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Type:

Solution Manual

Resource:

International Economics

Edition:

10th Edition

Author(s):

Paul R. Krugman Maurice Obstfeld Marc Melitz

INSTRUCTOR’S MANUAL to accompany

International Economics Tenth Edition

Dominick Salvatore Fordham University

Instructor’s Manual to accompany International Economics, 10 th Edition

CONTENTS Preface Chapter 1: Introduction

v 1-1

PART ONE: INTERNATIONAL TRADE THEORY Chapter 2: The Law of Comparative Advantage

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Chapter 3: The Standard Theory of International Trade

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Chapter 4: Demand and Supply, Offer Curves, and the Terms of Trade

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Chapter 5: Factor Endowments and the Heckscher-Ohlin Theory

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Chapter 6: Economies of Scale, Imperfect Competition, and International Trade

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Chapter 7: Economic Growth and International Trade

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PART TWO: INTERNATIONAL TRADE POLICY Chapter 8: Trade Restrictions: Tariffs

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Chapter 9: Nontariff Trade Barriers and the New Protectionism

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Chapter 10: Economic Integration: Customs Unions and Free Trade Areas

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Chapter 11: International Trade and Economic Development

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Chapter 12: International Resource Movements and Multinational Corporations

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PART THREE: THE BALANCE OF PAYMENTS, FOREIGN EXCHANGE MARKETS, AND EXCHANGE RATES Chapter 13: The Balance of Payments

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Chapter 14: Foreign Exchange Markets and Exchange Rates

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Chapter 14: Exchange Rate Determination

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Instructor’s Manual to accompany International Economics, 10 th Edition

PART FOUR:OPEN ECONOMY MACROECONOMICS AND THE INTERNATIONAL MONETARY SYSTEM Chapter 16: The Price Adjustment Mechanisms with Flexible and Fixed Exchange Rates

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Chapter 17: The Income Adjustment Mechanism and Synthesis of Automatic Adjustments

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Chapter 18: Open Economy Macroeconomics: Adjustment Policies

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Chapter 19: Prices and output in an Open Economy: Aggregate Demand and Aggregate Supply

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Chapter 20: Flexible versus Fixed Exchange Rates, The European Monetary System, and Macroeconomic Policy Coordination

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Chapter 21: The International Monetary System: Past and Present

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Instructor’s Manual to accompany International Economics, 10 th Edition

PREFACE Purpose of this Manual The purpose of this manual is to facilitate the use of the text by the Instructor. It contains the detailed outline of each chapter, lecture guides with suggestions on how best to present the material in each chapter, and suggested answers to the end-of-chapter problems. Course Outlines The text includes more material than can be covered in a one-semester undergraduate course in international economics, thus providing the Instructor with a great deal of flexibility as to what to include. The core chapters for a one-semester undergraduate course in international economics are: Chapters 1-6, 8-9, 13-18, 21. I would cover each of these 15 chapters in one week (except for doubling up in one week) of the semester. I would skip the appendices, or make some of them optional. I would give the midterm after Chapter 9 and the final on all chapters covered at the end of the semester. Some Instructors, of course, may want to follow a different format. In an undergraduate course in international trade, I would cover Chapters 1-12, and 21. In a one-semester undergraduate course in international finance, I would cover Chapters 1, 13-21. In a graduate course in International Trade in the MA, MBA, International Affairs, and International Political Economy, I would cover Chapters 1-12, and 21. I would also cover all the appendices and assign readings from the selected bibliography at the end of each chapter. In a graduate course in International Finance in the MA, MBA, International Affairs, and International Political Economy, I would cover Chapters 1 and 13-21. I would also cover all the appendices and assign readings from the selected bibliography. In a graduate course in International Economics, I would cover all 21 chapters, with or without the appendices and other readings from the selected bibliography.

Instructor’s Manual to accompany International Economics, 10 th Edition

Content of this Manual The lecture guide given in this manual is specifically designed for a one-semester undergraduate course in international economics. The questions for review at the end of each chapter involve only recall of what is clearly explained in the text. Their function is simply to emphasize those concepts and theories that the student needs to learn and remember. I would encourage the student to go over them on his own and check his answers in the text. I would assign the problems at the end of each chapter. These are challenging but not tricky or very time consuming. They are intended to enlist the active participation of students so as to make international economics truly come alive. The multiple-choice questions found in the accompanying Test Bank can be used for quizzes or to be part of the midterm and final examinations. There are also additional essays and problems with answers that can be used for class exams. The Instructor who feels that more questions and problems would be useful can consult my small and popular paperback Theory and Problems of International Economics (4th ed., 1996) in the Schaum's Outline Series, which includes a wealth of additional multiple-choice questions and solved problems and to the Study Guide prepared for this text by Professor Arthur Raymond of Muhlenberg College. A Personal Note to You, the Instructor I welcome any comment, suggestion, or opinion that you may have on the use of the text. You can correspond by e-mail directly with me or through John Wiley, and I will personally acknowledge your letter and comment on your suggestions. I will, of course, consider your comments for the next Edition of the text and would gratefully acknowledge any such contribution.

Dominick Salvatore salvatore@fordham.edu

Dominick Salvatore’s International Economics – 10th Edition

Instructor’s Manual

CHAPTER 1: INTRODUCTION *(Core Chapter) OUTLINE 1.1 Importance of International Economics Case Study 1-1: The Dell and Other PCs Sold in the United States Are All But American Case Study 1-2: What Is an "American" Car? 1.2 International Trade and the Nation's Standard of Living Case Study 1-3: Rising Importance of International Trade to the United States 1.3 The Major U.S. Trade Partners: The Gravity Model 1.4 The Subject Matter of International Economics 1.5 Purpose of International Economic Theories and Policies 1.6 Current International Economic Challenges 1.7 The Globalization Challenge 1.8 Organization and Methodology of the Book Appendix:

A1.1 Basic International Trade Data A1.2 Sources of Additional International Data and Information

KEY TERMS Interdependence Gravity model International trade theory International trade policy New protectionism Foreign exchange markets Balance of payments

Adjustment in the balance of payments Microeconomics Macroeconomics Open economy macroeconomics International finance Globalization Anti-globalization movement

LECTURE GUIDE As the first chapter of the book, the general aim here is simply to define the field of study of international economics and its importance in today's interdependent world.

(IM_c01_Introduction)

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The material in this chapter can be covered in two classes. I would utilize one class to cover Sections 1 to 4 and the second class to cover Sections 5 to 8. I would spend most of the second class on Section 6 on the major current international economic challenges facing the United States and the world today and to show how international economics can suggest ways to solve them. This should greatly enhance students' motivation.

SUGGESTED ANSWERS TO PROBLEMS 1. Go through your daily newspaper and identify: (a) Seven or eight news items of an international economic character; (b) the importance or effect of each of these problems on the United States economy; (c) the importance of each of these news items to you personally. a) International economic problems reported in our daily newspapers are likely to include: • trade controversies between the United States, Europe, Japan, and China; • great volatility of exchange rates; • Increasing international competition from China and fear of job losses in the United States and other advanced countries. • structural unemployment and slow growth in Europe, and stagnation in Japan; • financial crises in emerging market economies; • restructuring problems of transition economies; • deep poverty in many developing nations in the world. b) Can result in trade restrictions or even a trade war, which reduce the volume and the gains from trade; • discourage foreign trade and investments, and thus reduce the benefits from trade; • Can result in trade restrictions or even a trade war, which reduce the volume and the gains from trade; • reduces European and Japanese imports and the volume and the benefits from trade; • financial crises in emerging market economies could spread to the United States; • can lead to political instability, which will adversely affect the United States; • can lead to political instability in these countries - which also adversely affect the United States. c) Can result in your paying higher prices for imported products; • lead to great fluctuations in the price of imported products and cost of foreign travel; • Can lead higher prices for imported products and increases the chances that you will have to change jobs; • can lead you to support demands for trade protection in the United States; • can reduce the value of your investments (such as a stocks) in the United States; • can lead to your paying higher taxes for the United States to respond to these threats; • can result in your paying higher taxes to help these nations.

(IM_c01_Introduction)

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2. This question will involve you in measuring the economic interdependence of some nations. (a) Identify any five industrial nations not shown in Figure 1.1. (b) Go to your school library and find the latest edition of International Financial Statistics and construct a table showing the degree of economic interdependence for the nations you have chosen. Is the economic inter-dependence of the smaller nations in each group greater than that of the larger nations? a) Five industrial nations not mentioned are: Italy, France, Canada, Austria, and Ireland. b) See Table 1A. Table 1A Economic Interdependence as Measured by Imports and Exports as a Percentage of GDP, 2004 Nation Italy France Canada Austria Ireland

Imports as % of GDP 25.8 25.7 34 46.1 63.7

Exports as % of GDP 26.6 25.9 38.2 51 79

*Source: International Financial Statistics (Washington, D.C., IMF, March 2006).

Smaller nations, such as Ireland and Austria, are more interdependent than the larger ones. Note that interdependence was measured by the percentage of the value of imports and exports (line 98c and 90c, respectively in IFS) to GDP (line 99b). 3. Do the same as for Problem 2 for any five developing countries not shown in Figure 1.1. a) Five developing nations not mentioned in the text are: Brazil, Pakistan, Colombia, Nepal, and Tunisia. b) See Table 1B. Table 1B Economic Interdependence as Measured by Imports and Exports as a Percentage of GDP, 2004 Imports as % of GDP Exports as % of GDP Nation Brazil Pakistan Columbia Nepal Tunisia

13.4

16.7

20.7

19.4

31.7

17.3

49.6

46.7

*Source: International Financial Statistics (Washington, D.C., IMF, March 2006).

(IM_c01_Introduction)

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In general, the smaller the nation, the greater is its economic interdependence. Note that interdependence was measured by the percentage of the value of imports and exports (line 98c and 90c, respectively in IFS) to GDP (line 99b). 4. Does the trade between the United States and Brazil and Argentina follow the predication of the gravity model? Trade between the United States and Brazil is much larger than trade between the United States and Argentina. Since Brazil is larger and closer than Argentina, this trade does follow the predictions of the gravity model. 5. Take your principles of economics text (even if you have already had intermediate theory) and from the table of contents: (a) identify the topics presented in the microeconomics parts of the text; (b) compare the contents of the micro-economic parts of your principles text with the contents of Part One and Part Two of this text. (c) identify the topics presented in the macroeconomics parts of the text; (d) compare the contents of the macro-economics parts of your principles text with the contents of Part Three and Part Four of this text. a) Mankiw’s Economics (4th., 2007) includes the following microeconomics topics: • The market forces of demand and supply; • elasticity and its application; • the theory of consumer choice; • consumers, producers, and the efficiency of markets; • the costs of production; • firms in competitive markets; • monopoly; • oligopoly; • monopolistic competition; • markets for the factors of production; • the demand for resources; b) Just as the microeconomics parts of your principles text deal with individual consumers and firms, and with the price of individual commodities and factors of production, so do Parts One and Two of this text deal with production and consumption of individual nations with nations with and without trade, and with the relative price of individual commodities and factors of production. c) Mankiw’s Economics (4th. 2007) includes the following microeconomics topics: measuring a nation’s income and the cost of living; • production and growth; • savings investment and the financial system; • unemployment and its natural rate; • the monetary system, growth and inflation;

(IM_c01_Introduction)

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Dominick Salvatore’s International Economics – 10th Edition

• • • • • • •

Instructor’s Manual

money growth and inflation; open-economy macroeconomics: basic concepts; a macroeconomic theory of the open economy; aggregate demand and aggregate supply; the influence of monetary and fiscal policy on aggregate demand; the short-run tradeoff between inflation and unemployment five debates over macroeconomic policy.

d) Just as the macroeconomics parts of your principles text deal with the aggregate level of savings, consumption, investment, and national income, the general price level, and monetary and fiscal policies, so do Parts Three and Four of this text deal with the aggregate amount of imports, exports, the total international flow of resources, and the policies to affect these broad aggregates. *6. (a) What does consumer demand theory predict will happen to the quantity demanded of a commodity if its price rises (for example, as a result of a tax) while everything else is held constant? (b) What do you predict would happen to the quantity of imports of a commodity if its price to domestic consumers rose (for example, as a result of a tax on imports)? a) Consumer demand theory predicts than when the price of a commodity rises (cet. par.), the quantity demanded of the commodity declines. b) When the price of imports rises to domestic consumers, the quantity demanded of exports can be expected to decline (if everything else remains constant). *7. (a) How can a government eliminate or reduce a budget deficit? (b) How can a nation eliminate or reduce a balance-of-payments deficit? a) A government can reduce a budget deficit by reducing government expenditures and/or increasing taxes. b) A nation can reduce or eliminate a balance of payments deficit by taxing imports and/or subsidizing exports, by borrowing more abroad or lending less to other nations, as well as by reducing the level of its national income. 8. (a) How do international economic relations differ from interregional economic relations? (b) In what way are they similar? a) Nations usually impose restrictions on the free international flow of goods, services, and factors. Differences in language, customs, and laws also hamper these international flows. In addition, international flows may involve receipts and payments in different currencies, which may change in value in relation to one another through time. This is to be contrasted with the interregional flow of goods, services, and factors, which face no such restrictions as tariffs and are conducted in terms of the same currency, usually in the same language, and under basically the same set of customs and laws.

(IM_c01_Introduction)

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b) Both international and interregional economic relations involve the overcoming of space or distance. Indeed, they both arise from the problems created by distance. This distinguishes them from the rest of economics, which abstracts from space and treats the economy as a single point in space, in which production, exchange, and consumption take place. 9. How can we deduce that nations benefit from voluntarily engaging in international trade? We can deduce that nations benefit from voluntarily engaging in international trade because if they did not gain or if they lost they could avoid those losses by simply refusing to trade. Disagreement usually arises regarding the relative distribution of the gains from specialization in production and trade, but this does not mean that each nation does not gain from trade. *10. If nations gain from international trade, why do you think most of them impose some restrictions on the free flow of international trade? International trade results in lower prices for consumers but harms domestic producers of products, which compete with imports. Often those domestic producers that stand to lose a great deal from imports band together to pressure the government to restrict imports. Since consumers are many and unorganized and each individually stands to lose only very little from the import restrictions, governments often give in to the demands of producers and impose some import restrictions. These topics are discussed in detail in Chapter 9. 11. Can you think of some ways by which a nation can gain at the expense of other nations from trade restrictions? A nation can subsidize exports of the commodity to other nations until it drives the competing nation's industry out of business, after which it can raise its price and benefit from its newly acquired monopoly power. Some economists and politicians in the United States have accused Japan of doing just that (i.e., of engaging in strategic trade and industrial policy at the expense of U.S. industries), but this is a very complex and controversial aspect of trade policy and will be examined in detail in Chapter 9. 12. When the value of the U.S. dollar falls in relation to the currencies of other nations, what do you think will happen to the quantity of U.S. (a) imports? (b) exports? a) When the value of the U.S. dollar falls in relation to the currencies of other nations, imports become more expensive for Americans and so they would purchase a smaller quantity of imports. b) When the value of the U.S. dollar falls in relation to the currencies of other nations, U.S. exports become cheaper for foreigners and so they would purchase a greater quantity of U.S. exports.

(IM_c01_Introduction)

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Dominick Salvatore’s International Economics – 10th Edition

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* = Answer provided at www.wiley.com/college/salvatore.

(IM_c01_Introduction)

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Dominick Salvatore’s International Economics – 10th Edition

Instructor’s Manual

CHAPTER 2: THE LAW OF COMPARATIVE ADVANTAGE *(Core Chapter) OUTLINE 2.1 Introduction 2.2 The Mercantilists' Views on Trade Case Study 2-1: Munn's Mercantilistic Views on Trade Case Study 2-2: Mercantilism Is Alive and Well in the Twenty-first Century 2.3 Trade Based on Absolute Advantage: Adam Smith 2.3a Absolute Advantage 2.3b Illustration of Absolute Advantage 2.4 Trade Based on Comparative Advantage: David Ricardo 2.4a The Law of Comparative Advantage 2.4b The Gains from Trade 2.4c Exception to the Law of Comparative Advantage 2.4d Comparative Advantage with Money Case Study 2-3: The Petition of the Candlemaker 2.5 Comparative Advantage with Opportunity Costs 2.5a Comparative Advantage and the Labor Theory of Value 2.5b The Opportunity Cost Theory 2.5c The Production Possibility Frontier Under Constant Costs 2.5d Opportunity Costs and Relative Commodity Prices 2.6 The Basis and the Gains from Trade Under Constant Costs 2.6a Illustration of the Gains from Trade 2.6b Relative Commodity Prices with Trade 2.7 Empirical Tests of the Ricardian Model Case Study 2-4: Relative Unit Labor Costs and Relative Exports – United States and Japan Appendix:

A2.1 Comparative Advantage with More than Two Commodities A2.2 Comparative Advantage with More than Two Nations

KEY TERMS Basis for trade Gains from trade Pattern of trade

(IM_c02_The Law of Comparative Advantage)

Labor theory of value Opportunity cost theory Production possibility frontier

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Instructor’s Manual

Mercantilism Absolute advantage Laissez-faire Law of comparative advantage

Constant opportunity cost Relative commodity prices Complete specialization Small country case

LECTURE GUIDE 1.

This is a long and crucial core chapter and may require four classes to cover adequately. In the first lecture, I would present Sections 1, 2, and 3. These are short sections and set the stage for the crucial law of comparative advantage.

In the second lecture of Chapter 2, I would concentrate on Section 4 and carefully explain the law of comparative advantage using simple numerical examples as in the text. The crucial parts here are 4b (which explains the law) and 4d (which establishes the link between trade theory and international finance). I find that presenting the numerical explanations before the graphical analysis really helps the student to truly understand the law. The simple lawyer-secretary example should also render the law more immediately relevant to the student. I would also assign Problems 1-6.

In the third lecture, I would cover Sections 2.5 and 2.6a. I would pay particular attention to Sections 2.5c, 2.5d, and 2.6, which are the heart of the chapter.

In the fourth lecture, I would cover the remainder of the chapter. The crucial section here is 2.6b and the most difficult concept to explain is the shape of the combined supply curve for wheat and cloth. The appendixes could be made optional for the more enterprising students in the class. I would also assign Problems 7-13.

International Economics, 10th Edition Solution Manual