economics: Trade and Money Part I International Trade Theory xxii I 3 6 7 Labor Productivity and Comparative Advantage: The Ricardian Model 10 The Concept of Comparative Advantage A One-Factor Economy Production Possibilities Relative Prices and Supply Trade in a One-Factor World Box: Comparative Advantage in Practice: The Case of Babe Ruth Determining the Relative Price after Trade The Gains From Trade A Numerical Example Relative Wages Misconceptions about Comparative Advantage Productivity and Competitiveness The Pauper Labor Argument Exploitation Box: Do Wages Reflect Productivity? Comparative Advantage with Many Goods Setting Up the Model Relative Wages and Specialization Determining the Relative Wage in the Multigood Model Adding Transport Costs and Nontraded Goods Empirical Evidence on the Ricardian Model Summary 10 12 12 14 14 16 16 19 20 22 23 23 24 24 25 26 26 27 28 30 31 34 VII viii Contents Specific Factors and Income Distribution 38 The Specific Factors Model Assumptions of the Model Box: What Is a Specific Factor? Production Possibilities Prices, Wages, and Labor Allocation Relative Prices and the Distribution of Income International Trade in the Specific Factors Model Resources and Relative Supply Trade and Relative Prices The Pattern of Trade Income Distribution and the Gains From Trade The Political Economy of Trade: A Preliminary View Optimal Trade Policy Income Distribution and Trade Politics Box: Specific Factors and the Beginnings of Trade Theory Summary 39 39 40 40 44 49 50 51 52 53 54 57 57 58 59 60 Appendix: Further Details on Specific Factors 63 Marginal and Total Product Relative Prices and the Distribution of Income 63 64 Resources and Trade: The Heckscher-Ohlin Model 67 A Model of a Two-Factor Economy Assumptions of the Model Factor Prices and Goods Prices Resources and Output Effects of International Trade Between Two-Factor Economies Relative Prices and the Pattern of Trade Trade and the Distribution of Income Factor Price Equalization Case Study: North-South Trade and Income Inequality Empirical Evidence on the Heckscher-Ohlin Model Testing the Heckscher-Ohlin Model , Implications of the Tests Summary 68 68 69 72 75 76 76 78 80 82 82 85 86 Appendix: Factor Prices, Goods Prices, and Input Choices 89 Choice of Technique Goods Prices and Factor Prices 89 91 The Standard Trade Model 93 A Standard Model of a Trading Economy Production Possibilities and Relative Supply Relative Prices and Demand The Welfare Effect of Changes in the Terms of Trade 94 94 95 98 Contents Determining Relative Prices Economic Growth: A Shift of the RS Curve Growth and the Production Possibility Frontier Relative Supply and the Terms of Trade International Effects of Growth Case Study: Has the Growth of Newly Industrializing Countries Hurt Advanced Nations? International Transfers of Income: Shifting the RD Curve The Transfer Problem Effects of a Transfer on the Terms of Trade Presumptions about the Terms of Trade Effects of Transfers Case Study: The Transfer Problem and the Asian Crisis Tariffs and Export Subsidies: Simultaneous Shifts in RS and RD Relative Demand and Supply Effects of a Tariff Effects of an Export Subsidy Implications of Terms of Trade Effects: Who Gains and Who Loses? Summary 103 104 105 105 107 108 109 109 110 111 113 Appendix: Representing International Equilibrium with Offer Curves 117 Deriving a Country's Offer Curve International Equilibrium Economies of Scale, Imperfect Competition, and International Trade Economies of Scale and International Trade: An Overview Economies of Scale and Market Structure The Theory of Imperfect Competition Monopoly: A Brief Review Monopolistic Competition Limitations of the Monopolistic Competition Model Monopolistic Competition and Trade The Effects of Increased Market Size Gains from an Integrated Market: A Numerical Example Economies of Scale and Comparative Advantage The Significance of Intraindustry Trade Why Intraindustry Trade Matters Case Study: Intraindustry Trade in Action: The North American Auto Pact of 1964 Dumping The Economics of Dumping Case Study: Antidumping as Protectionism Reciprocal Dumping The Theory of External Economies Specialized Suppliers Labor Market Pooling Knowledge Spillovers 98 99 100 101 101 117 118 120 120 122 123 123 126 131 132 132 133 136 139 140 141 142 142 145 146 147 147 148 149 ix Contents External Economies and Increasing Returns 150 External Economies and International Trade 150 External Economies and the Pattern of Trade Trade and Welfare with External Economies Dynamic Increasing Returns 150 151 152 Box: Tinseltown Economics Summary 153 155 Appendix: Determining Marginal Revenue 158 International Factor Movements 160 International Labor Mobility 161 A One-Good Model Without Factor Mobility International Labor Movement Extending the Analysis Case Study: Wage Convergence in the Age of Mass Migration Case Study: Immigration and the U.S Economy International Borrowing and Lending Intertemporal Production Possibilities and Trade The Real Interest Rate Intertemporal Comparative Advantage Direct Foreign Investment and Multinational Firms Box: Does Capital Movement to Developing Countries Hurt Workers in High-Wage Countries? The Theory of Multinational Enterprise Multinational Firms in Practice 165 166 167 167 168 169 169 170 172 173 Case Study: Foreign Direct Investment in the United States Box: Taken for a Ride? Summary 175 177 177 Appendix: More on Intertemporal Trade 181 Part International Trade Policy 161 162 163 185 The Instruments of Trade Policy 186 Basic Tariff Analysis 186 Supply, Demand, and Trade in a Single Industry Effects of a Tariff Measuring the Amount of Protection Costs and Benefits of a Tariff 187 189 190 192 Consumer and Producer Surplus Measuring the Costs and Benefits 192 195 Other Instruments of Trade Policy 196 Export Subsidies: Theory Case Study: Europe's Common Agricultural Policy 197 198 Contents Import Quotas: Theory Case Study: An Import Quota in Practice: U.S Sugar Voluntary Export Restraints Case Study: A Voluntary Export Restraint in Practice: Japanese Autos Local Content Requirements Box: American Buses, Made in Hungary Other Trade Policy Instruments The Effects of Trade Policy: A Summary Summary 200 200 202 203 203 204 205 206 206 Appendix I: Tariff Analysis in General Equilibrium 210 A Tariff in a Small Country A Tariff in a Large Country 210 212 Appendix II: Tariffs and Import Quotas in the Presence of Monopoly The Model with Free Trade The Model with a Tariff The Model with an Import Quota Comparing a Tariff and a Quota M 214 214 215 216 216 The Political Economy of Trade Policy 218 The Case for Free Trade Free Trade and Efficiency Additional Gains from Free Trade Political Argument for Free Trade Case Study: The Gains from 1992 National Welfare Arguments Against Free Trade The Terms of Trade Argument for a Tariff The Domestic Market Failure Argument Against Free Trade How Convincing Is the Market Failure Argument? Box: Market Failures Cut Both Ways: The Case of California Income Distribution and Trade Policy Electoral Competition Collective Action Modeling the Political Process Who Gets Protected? Box: Politicians for Sale: Evidence from the 1990s International Negotiations and Trade Policy The Advantages of Negotiation International Trade Agreements: A Brief History The Uruguay Round Trade Liberalization From the GATT to the WTO Benefits and Costs Box: Settling a Dispute—and Creating One Preferential Trading Agreements 218 219 219 221 221 223 223 224 226 227 229 229 230 231 232 233 234 235 237 239 239 240 241 242 243 xi xii Contents 10 I I Box: Free Trade Area versus Customs Union Box: Do Trade Preferences Have Appeal? Case Study: Trade Diversion in South America Summary Appendix: Proving that the Optimum Tariff Is Positive Demand and Supply The Tariff and Prices The Tariff and Domestic Welfare 252 252 252 253 Trade Policy in Developing Countries 255 Import-Substituting Industrialization The Infant Industry Argument Promoting Manufacturing Through Protection Case Study: The End of Import Substitution in Chile Results of Favoring Manufacturing: Problems of Import-Substituting Industrialization Problems of the Dual Economy The Symptoms of Dualism Case Study: Economic Dualism in India Dual Labor Markets and Trade Policy Trade Policy as a Cause of Economic Dualism Export-Oriented Industrialization: The East Asian Miracle The Facts of Asian Growth Trade Policy in the HPAEs Box: China's Boom Industrial Policy in the HPAEs Other Factors in Growth Summary 256 256 258 260 Controversies in Trade Policy Sophisticated Arguments for Activist Trade Policy Technology and Externalities Imperfect Competition and Strategic Trade Policy Case Study: When the Chips Were Up Globalization and Low-Wage Labor The Anti-Globalization Movement Trade and Wages Revisited Labor Standards and Trade Negotiations Environmental and Cultural Issues The WTO and National Independence Case Study: The Shipbreakers of Alang Summary 244 245 246 247 261 263 263 264 264 267 267 268 269 270 270 271 272 276 276 277 278 282 283 284 285 287 288 288 289 290 740 Index Deflation (continued) floating rates and, 570n full employment and, 533-534 in Great Depression, 546 De Gaulle, Charles, 556n De Grauwe, Paul, 404n De Gregorio, Jose, 421 n Demand See also Aggregate demand; Intertemporal trade derived, 29 effects of changes in, 721-722 and foreign exchange market equilibrium, 522-523 money supply and, 362-366 relative prices and, 95-98 supply and long-run real exchange rate, 415-416 and supply and trade in single industry, 187-189 in trading world economy, 17-722 Demand curve consumer surplus derived from, 193/ relative, 17 Democracies, trade barriers and, Deposit insurance, 648, 649 Depreciation defined, 326 devaluation and, 497n price level adjustment and 398 rate of, 338-340 real 414 in yen, 420 Derived demand, defined, 29 Destabilizing speculation defined, 574 floating exchange rates and, 573, 574-575, 594 Deutschemark, 337/ 379/ 401/ 560 See also Exchange rate(s); Germany European currency pegged to, 589 Devaluation, 609 balance of payments crisis and, 503-504 defined, 496-497 of dollar, 560-561 effect of, 498 exchange rates and, 498-499 IMF and, 548, 551 Developing countries, 665-702 borrowing and debt of, 671-676 capital movement to, 170, 672 defined, 255 economic dualism in, 263-267 effective protection of manufacturing in, 262f excessive deficits in, 536 export-oriented industrialization in East Asia, 267-272 financial crises in, 671-702 fixed exchange rates and, 482 import-substituting industrialization in, 256-263 income inequality and, 80-81, 80f lessons from crises in, 697-702 peg to dollar by, 56In shipbreaking and, 289-290 structural features of, 668-671 trade policy in, 255-272 Diaz Alejandro, Carlos F., 68In, 682 Diminishing returns, defined, 41 Direct foreign investment, 169-176, 676 defined, 169 Discipline, floating exchange rates and, 573-574, 593-594 Disequilibrium, and floating exchange rates, 570 Disinflation, growth, crisis, recession, and (1980-2002), 584-590 Disposable income, current account and, 437 Dispute settlement, WTO and, 241-242 Dissaving, 299 Distribution of income See Income distribution Diversification See Portfolio diversification Dividends, 360n Doha Round, 238 Dollar (Canadian), 329, 331n Dollar (U.S.), 666n currency pegging to, 56In and Deutschemark, 379/ 401/ devaluation of, 560-561 exchange rate and, 343f, 369-370, 370-373 exchange rate and economic slowdown, 461-462 gold standard and, 560 as monetary standard, and rise in interest rate, 348/ value of, 329, 33In weakness in (1976-1979), 580-581 Dollar/euro exchange rate, money supply and, 370-373, 371/ 372/ Dollarization, defined, 696 Dollar shortage, 550 Domestic absorption, 3O2n Domestic capital markets, Domestic credit, 5O8n Domestic market failure, 224-226 defined, 225 Domestic market failure argument for tariff, 226 validity of, 226-228 Domestic prices, 325-327 Domestic welfare, tariffs and, 253-254 Dominguez, Kathryn M., 51 In Dooley, Michael P., 658n Dornbusch, Rudiger, 406n, 418n, 505n, 675n,685n, 686n Downs, Anthony, 229n Dual economy, 263-267 See also Economic dualism defined, 263 labor markets and trade policy in, 264-267 Duisenberg, Willem F., 615 Dumping, 142-147, 144/ antidumping as protectionism and, 145-146 defined, 142 reciprocal, 146-147 Dunis, Christian, 349n Duties, anti-dumping ("countervailing"), 145 Dynamic gains, from free trade, 219n Dynamic increasing returns, 152-155 defined, 154 East Asia, 669, 688r See also specific countries economic crisis in, 589-590, 687-692 high-performance economies in, 267-272 East Asian Miracle, The (World Bank), 689 Eastern Caribbean Currency Union (ECCU), 483 Eastern Europe, debt crisis in, 692-694 ECB See European Central Bank (ECB) ECCU See Eastern Caribbean Currency Union (ECCU) Economic and Monetary Union (EMU), 604, 612-613 defined, 612 Economic dualism, 263-267 defined, 263 in India, 264 symptoms of, 263-264 trade policy as cause of, 267 Economic growth, 722-725 disinflation, crisis, recession, and (1980-2002), 584-590 international effects of, 101-103 relative supply and, 102/ shift of RS curve and, 99-100 Economic integration, LL schedule and, 620-622 Economic policy, euro and, 613-617 Economic policy, floating exchange system and, 573, 576 Economic profits, 126n Economic stability loss, defined, 620 Economic summit meetings, 579-580 Economies categories of, 666 gains from trade and, 54-57 immigration and, 166 of Japan, 589 one-factor, 12-14 production function of, 162/ trading world economy and, 717-725 Economies of scale See also External economies comparative advantage and, 136-138 external, 122 Index from free trade, 219 internal, 122 international trade and, 120-122 market structure and, 122-123 Ricardian model and, 32 Edwards, Sebastian, 262n, 697n Effective rate of protection, defined, 192 Efficiency case for free trade, defined, 219 Efficiency loss, defined, 196 Efficient production, 709/ Eichengreen, Barry, 539n, 545n, 596n, 626-627 Elasticity of demand, price discrimination, dumping, and, I45n Elliott Kimberly Ann, 20In, 287 Embargo, on shipping, 22 Emerging markets See also Developing countries defined, 652 financial regulation and, 652 Employment See Fixed exchange rate(s); Full employment EMS See European Monetary System (EMS) EMU See Economic and monetary union (EMU) Energy prices, and 1974-1975 recessions, 577-578 Engel, Charles, 409n, 660n England (Britain) See also United Kingdom embargo against, 22 gold standard in, 544 specific factors model in, 59 Enoch, Charles, 697n Entertainment sector, exports and, 153 Environment globalization and, 288 WTO and, 242 Equalization of factor prices, defined, 78-81 Equations See Mathematical models; specific models Equilibrium, 717 See also Short-run equilibrium in automobile market, 133-136, 135/ in foreign exchange market, 341-346,522-524 interest parity and, 341-342 interest rates, expectations, and, 346-350 international, 117-119, 119/ long-run, 373 in money market and foreignexchange market, 368/ 582n in monopolistically competitive market, 129/ supply, demand, and stability of, 719-721 trading, 55/ worldwide, 189/ Equilibrium exchange rate, 344-346, 346/ Equilibrium interest rate determination of, 364/ money supply, demand, and, 362-366 Equilibrium relative wage, 29 Equity, vs debt, 640 Equity finance, 676 Equity instruments, defined, 640 ERM (revised exchange rate mechanism), 616-617 Euro, 7, 561 n See also Euro zone; Optimum currency areas currencies pegged to, 619-620 and economic policy, 613 -617 evolution of, 604-613 exchange rate and, 343/, 369-373 naming of, 616-617 reasons for adopting, 606 and rise in interest rate, 348/ zone for, 337n Eurobanks, 645 defined, 644 Eurocurrencies, defined, 644 Eurocurrency trading, growth of, 644-647 Eurodollars, 645 defined, 644 and onshore U.S interest rates, 658/ Euronyms, glossary of, 606/ Europe economic and monetary union (EMU) in, 612-613 free trade in, 141,221-223 inflation in, 562r mobility of labor force in, 626-629, 627r monetary policy in, 589 money supply and dollar/euro exchange rate in, 370-373 as optimum currency area, 625-626, 629-630,631 European Centra] Bank (ECB), 615, 616 European Commission, report on Europe's economic difficulties, 103 • European Currency Unit (ECU), 606 See also Euro European Economic Community (EEC) See Common Market European Monetary System (EMS), 56In, 597, 607-609 defined, 607 exchange rates in, 589 European Monetary Union (EMU), future of, 630-632 European single currency See Euro European System of Central Banks (ESCB), 369, 607, 615-616 European Union (EU) capital and labor migration in, 629-630 741 Common Agricultural Policy in, 198-199, 199/ euro and, 604 expansion plans of, 632 GNP and, 307 governing bodies in, 607 Maastricht Treaty and single currency in, 612-613 1992 initiative 610-612 Poland, Hungary, Czech Republic, and, 693n Single European Act and, 221 -223 Euro zone, 604, 605/ See also Euro economic policy and, 613-617 exchange rate policy for, 616 fiscal federalism and, 629 inflation in, 630/' intraindustry trade and, 627-629 Excess returns, defined, 279 Exchange control, 669 in developing countries, 699 Exchange rate(s) See also Bretton Woods agreement; Fixed exchange rate(s); Floating exchange rates; Gold standard adjustment to changes in, 498-499 asset returns and, 337-340 as automatic stabilizers, 569,592-593 capital mobility and, 699-701 central bank fixing of, 490-493 changes in, 496-497, 588/ conflict over America's monetary standard (1890s), 541-543 defined, 324 and demand for foreign currency assets, 334-341 dollar/euro, 369-370 EMS and, 607 equilibrium, 344-346 expectations of, 382 and expected return, 343/, 345/ flexible price-monetary approach and, 430-432, 431/' floating, 481,568-577 forecasting, 349 foreign exchange market and, 324-350 forward, 332 forward rates and covered interest parity 354-356 Group of management of, 586-588 impact of changes on expected returns, 342-344 inflation and, 378-384 international transactions and, 325-327 long-run, 411-421 long-run model based on PPP, 392-399 Maastricht Treaty and, 616 monetary approach to, 392 monetary policy and, 357, 483/-485r money, interest rate, and, 367-369 742 Index Exchange ra(e(s) (continued) money and price level in long run and, 373-378 money market and, 370/ money supply in short run and, 366-373 nominal, 412, 418? nominal and real effective indexes, 580.581/ between oil shocks (1973-1980), 577-582 output, asset market equilibrium, and, 445-446, 447/1 pass-through and inflation, 465-466 pegging, 623/ permanent money supply changes and, 381-383 and price levels, 388-424,401/ quotations for, 326? real dollar/yen, 420/ real exchange rate, 411-418 relative prices and, 327, 328? in short run, 433-466 spot rates, 331 sterilized intervention and, 505-511 trends and inflation differentials, 591/ U.S economic slowdown and, 461-462 of yen and dollar, 419-421 zones of, 587-588 Exchange rate determination, 6-7 Exchange rate mechanism (ERM) 607n, 612 revised (ERM 2), 616-617 Exchange rate overshooting, 383-384 defined, 383 Exchange rate regimes in developing countries, 697 financial crisis risk and, 701-702 political economy of, 541-543 Exchange rate systems, international capital market growth and, 643 Exchange rate volatility, 595n Expansion, in 1990s, 589 Expectations, interest rates, equilibrium, and, 346-350 Expected rate of return, 334 Expected returns exchange rates and, 342-344, 345/ from money, 360 Expected utility, 731/ Expected value, risk aversion and, 638 Expenditure-changing policy, 554-556 defined, 554 Expenditure-switching policy, 554-556 defined, 554 Exploitation, 24-26 Export-biased growth, defined, 101 Export credit subsidies, 205 Export demand, fall in, 571-572, 572/ Export restraint, defined, 186-187 Exports, 1, benefits from, in developing countries, 670 entertainment sector and, 153 of goods whose production is intensive in abundant factors, 76 as percentage of national income, 260? productivity and, 33/ subsidies to, Export subsidy, 197-199 credit, 205 defined, 109, 197 effects of, J10-111, 111/ 198/ EU's Common Agricultural Policy and, 198-199 foreign, 112 tariffs and, 109-113 Export supply curve, 188/ defined 187 External balance under Bretton Woods system, 550-551 defined, 533 and "four zones of economic discomfort," 553/ under gold standard, 537-538 maintaining, 553-554 optimal level of current account 534-537 policies for, 555/ rise in foreign price level and, 563/ U.S problem with, 556-557 External economies increasing returns and, 150 international trade and, 150-155 losses from trade and, 152 pattern of trade and, 150-151 specialization and, 151/ theory of, 147-150 trade and welfare with, 151-152 External economies of scale, defined, 122 Externalities, defined, 277 External prices, defined 109 Factor abundance, defined, 67 Factor content of trade between advanced countries andNIEs, 81 of U.S exports and imports (1962), 83? Factor endowment, 411 n Factor intensity, defined, 67 Factor movements, 160-161 defined, 160 extending model of, 163-164 Factor prices defined, 68 determination in specific factors model, 710-712 equalization of, 78-81 goods prices and, 69-75, 70/ 89-92 and input choices, 70/ Factor proportions model, 714-716 basic equations in, 714 factor supplies and outputs in, 715-716 goods and factor prices in, 715 Factor-proportions theory See also Heckscher-Ohlin model defined, 67 Leontief paradox and, 82 Factors of production See also Labor; Specific factors model abundance of, 67 Factor specificity See Specific factors model Factor trade, size of, 85 Falling prices, 534 Fallows, James, 27In, 282 Federal Deposit Insurance Corporation (FDIC), 648 Federal Reserve System, 313 anti-inflation policy of, 683 Eurodollar system and, 645 money supplies and, 359n, 369 Feeny, Michael, 349n Feis, Herbert, 538n Feldstein, Martin, 656 Financial account, 312-313 defined, 308 Financial crises See Developing countries; specific countries and regions Financial inflow, defined, 312 Financial institutions, nonbank, 641 Financial outflow, defined, 313 Fiscal expansion exchange rates and, 498 and IS-LM model, 474/' permanent, 458-460, 459/' Fiscal federalism, defined, 629 Fiscal policy adjustment to, 498-499 current account, protectionism, and, 585-586 defined, 450, 451-454 fixed exchange rate and, 494-497, 496/ permanent fiscal expansion and, 582-583 permanent increase in, 456-460 Stability and Growth Pact and, 631-632 temporary expansion in, 453/ Fischer, Stanley, 700n Fisher, Irving, 396n Fisher effect 396-399, 423, 534n flexible price-monetary approach and, 430-432,431/ defined, 396 Fixed exchange rate(s), 6-7, 619/ See also Bretton Woods agreement; Exchange rate(s); Floating exchange rates currency boards and, 695-697 Index foreign exchange intervention and, 481-517 foreign exchange market equilibrium under, 491-493 GG schedule and, 618-620 liquidity trap and, 499-501, 502/ LL schedule and, 620-622 money market equilibrium under, 491-492 as option, 595, 596 reasons for studying, 481-482 reserve currency, gold standards, and, 512 stabilization policies with, 494-499 Fixed parities, in Europe, 589 Flam, Harry, 61 On Flandreau, Marc, 539n Flexible price-monetary approach, Fisher effect, interest rate, and exchange rate under, 430-432, 431/ Floating exchange rates, 7, 481 See also Fixed exchange rate(s) autonomy and, 573, 576-577, 590-592 case against, 573-577 case for, 568-573 destabilizing speculation and, 573, 574-575, 594 discipline and, 573-574, 593-594 Eurodollar system and, 645-646 fall in export demand and, 572-573 fixed exchange rates and, 596 international trade and investment and, 573, 575-576, 594-595 macroeconomic interdependence under, 582-583 monetary policy autonomy and, 590-592 policy coordination and, 568-597 reform of, 596-597 stabilization through 569, 571-573, 592-593 stagflation and, 578-579 symmetry and, 592-593 uncoordinated economic policies and, 573, 576 world wide inflation and, 561-564 Flood, Robert P., 527n Food regulation, in Europe, 222 Forecasting, of exchange rates, 349 Foreign aid, 107 Foreign competition, myth of, 24 Foreign currencies, as reserves, 538n Foreign currency assets, demand for, 334-341 Foreign debt, default and, 674 Foreign direct investment, in United States, 175-176, 176/ Foreign exchange, return, risk, and liquidity in, 335-336 Foreign exchange intervention, 314 effects of, fixed exchange rates and, 481-517 money supply and, 487-488 signaling effect of, 510-511 sterilized, 488-489 Foreign exchange market, 328-334 actors in, 328-330 characteristics of, 331-332 defined, 328 efficiency of, 658-662 equilibrium in, 341-346, 491-493, 493/ 522-524 exchange rates in, 324-350 interest parity and, 659-660 Reagan and, 586 return, risk, and liquidity in, 340-341 risk premiums and, 660-661 spot rates, forward rates, and, 331-332 volatility and, 661 Foreign-exchange market, equilibrium in U.S money market and, 368/ Foreign exchange market equilibrium, under imperfect asset substitutability, 507-508 Foreign exchange option, 333 Foreign exchange swaps, 332-333 Foreign indebtedness, current account balance and, 301-304 Foreign investment See International investment; Investment Foreign ownership by France, 174 by Japan, 174 by United Kingdom, 174 by United States, 174 Foreign price level, effect on internal and external balance, 563/ Foreign prices, 325-327 Forward exchange rates, 333/ and covered interest parity, 354-356 defined, 332 Forward-falling supply curve, defined, 150 Four "tigers," 268 "Four zones of economic discomfort," external and internal balance and, 553/ France Bretton Woods and, 556n Japanese videocassette recorders and, 205 shares of foreign-owned firms in, 174f Frankel, Jeffrey A., 409n, 511 n Free competition, pricing to market and, 405-408 Free trade, 81 See also Infant industry argument and 1992 Single European Act, 221-223 case for, 218-223 domestic market failure argument against, 224-226 743 efficiency case for, 219, 220/ in Europe, 221-223 gains from 219-221 international negotiations and, 235-237 monopolist under, 215 myths about, 23-24 political argument for 221-223 Free trade area vs customs union, 244 in Europe, 141 Free trade equilibrium, for small country, 211/ Frenkel, Jacob A 40 In 418n, 511 n 525n Friberg, Richard, 412-413 Frieden, Jeffry, 542, 543 Friedman, Milton 380n Full employment 533-534 maintaining, 452-454 after money-demand increase 454/' price-level stability, and, 533-534 and world demand for domestic products, 453/ Fundamental disequilibrium fall in export demand and, 572-573 IMF and, 548, 551 Future goods, current goods and, Futures contract, 333-334 Gains from trade, 3-4 19-21 defined, 19 income distribution and, 54-57 international capital market and, 637-640 and terms of trade, 196 Garber, Peter M., 527n GATT See General Agreement on Tariffs and Trade (GATT) GATT-WTO system, 238-239 GDP See Gross domestic product (GDP) Gelb Alan, 406n Genberg Hans, 40In General Agreement on Tariffs and Trade (GATT), 7, 233-234, 237-240, 546n Mexico and, 687 General Agreement on Trade in Services (GATS), 240 General equilibrium analysis, defined, 17 Genoa Conference, 543-544 Germany See also Deutschemark Bundesbank in, 315, 3!6 Eurocurrency business and, 646 hyperinflation in, 543 money supply and international reserves in (1968-1972), 564/ recession of 1974-1975 and, 579 reunification of, 7, 589, 608 Germany EMS credibility theory and, 609-610 744 Index GG-LL model, 622-624, 625 See also GG schedule; LL schedule GG schedule, 619/ fixed exchange rate and, 618-620 and LL schedule, 622-624 Ghagwati, Jagdish, 102 Giavazzi, Francesco, 505n, 61 On, 658n Giovannini, Alberto, 42In Globalization, 283-290 anti-globalization movement and, 5, 284-285 labor standard, trade negotiations, and,287-288 trade, wages, and, 285-287 GNP See Gross national product (GNP) Goldberg, Pinelopi Koujianou, 4()()n, 4()6n Gold crisis, Bretton Woods and, 558-559 Gold exchange standard, 516-517 defined 516 Gold standard, 511 -512, 513-517 5ft' also Bretton Woods agreement benefits and drawbacks of, 515-516 defined, 511 era of, 532 external balance under, 537-538 and Great Depression, 545-546 internal balance under, 541 international economic disintegration and, 544-545 international macroeconomic policy under (1870-1914), 537-543 during interwar years (1918-1939), 543-556 origins of, 537 price of gold and, 559-560 rules of game of, 539-541 symmetric monetary adjustment under, 514-515 Gold Standard Act (1900), 542 Goldstein, Morris, 51 In Goods, relative prices of, 14 Goods prices factor prices, input choices, and, 89-92 factor prices and, 69-75 and input choices, / Government agencies, banking and, 641-643 Government budget deficit and current account surplus, 306-307 defined, 305 Government purchases defined, 299-300 GNP and, 296 Government saving, 305-307 Great Depression default during 674 gold standard and, 544, 545-546 Great Society, Bretton Woods and, 558 Greenbacks, 537 Greenpeace, Alang shipbreaking industry and, 290 Greenspan, Alan, 587 Gross domestic product (GDP) defined, 298 intra-EU trade as percent of, 626/ per capita, 256/ Grossman, Gene M., 231 n, 660n Gross national product (GNP), 295-298 in United States, 297/ Group of (G-5), exchange rate management by, 586-588 Growth See also Economic growth production possibility frontier and, 100-101 Hall, Robert E., 379n Hamburger standard See Big Mac standard Hansen, Lars Peter, 660n Harris, John, 266 Harris, Richard, 220n Hatta, Tatsuo, 107n Heckscher-Ohlin model, 67-86, 93 assumptions of, 68-69 empirical evidence on, 81-86, 84r factor prices, goods prices, and, 69-75 and international trade between twofactor economies, 75-81 resources, output, and, 72-75 Hedgers, 34In Helpman, Elhanan, 23In Henderson, Dale W., 5lOn Herbert, Bob, 26n Herin, Jan, 418n Hicks, J R., 470n High-income economies, 666 High performance Asian economies (HPAEs), 267-272, 689 factors in growth of, 268, 271-272 industrial policy in, 270-271 trade policy in, 269 High-technology industries, government support for, 277-278 High-wage nations capital movement to developing countries and, 170 trade with low-wage nations, 139n Hodrick, Robert J., 51 On, 660n Hollywood See Entertainment sector Hong Kong, 25, 268, 688 currency board in, 695 inflation in, 406-407 Horioka, Charles, 656 HPAEs See High performance Asian economies (HPAEs) Hsieh, Chang-Tai, 546n Hufbauer, Gary Clyde, 20In Hume, David, l,3,539n vs mercantilists, 540 Humpage, Owen F., 51 In, 697n Hungary buses from, 204 NATO and, 693n Hyperinflation in Argentina, 685 in Bolivia, 380 in Germany, 418n, 543 IBFs See International banking facilities (IBFs) Illiquid assets, 360n IMF See Internationa) Monetary Fund (IMF) IMF conditionality, defined, 548 Immigrants and immigration See also Labor mobility economy of U.S and, 166 Immiserizing growth, defined, 102-103 Imperfect asset substitutability, 554n defined, 507 equilibrium in foreign exchange market with, 522-524 foreign exchange market equilibrium under, 507-508 sterilized intervention and, 508-510, 509/ Imperfect capital markets defined, 257 as justification for infant industry protection, 258 Imperfect competition, 123-131 defined, 123 monopolistic competition and, 126-131 monopoly and, 123-126 strategic trade policy and, 278-282 Import-biased growth, defined, 101 Import demand curve, 188/ defined, 187 Import quota, 200-202 defined, 186 monopolist protected by, i 6, 216/ in presence of monopoly, 214-217 on U.S sugar, 200-201,201/ Import restriction, politics of, 59 Imports, 1, of agricultural products, 232 benefits from, quotas on, tariffs and composition of, 234n Import-substituting industrialization, 256-263 defined, 258 infant industry argument and, 256-258 promoting manufacturing through protection, 258-260 results of favoring manufacturing and, 261-263 Import substitution, in Chile, 260-261 Import tariffs, defined, 109 Incentive, economies of scale as, 121 Index Income of capital owners, 65/ international transfers of, 104-108 of land, 66/ prices, utility, and, 718-719 production and, 717-718 trade and distribution of, 76-78 in world economy, 665-668 Income distribution within countries, 112-113 gains from trade and, 54-57 Heckscher-Ohlin model and, 85-86 international, 111-112 labor allocation and, 46 within manufacturing sector, 65/ relative prices and, 49-50,64-66 trade and, 38-39, 76-78 trade policy and, 229-234 trade politics and, 58-60 Income distribution effects, 58 Income effects, 97, 719-720 Income gap, 666-668 Income inequality, North-South, 80-81,80/ Increasing returns dynamic, 152-155 external economies and, 150 India economic dualism in, 264 import substitution and, 259 "shipbreaking" industry in, 289-290 Indifference curves, 96-97, 730/ defined, 96 Indirect business taxes, 297-298 Individual demand for money, 359-361 Indonesia, 108, 268, 688, 691 Industrial countries, output in, 682 Industrial districts, Marshall on, 147, 149 Industrialization, import-substitution and, 256-263 Industrial policy, in HPAEs, 270-271 Industrial production, wholesale price index changes and, 547/ Infant industry argument, 256-258 defined, 154 Inflation in Argentina, 685 in Brazil, 685-686 convergence within six original EMS members, 611/ defined, 378 in EMS countries, 609-610 in European countries (1966-1972), 562/ in euro zone, 630/ exchange rate and, 378-384 exchange rate pass-through and, 465-466 exchange rate trends and differentials in, 591/ expectations of, 380 floating exchange rates and, 561-564,569,571 full employment and, 533 in Hong Kong, 406-407 in industrialized countries (1981-2000), 585/ interest parity, PPP, and, 394-395 interest rates and, 399/ in Latin America, 377, 678-681 in Mexico, 687 monetary policy effects on, 602/ in 1980s, 589 Inflation bias, 455-456 defined, 455 Input, output and, 121/ Input choices, 68 factor prices, goods prices, and, 89-92 from goods prices to, / Input possibilities, in food production, 69/ Insulation, against foreign inflation, 569-570,590-591 Integer constraint problem, 13 In Integrated market, gains from, 133-136 Intensity, defined, 67 Interbank trading, defined, 328 Interest parity, foreign exchange market efficiency and, 659-660 Interest parity condition, defined, 341-342 Interest payments, surplus and, 314-315 Interest rate, 336-337, 346-350 aggregate money demand and, 361, 363/ capital flight, money supply, and, 503/ current exchange rate and, 347 defined, 336 on dollar and Deutschemark deposits, 337/ exchange rate management and, 586-587 flexible price-monetary approach and, 430-432, 431/ in Germany, inflation, PPP and, 394-395 inflation and, 399/ money, exchange rate, and, 367-369 money demand and, 360 money supply and, 365, 366/ nominal, 423 output and, 366 real, 423 real exchange rate and, 421-423 rise in dollar rate and, 348/ rise in euro rate and, 348/ rise in real income and, 367/ Interindustry trade, 138 defined, 137 Internal balance under Bretton Woods, 552-553 defined, 533 745 and "four zones of economic discomfort," 553/ full employment, price-level stability, and, 533-534 under gold standard, 541 policies for, 555/ rise in foreign price level and 563/ Internal economies of scale, defined, 122 Internalization, defined, 172 Internal prices, defined, 109 International asset trade, 637 debt vs equity and, 640 portfolio diversification and, 639-640 risk aversion and, 638-639 International banking and international capital market, 640-647 regulating, 647-654 International banking facilities (IBFs), 646-647 Internationa! borrowing and lending, 4, 53n, 167-169 intertemporal comparative advantage and, 169 intertemporal production possibilities, trade, and, 167-168 multinational firms and, 171 real interest rate and, 168-169 International capital market, 7-8, 636-662 borrowing in, 642/ defined, 636 gains from trade and, 637-640 growth of, 643 international banking and, 637-647 performance and policy problems of, 655-662 regulating, 647-654 structure of, 641 -643 International distribution of income See Income distribution International economics, subject matter of, 3-8 International gold standard See Gold standard International investment See also Investment floating exchange rates and, 573, 575-576, 594-595 U.S position in, 319 International Ladies' Garment Worker's Union, 232 International macroeconomics See Macroeconomic policies; Macroeconomics International Monetary Fund (IMF) aid to Asia, 691 Bretton Woods system and, 546-549 convertibility and, 548-549 default crises and, 675 defined, 546 demonstrations against, 284 746 Index International Monetary Fund (IMF) (continued) elasticity estimates for trade in manufactured goods, 479/ goals and structure of, 547-548 revising charter of, 579-580 Russia and, 693 International monetary policy, International monetary system, 532-564 Bretton Woods System, International Monetary Fund, and, 546-556 external balance problem of United States and 556-557 under gold standard {1870-1914), 537-543 interwar years (1918-1939) and, 543-546 macroeconomic policy goals in open economy, 533-537 reform of, 597 reserve currencies in world system, 511-513 worldwide inflation and transition to floating rates, 561-564 International money, International negotiations advantages of, 235-237 benefits and costs of, 241-243 defined, 235 from GATT to WTO, 240-241 history of, 237-239 preferential trading agreements and, 243-247 trade liberalization and, 239-240 trade policy and, 234-247 Uruguay Round and, 239 International policy coordination See Policy coordination International reserves, in Germany, 564/ International trade, See also Exchange rate(s); Trading economy between advanced and low-wage countries, 80-81,80/ amount of, 5-6 anti-globalizution movement and, 285-287 benefits from, 38 comparative vs absolute advantage and, 32-33 consumption possibilities expanded by, 56 currency unions and, 628 distribution of income and, 76-78 economies of scale and, 120-122 effects of, 85-86 as exploitation, 24-25 external economies and, 150-155 floating exchange rates and, 573, 575-576, 594-595 gains from, 3-4, 19-21 Heckscher-Ohlin model of, 67-86 and income distribution vs change in relative goods prices, 81 without increasing returns, 137/ with increasing returns and monopolistic competition, 138/ interindustry, 137, 138 intertemporal, 167, 181-184,302 intertemporal production possibilities and,167-168 intraindustry, 137, 138-141 invisible, labor standards and, 287-288 leads and lags in, 550 and low-skilled workers in U.S., 78 monopolistic competition and, 132-141 mutual benefit from, in one-factor world, 14-23 pattern of, 4-5, 27-28, 53-54 political economy of, 57-60 potential gain from, 56-57 reasons for engaging in, 10 relative prices and, 16-19, 52/ 76 Ricardian predictions about, 31-34 in specific factors model, 50-54 in standard trade model, 97/ statistics on, and supply and trade in single industry, 187-189 two-factor economies and, 75-81 types of transactions, 638 between United States and South Korea, 84/ welfare, external economies, and, 151-152 International Trade Organization (ITO), 237,546n International transfers, 297-298 International wealth, diversification in, 621n Intertemporal budget constraint, 182 Intertemporal comparative advantage, 169 Intertemporal consumption pattern, 182/ Intertemporal production possibility frontier, 167-168, 168/ defined, 167 Intertemporal trade, 181-184, 302 consumption demand and, 475-476 defined, 167 developing country borrowing and, 672 extent of, 656 foreign production and consumption patterns, 183/ gains from, 637 international equilibrium in terms of offer curves, 184/ pattern of home country, 181/ Intra-EU trade, as percent of EU GDP, 626/ Intraindustry trade, 138, 627 defined, 137 North American Auto Pact (1964) as, 141-142 significance of, 139, 140-141 for U.S industries, 140/ Investment See also International investment defined, 299 direct foreign, 676 GNP and, 296 net foreign, 304 portfolio, 676 Investment banks, 641 Investment rates, averages by country, 657/ Irwin, Douglas, 22 Isard, Peter, 400n, 658n IS-LM model capital flight and, 504n DD-AA model and, 470-474 fiscal expansions in, 474/ short-run equilibrium in, 472/ Isocost lines, 89 Isovalue lines, 94-95 defined, 94 Ito, Takatoshi, 658n Janssens, Marc, 404n Japan, 688, 691 agricultural exports of, 232 economic crisis in, 589 foreign ownership by, 174 French purchase of videocassette recorders, 205 growth in, 268 inflation in, 589 investments in U.S by, protection in, 236 semiconductor industry in, 282-283 voluntary export restraint for autos, 203,218 yen and,419-421 J-curve, 464-465, 464/ defined, 464 Jefferson, Gary, 406n Jefferson, Thomas, 22 Johnson, Harry G., 525n Johnson, Lyndon B., expansionary policies under, 597 Jones, Ronald W., 39n Katz, Lawrence F., 40n, 627n Kenen, Peter B., 615n Kennedy, Paul, 23n Kennedy Round, 238 Keynes, John Maynard, 105, 107, 108, 557n on gold standard, 516 on "rules of the game," 540 Knetter, Michael M., 400n, 406n Knowledge spillovers, 149 defined, 147 Kochin, Lewis A., 545n Index Kravis, Irving B., 400n, 410, 595n Kreicher, Lawrence L., 658n Krone See Norway Krugman, Paul R., 272n, 404n, 406n, 500n, 527n Laban, Raul, 686n Labor changes in unit labor costs, 25? high- vs low-skilled in U.S 77-78 low-wage, 283-290 marginal product of, 163/ pauper labor argument and, 24 relative demand for, 29 Labor allocation, 41-42,45/ prices, wages, and, 44-49 Labor demand curve, manufacturing, 48/ Labor force, mobility of European, 626-629, 627/ Labor-intensive production, 68 Labor market(s) in dual economy, 264-267 in less-developed countries, 266 Labor market pooling, 148-149 defined, 147 Labor mobility, 161-166, 162-163 causes and effects of, 164/ in EU, 629-630 immigration, economy, and, 166 international labor movement and, 162-163 in one-good model, 161-162 wage convergence and, 165 Labor productivity, differences in, 33-34 Labor standards, trade negotiations and, 287-288 "Lags," in trade, 550 Laissez-faire activist policy and, 276 balance of payments and, 538 Land income of, 66/ increase in supply of 74/ Land-intensive production, 68 Land-labor ratio, 68-69, 70/ choosing optimal, 90/ for two different factor price ratios, 89 Laney, Leroy O., 505n Latin America, 590 See also specific countries crisis to reform in, 676-687 debt crises in, 678-681 default and, 673 import substitution and, 259 inflation and money-supply growth in, 377 loans to, protection in, 262r trade diversion in, 245-246 Law(s), Asian economies and, 690-69! Law of one price defined, 389 McDonald's and, 402 PPP and, 400-404 purchasing power parity and 390-391 sticky prices and, 412-413 Lawrence, Robert, 81n "Leads," in trade, 550 Learner, Edward E., 83 Learning curve, 154/ defined, 154 Leliaert, Hilde, 404n Lender of last resort (LLR), 650 defined, 649 in Italy, 651 Lending, 53n See also International borrowing and lending by IMF, 548 official, 675-676 as trade, Leontief, Wassily, 82 Leontief paradox, 82-83 defined, 82 Lessard, Donald R., 349n Less-developed countries (LDCs), 255n See also Developing countries Levich, Richard M., 349n Lewis, Karen, 660n Lindbeck, Assar, 418n Lindert, Peter H., 675n Lipsey, Robert E., 400n, 595n Liquidity, 336, 361 defined, 335 fixed exchange rate and, 499-501 502/ in foreign exchange market, 340-341 money demand and, 361 Liquidity trap, low-output, 501/ LLR See Lender of last resort (LLR) LL schedule, 620-622, 623/ and GG schedule, 622-624 Loans, as transfers of income, 104-105 Local content requirement, 203-205 Location, defined, 172 Long run defined, 367 exchange rate model based on PPP, 392-399 money and exchange rate in, 376-378 money supply changes in, 374-375 PPP in, 408-409 price flexibility in, 378-380 price levels and exchange rate in, 388-424 Long-run equilibrium, defined, 373 Long-run equilibrium price level, 373 Long-run exchange rates, model of, 411-421 Long-run neutrality of money, 374n Long Term Capital Management (LTCM), collapse of, 653-654 747 Losses consumption distortion 196 efficiency, 196 from non-trade, 22 production distortion 196 Louvre accord (1987), 587 exchange rate changes since, 588/ Lower middle-income economies, 666 Low-income economies, 666 Low-wage labor, globalization and, 283-290 Low-wage nations, trade with highwage nations, 139n LTCM See Long Term Capital Management (LTCM) Lustig, Nora, 686n Ml, 359 M2, 359n M3, 359n Maastricht Treaty, 612-613 See also Euro; Euro Zone convergence criteria and stability and growth pact, 613-615 defined, 612 MacDougall, G.D.A., 32 Macroeconomic effects, of monetary and fiscal policies 45 In Macroeconomic policies current account and, 460-463,463/ and floating exchange rates, 568-597 international coordination of in open economy 532 U.S macroeconomic data (1964-1972) and, 559/ Macroeconomics, 294-295 defined, 294 money, price level, and, 294-295 saving and, 294-295 trade imbalances and, 294-295 unemployment and 294-295 Magee, Christopher, 233 Malaysia, 108,268,688,691 Managed floating exchange rates, defined, 481 Managed trade, free trade and, 219-220 Manufactures, North-South trade in 86 Manufacturing effective protection in developing countries, 262/ promoting through protection, 258-260 results of favoring through importsubstituting industrialization, 261-263 rural-urban migration and, 266 Manufacturing labor demand curve 48/ Maquiladoras, 285 Marginal cost, 125-126 vs average cost, 126/ defined, 125 Marginal product, specific factors and, 63-66 748 Index Marginal product curve, equal output and, 64/ Marginal product of labor, 40-44, 161, 163/ defined, 40 Marginal propensity to spend, defined, 106 Marginal revenue defined 123 determining, 158-159 monopoly and, 123-124 price and, 124-125 Marginal social benefit, defined, 225 Marginal utility, 728-729 Mark, Nelson C , 661 Market(s) See also International capital market emerging, 652 Market equilibrium monopolistic equilibrium and, 128-131 output, in short run, 440-445 Market failure(s), infant industry protection and, 257, 258 Market failure argument See also Domestic market failure argument California and, 227 Market integration in EU 611 gains from, 136/ Market shocks, capital and labor migration and, 629-630 Market size, monopolistic competition, trade, and, 132-133, 133/ Market structure, economies of scale and,122-123 Marshall, Alfred, 147, 149, 153 Marshall-Lemer condition, 436n and empirical estimates of trade elasticities, 477-480 Marshall Plan, 550 Marston, Richard C , 40tn, 420-421, 660n Maskus, Keith E., 82n Mass migration See Labor mobility Mastropasqua, Cristina, 505n Mathematical models factor proportions model, 714-716 monopolistic competition model, 726-727 risk aversion and international portfolio diversification, 728-735 specific factors model, 708-713 trading world economy and, 717-725 McCormick, Frank, 355n McDonald's, law of one price and, 402 Mclntire, Jean M., 697n McKinley, William, 542 McKinnon, Ronald, 500n, 592, 597n Median voter, defined, 229 Medium of exchange, money as, 35S Meese, Richard A., 661 Meltzer, Allan H.,409n Mendoza, Enrique G., 421 n Menem, Carlos, 684 Mercantilists, Hume and, 540 Mercosur, 246-247 Metzler, Lloyd, 112 Metzler paradox, 191n defined, 112-113 Mexico See also North American Free Trade Agreement (NAFTA) balance of payments crisis in, 506 debt crisis in, 683, 685, 686-687, 696 NAFTA and, real wages in, 285-287, 285t, 285/ trade with United States, 139n U.S auto firms in, 205 MFN See Most favored nation (MFN) Micossi, Stefano, 505n Microeconomics, defined, 294 Middle East, oil revenues from, 7-8 Migration See also Labor mobility as trade, Miller, Marcus H., 505n, 597n Misalignments, 595 Mishkin, Frederic S., 359n, 487n Mobile factor, defined, 39 Mobility See Labor mobility; Migration Monetary analysis, of Hume, Monetary approach to balance of payments, 525-526 Monetary approach to exchange rate defined, 392 PPP and, 392-394 Monetary efficiency gain, defined, 618 Monetary growth and price-level change, 376/ in United States, 589 Monetary issues, trade and, Monetary policy, See also Exchange rate(s); Floating exchange rates autonomy of, 568-570, 590-592 defined, 450 effects on inflation and unemployment, 602/ exchange rates and, 483/-485f in 1980s, 589 payoff matrix for moves in, 603/ permanent monetary expansion and, 582 permanent shift in, 456-460 stabilization policies and, 494-495 temporary changes in, 450-451 Monetary system See International monetary system Monetary theories, of nominal exchange rates, 418n Money See also Money supply aggregate demand and, 361-362 demand for, 360-361 and exchange rate in long run, 376-378 individual demand for, 359-361 interest rate, exchange rate, and, 367-369 interest rates and, 360 liquidity of, 361 long-run neutrality of, 374n as medium of exchange, 358 money prices and, 373-374 price level and, 295 price level and exchange in long run, 373-378 as store of value, 358-359 as unit of account, 358 Money market effects on long-run nominal dollar/euro exchange rate, 418/ equilibrium in, 362-365, 582n exchange rate and, 370/ Money market equilibrium under fixed exchange rate, 491-492 in United States, 373n Money prices, money and, 373-374 Money supply See also Money balance of payments and, 489-490 in Bolivia, 380 capital flight, interest rate, and, 503/ central bank and, 482-490 central bank balance sheet and, 486-487 defined, 359 determining, 359 dollar/euro exchange rate and, 369-370, 370-373 economic variables after increase in growth rate of, 397/ effect of increase on interest rate, 366/371/372/ empirical evidence on, 375-376 equilibrium interest rate and, 362-366 and exchange rate in short run, 366-373 expected returns and, 360 foreign exchange intervention and, 487-488 in Germany, 564/ inflation and growth in Latin America, 377 long-run effects of changes in, 374-375 permanent changes and exchange rate, 381-383 permanent increase in, 456-460, 457/ 458/ shift in relative growth rates of, 417 shift in reiative levels of, 416-417 temporary changes in, 452/ time paths of variables after permanent increase in, 384/" Money supply interest rates and, 365 Monopolistic competition, 126-131 defined, 126-127 equilibrium and, 129/ limitations of, 131 market size and, 132-136 Index model, 127-128,726-727 trade and, 132-141 Monopoly 123-126 dumping and, 143 under free trade, 215 protected by import quota, 216, 216/ protected by tariff, 215/ pure, 123 tariffs and import quotas in presence of, 214-217 Morales, Juan-Antonio, 381 Moral hazard, 679 defined, 654 Morton, Peter J., 675n Most favored nation (MFN), 243 Multi-Fiber Arrangement, 203, 232, 239 Multigood model comparative advantage with, 26-29 relative wage in, 28-29 Multinational firms Daimler-Chrysler and, 177 defined, 171 direct foreign investment and, 169-176 in practice, 173-175 shares of foreign-owned firms, 174r theory of, 172-173 Mundell, Robert A., 470n, 516n, 618n Mundell-Fleming model, 470n Mussa, Michael, 409n Mutual benefit, from trade, Myhrman, Johann, 418n NAFTA See North American Free Trade Agreement (NAFTA) National income, 296-297 aggregate money demand and, 361 defined, 296 exports and imports as percentages of U.S., National income accounting, balance of payments accounts and, 307-319 components of, 294-295 defined, 295, 300 GNP and, 296 for open economy, 299-307, 301 r National income identity, for open economy, 300 National output accounts, GNP and, 296 National procurement, 205 National product, national income and, 296-297 National saving See also Saving defined, 303-304 National welfare, arguments against free trade and, 223-228 Natural resources, in developing countries, 670 Net foreign investment, 304 Net national product (NNP), 298 Newly industrializing economies (NIEs) capital movement, workers, and, 170 impact of growth on advanced nations, 103-104 income inequality and, 80-81, 80/ "1992" (Single European Act), 610-612 free trade and, 221-223 Nixon, Richard M., 560, 561 NNP See Net national product (NNP) Nominal and real effective exchange rate indexes, 581/ defined, 580 Nominal exchange rates defined, 412 in long-run equilibrium, 416-418 monetary theories of, 418n Nominal interest rates, 337n defined, 423 Nonbank financial institutions, 641 foreign exchange and, 330 international activities of, 652-653 Nontariff barriers, defined, 186 Nontradables relative price of, 422/ trade barriers and, 404-405 Non-trade, losses from, 22 Nontraded goods defined, 31 transport costs and, 30-31 North American Auto Pact (1964), 141-142 North American Free Trade Agreement (NAFTA), 5, 233-234, 244 California and, 227 maquiladoras and, 285 North Atlantic Treaty Organization (NATO), Poland, Hungary, Czech Republic, and, 693n North-South trade growth in manufactures, 86 income inequality and, 80-8lr Norway, euro and, 618-622 Obstfeld, Maurice, 40In, 505n, 51 In, 527n, 596n, 615n, 627n, 658n, 660n O'Connell, Paul G J., 409n Offer curves, 117-119, 117/ 118/ 119/ Official foreign exchange intervention, defined, 314 Official international reserves, defined, 313-314 Official settlements balance defined, 316 of United States (2000), 317 Offshore banking, 643-644 defined, 643 onshore differentials with, 657-658 Offshore currency trading, 643-644 defined, 644 Ohlin, Bertil, 105, 106, 107 Ohno, Kenichi, 500n 749 Oil exports, 224 Oil shocks exchange rates between (1973-1980) 577-582 first (1973-1975) 577-579 second (1979-1980), 581-582 Oligopoly, defined 126 Olson, Mancur, 230 One-factor economy, 12-14 trade in, 14-23 One-factor model See also Ricardian model specific factors model and, 59 One-good model, without factor mobility, 161-162 Onshore-offshore interest differentials, 657-658 OPEC See Organization of Petroleum Exporting Countries (OPEC) Open economy imaginary, 300-301 IS-LM model and, 470n macroeconomic policy goals in, 533-537 macroeconomic policy in, 532 national income accounting for, 299-307,301/ policy trilemma for, 700/ short-run equilibrium for, 448-450, 449/ Opportunity cost, 360 defined, 11 production possibility frontier and, 13 Optimal portfolio analytical derivation of, 728-729 diagrammatic derivation of, 729-730 Optimal trade policy, 57-58 Optimum currency areas, 617-629 See also GG-LL model defined, 618 Europe as, 625-626, 629-630, 631 fiscal federalism and, 629 intraindustry trade and, 627-629 Optimum tariff, 224/ defined, 223-224 proving positive nature of 252-254 Options, 333-334 Orderly marketing agreements (OMAs), 203 Organization of Petroleum Exporting Countries (OPEC) 577 579 Output aggregate demand and, 439/ in Argentina vs industrial countries, 682 change in, 476/ and currency depreciation with fixed output prices, 441/ exchange rate, asset market equilibrium, and, 445-446, 447/' input and, 121/ interest rate and, 366 per capita 668/ 7S0 Index Output (continued) real output growth in Russia and Poland 693/ relative prices and, 95/' resources and, 72-75 in short run, 433-466, 440/ Output demand, shift in relative, 417 Output market, effects of changes on long-run nominal dollar/euro exchange rate, 418r Output market equilibrium, in short run, 440-445 Output market variability, increase in, 624/' Output prices, real exchange rate and, 477n Output supply, shift in relative, 417 Overemployment, 533 Pagano, Marco, 61 On, 658n Paired transactions, 309-310 Paraguay, Mercosur and, 246-247 Parity fixed, 589 under IMF, 548 Partial equilibrium analysis, defined, 16-17 Pass-through defined, 465 exchange rate, 465-466 Patterns of trade, 4-5 external economies and, 150-151 Heckscher-Ohlin model and, 85-86 relative prices and, 76 Pauper labor argument, 24 Peebles, Gavin, 406n Pegged exchange rates, 56In, 589, 619-620, 623/ See also Currency crawling peg as, 678 Per-capita income, corruption and, 671/ Per capita output, 668/ Perfect asset substitutability defined, 507 and sterilized intervention, 505-507 Peri, Giovanni, 627n Peron, Juan, Argentina's economy and, 682 Plaza meeting (1985), 586-587 Poland NATO and, 693n real output growth in, 693/ Policy coordination, failures in, 601-603 floating exchange rates and, 595-596 Political argument for free trade, 221-223 Political competition, 229-230, 230/ Political economy of trade, 57-60, 218-247 case for free trade and, 218-223 income distribution and, 229-234 international negotiations and, 234-247 national welfare arguments against free trade, 223-228 Politics America's monetary standard in 1890s and, 541-543 campaign contributions and trade policy, 233 of trade, 58-59 Pooling, labor market, 147, 148-149 Portfolio diversification defined, 639 extent of, 655-656 and international asset trade, 639-640 nondiversified portfolios and, 732/ risk aversion and, 638-639, 728-735 Portfolio investment, in ownership of firms, 675-676 PPP See Purchasing power parity (PPP) Preferential trading agreements, 243-247 defined, 243 Price(s) change in relative, 47-49 distribution of income and relative prices, 49-50 domestic and foreign, 325-327 equal proportionate change in, 46-47, 47/' external, 109 in factor proportions model, 715 of factors, 708-712 flexibility in long run, 378-380 income, utility, and, 718-719 internal, 109 marginal revenue and, 124-125 relative, 14, 64-66 rigidity in short run, 378-380 rise in, 48/ 92/ tariff effects on, 253/ wages, labor allocation, and, 44-49 Price discrimination conditions for, 145n defined, 142 Price level aggregate money demand and, 361 defined, 361 empirical evidence on, 375-376 and exchange rate in long run, 388-424 international measurement differences, 408 monetary growth and, 376/ money and, 295 money and exchange in long run, 373-378 in poorer countries, 409-411 real incomes and, 410/ Price-level stability, 533-534 Price setter, 123 Price-specie-flow mechanism, defined, 538-539 Price taker, firms as, 123 Pricing to market, defined, 406 Prisoner's dilemma, defined, 236 Private capital inflows, 679-681 movements in developing countries, 699-700 Private saving, defined, 305 Privatization in Africa, 677/ defined, 676 Procurement government, 240 national, 205 Producer surplus, 193-194 defined, 193 Product differentiation, 126-127 Production hypothetical changes in, 51/ income and, 717-718 intertemporal foreign patterns, 183 opportunity cost and, 11 in specific factors model, 46/ in standard trade model, 97/ Production distortion loss, defined, 196 Production function, 162/ defined, 39 for manufactures, / Production possibilities 40-44 biased expansion of, 74-75 in Heckscher-Ohlin model, 93 relative supply and, 94-95 resources and, 73-74, 75/ in Ricardian model, 93 in specific factors model, 93 trade and, 167-168 Production possibility curve, production on, 95n Production possibility frontier, 13/ If defined, 12-13 41 growth and, 100-101 intertemporal, 168/ in specific factors model, 43/ Productivity in Asia, 689-690 competition and, 23-24 exports and, 33/' in Japan, 420-421 reflected in wage, 25 Profits, economic vs accounting definition of, 126n Prohibitive tariff, 216n Protection choice of industries for, 232-234 cost as percentage of national income, 220/ effective rate of, 192 effects in United States, 233r free trade and, 219 promoting manufacturing through, 258-260 rates in Asia, 269/ from tariffs, 190-192 Index Protectionism, See also Tariff(s); Trade barriers anti-dumping as, 145-146 fiscal policies, current account, and, 585-586 "Pseudoinfant industry," 257 "Pseudo-intraindustry" trade, 139n Public good, politics as, 230-231 Purchasing power parity (PPP), 391-392 absolute and relative, 391-392 defined, 388 income gap and, 666n inflation, interest parity, and, 394-395 and insulation against foreign inflation, 570 international differences in price level measurement, 408 law of one price and, 390-391, 400-404 long-run exchange rate model and, 392-399,411-421 McDonald's, law of one price, and, 402 and price levels in poorer countries, 409-411 problems with, 411 in short and long run, 408-409 Pure monopoly, defined, 123 Put option, 334 Quota rent, defined, 200 Quotas(s) import, 6, 186,200-202 tariffs and, 214-217,217/ Rambouillet decisions, 579-580 R and D See Research and development