The Addison-Wesley Ser amen Sea vice ican gestae ae comnene {ior fpteson oe Poke Smet a eee Eee. emt "a ete ‘eer Ket ioe rman eae, ste a ‘Sette ‘ero vac Try a an pec "The Feces oP see 5 in Economics fea Path Emer fe oa os cee cred See aes Sea oa senor te ree ST sna id a eur ‘oun Decloant Naltenlenen ‘nal Oot: Tere International Economics Theory and Policy SIXTH EDITION Paul R. Krugman Princeton University Maurice Obstfeld University of California, Berkeley wise, ae aston Sn Face New ok london Toronto Sydney Tokyo Singapore Madeit Mexico City Manic Paris Cape Town Hong Kong Montesa = E05 ingens "Lec han $10 ben pa year =$10-20bi8on| = 820-10 en 8100-18000 MR «oer scossyFor Robin and Leslie Ann to-n-Chiet: Denise Clinton Executive Developmeat Manager Sylvia Mallory Developmont Editor: Jane Tatts ‘Web Development: Melissa Honig, Managing Esior: Iomes Rigney Prodction Supervisor: Katherine Watson Design Manage: Regina Kolerds ‘Text Design, Electronic Compesition, sd Pract Manageme: lm Street Publishing Serves ne (Cover Designer: Regina Kolenda (Cover Lmage: © Digital Vision Li ‘Supplements Editor: Andrea Basso Marketing Manager: Addieone D'Ambrosio Manufactoring Coordinator: Hugh Crawford International Reonomics: Theory and Pulicy CCopycight © 2003 by Pau R. Kruginan and Maurie Obstetd Aight eer No pr of hs pletion may be repodee, dared ia rei ‘So eens ay fx rby ay meat, leone, econ Rca tg oar tothe pe writen coc of he pls Eorintosaton toting peo he of ler os or, please tans writen equa io Peon Bouton, in Rigs an Contacts Depart, 5 gon SS 9 Boson, MA C2116 ax our ques (617) 48-147 Frined he Unto Sites Anca ISBN: 0321-11638.9, WORLD STUDENT SERIES “This edition may be sld only in those courtees to whichis consigned by Pearson Education Internationa. I ¢ not o be ee-expored and itis not for sal in the US.A. ‘or Canada. 123456789 10-CRW06 05 04 63 02 Part 3 2 1B 14 15 16 7 Part 4 18 19 2 22 BRIEF CONTENTS coments Price International Trade Theory Labor Productivity and Comparative Advantage: ‘The Ricardian Model Specific Factors and Income Distribation Resources and Trade: The Hecktcher-Ohlin Model The Standatd Trade Model Economies of Seale, Imperfect Competition, and International Trade International Fector Movements International Trade Policy ‘The Instruments of Trade Policy ‘The Political Economy of Trade Policy ‘Trade Policy in Developing Countries Controversies in Trade Policy Exchange Rates and Open-Economy Macroeconomi National Income Accounting and the Balance of Payments Exchange Rates and the Foreign Exchange Market: ‘An Asset Approach Money, Interest Rates, and Exchange Rates Price Levels and the Exchange Rate in the Long Run Cuiput and the Exehenge Rate inthe Short Rua Fixed Exchange Rates and Foreign Exchange Intervention International Macroeconomic Policy ‘The Intecnational Monetary System, 1870-1973 Macroeconomic Policy and Coordination under Floating Exchange Rates (Optimum Currency Areas and the European Experience ‘The Global Capital Market: Performance and Policy Problems Developing Counties: Growth, Crisis, and Reform 10 38 a 120 160 las 186 218 255 26 293 324 357 388 433 4a 531 532 568 36.Brief Contents Mathematical Postseripts Posiscript to Chanter 3: The Specific Factors Model Postscript «9 Chapter 4: The Factor Proportions Mode! Posisctipt to Chapter 5: The Trading World Economy Postsript to Chapter 6: The Monopolistic ‘Competition Mod! Postsoript to Chapter 21: Risk Aversion and International Portfolio Diversification Index 707 708 4 m7 ns 8 37 CONTENTS Pretase 1 Introduction ‘What Is ternational Beonoles About? ‘The Gains from Trade ‘The Pater of Tense How Mach Ted? ‘The Balance of Payments Exchange Rae Detention International Policy Coonan “The Imerntional Capital Market International Ezanomis: Trade and Money Part | In¢ernational Trade Theory 2. Labor Productivity and Comparative Advantage: The Ricardian Model, “The Concept of Comparative Advantage {A One-Factor Economy Production Possbikes Relative Prices and Supply ‘Trade ina One-Factor World Box: Comparative Advantage in Practice: The Case of Babe Ruth Desermining tb Relive Price after Trade “The Gains rom Texde ‘A Numerical Example Relaive Wages Misconceptions about Comparative Advantage Productivity and Competitiveness “The Pauper Labor Argument Eoplotation Box: Do Wages Reflect Productivity? ‘Comparative Advantage with Many Goods Satin Up the Mosel elaie Wages and Specialization Determining ie Reotve Wage in he Mullgood Mode! ‘Adding Trarsport Costs and Nontraded Goods Empieleal Evitenceon the Ricardian Model SommaryContents 3. Specific Factors and Income Distribution “The Specific Factors Model ‘Assamplons of the Made ‘Bn: What isa Specie Factor? Peoduction Posstiten Prices, Wags, nd Labor Allocation Relative Prices and ie Dintribution of Income Internation! Trade inthe Specific Factors Model Resoures and Relative Soply Trade and Relive Pres The Paten of Trade Iaceme Distribution and the Gains From Trade ‘The Political Beonomy of Trade: A Preliminary View ‘Optimal Trad Policy Iecome Disvibuton and Tale Poles Box: Specific Factors and the Beginnings of Trade Theory ‘Summary “Appendix: Further Details on Specific Factors Marga a Tal Product Relnine Prices nd the Disbuton of come Resources and Trade: The Heckscher-Ohlin Model A Mode ofa Dw0-Factor Reonomy ‘Assumpsions of the Model Factor Prices nd Goods Priest Resouces nd Oupat Erfecs of tnternational Trade Retween Two-Factor Economies Rovaive Prices ne the Pater of Trade “Trade andthe Dist of lca Factor Price Equalization Case Study: North-South Trade and Income Inequality [Empirical Evidence on the Heckscher-Ohlin Model “Testing he Hoekscher Olio Medel Implications of he Tess Summary ‘Appendix: Factor Prices, Goods Prices, and Input Choices ‘Choice of Teenie ‘Goode Prices and Facor Pies ‘The Standard Trade Model A Standard Model of 2 Trading Economy Production Posies and Relative Supp Relaive Prices and Demand “The Welle Etec of Changes inthe Tes of Trade Determining Relative Prices [Economie Growth: A Shi of he RS Curve ‘Growth and the Production Possibility Foner Relative Supply andthe Terms of Tine Internuicnal fess of Groth ‘Cace Study: Has the Growih of Ney Industializng Countries Hurt Advanced Nations? ternational Transfers of lncom ‘The Trnafer Problem Effects of Taf on the Tes of Trae Presumptions abou the Tens of Trade Elects of Transtoe (Case Study: The Transfer Problem and the Asian Crisis ‘Tariffs and Export Subsidies: Simaitancous Shifts in RS and RD Relalve Dead and Supply Elects of aif tects ofan Expert Subsidy ules of Tere Te Es Wo Gai a Who Las? summary Appendix: Representing International Rquilbrium ‘with Offer Curves Deriving a Coun’ Oter Curve memationl Bolum ting the RD Curve 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 “Monopoistie Competition Limitations af ike Monapoisic Compson Model Monopotstic Competition and Trade ‘The Etfeess of Inresed Macel Sie Gains from an negated Marke A Noneiesl Example Economies of Seal até Compra Advonage “The Sigifianc of Intmindutry Trade Why Insist Tne Mars (Case Study: Intraindstry Trade in Action: The North ‘American Auto Pact of 1968 Dumping ‘The Bconmics of Dumping Case Suxdy: Antidumping as Protetionism Reeisocal Damping ‘The Theory of External Economies Specialized Supplier Lior Market Pooling Knowledge Spiovers Contents oR 100 101 101 03 103 105 108 10 9 uo ut 413, 7 "7 us M6 18. “9‘Contents Excemsl Beonoaes and Increasing Retirns ‘External Beonomies and Internationa Trade Extent Economies ad te Pate of Pade ‘Trades Welre with External Economies Dynamic Inereasing Rewrs Lox: Tinseltown Economics, ‘Summary ‘Appendix: Determining Marginal Revenue 7 International Factor Movements. International Labor Mobi ‘A Ope-Good Model Without Foctor Mobily Taran Labor Moven Exienlng the Analysis, Case Study: Wage Convergence nthe Age of Mass Migration Gave Studs: Immigration and the US. Keonomy International Borrowing and Lending Interempoal Production Posse andTade “The Rea nerest Rate Imererporl Comparative Advantage Dircet Foreign lavestment and Multinational Firms Box; Dots Capital Movement to Descloping Countries Hurt ‘Workers in High-Wage Countries? “The Thory of Moliinal Exerprise ‘Moliesional Fins in Practice (Case Study: Foreign Direct Investment in the United States Box: Taken fora Ride? ‘Summary Append : More on Intertemporal Trade Part 2 International Trade Policy & The Instruments of Trade Policy Basie Tari Analysis ‘Sopaly, Demand, td Trade ina Single Indusiy effets of Tait -Measoring te Amoust of Protection Costs and Benefits ofa Tritt ‘Consume and Producer Surplus Measuring the Costs ard Benes Other Instruments of Trade Policy Export Sebsidier: Teac) (Case Suedys Europe's Common Agricultural Foley 150 150 130 rn 132 153 155 158 185 186 185 187 19 190 92 192 195, 1 198 Igor Quota: Theory ‘Case Study: Am Import Quota in Pract ‘Voluntary Expon Restains ‘Case Study: A Voluntary Export Restraint in Practice: ‘Japanese Autos {Local Content Requires Box: American Buses, Made in Hungary ter Trade Policy Hsrunents ‘The Elfecis of Tade Policy: A Summary Summary Appendix I: Tariff Analysis in General Equilibrium ‘A Tain x Small Canty ATwihin Large County Appendix Il Tariffs and Import Quotas is ‘of Monopoly ‘The Model wih Fee Trade ‘The Model with a Tait “The Model wi an gon Quota Conpaving 2 Tarif nd a Quote S.Surar the Presence ‘The Political Economy of Trade Policy "The Case for Free Trade Fr Tate and fficexy ‘Aiona Gans fom Free Trade Polical Argument for Fre Trade ‘Case Study: The Gains from 1992 [National Welfare Arguments Against Free rade “The Terms of Trade Argument fora Taft “The Domes Market Fale Argumen Again Free Teds How Convincing Is the Market File Argument? ox: Market Failures Cat Both Woys: The Cas of California Income Distribution and Trade Paley leetorat Competition Collective Acton Moseting the Poieal Process Who Ges Proetad? ‘Box: Politilans for Soe: Evidence from the 19908 international Negotitions and Trade Policy ‘Tae Advantages of Negotiation Intrnctinal Trade Agreements A Brief Hisiogy The Unogeay Round ‘Trade Libemization From the GATT tothe WTO Berefitsand Cons Box: Settling a Dispale—and Creating One Preferial Trading Agreements Contents xd om 203 m3 204 206 206 210 210 m2 ud na as 26 biex Coneenns Box: Free Trade Area versus Customs Union (Box: Do‘Trade Preferences Have Appeal? ‘Case Siudy: Trade Diterson in South America Surmmary ‘Appendix: Proving that the Opt Is Positive Demand and Suppty ‘Te Tiff nd Poe “The Tariff nd Domestic Walfne "Tacit ‘Trade Policy in Developing Countr Import Substituting Indust "The nf ney Argent Pramatng Manoficuing Thowgh Protection (Case Su: The End of Import Substitution in Chile Results of Favoring Manufcusag: Problems of pon Subst ndestsization Probleme ofthe Dual Economy "The Symptoms of Busse ‘Case Study: Beonomie Duatism in India ‘Dual Labor Makes and Trade Policy Tide Policy esa Cause of Bearomic Duals Export-Orlented Industralizatin: The East Asian Miracle “The Face of Asan Growth “Trade Policy nthe HPAES Box: China's Boom Indust Poy io the HPAES Other Factors in Groth Sommory Controversies in Trade Policy Sophisticated Argument for Activist Trade Policy “Technology and Extraites Inmperect Competition ad Static Trade Policy Case Study: When the Chips Were Up Globalization and Low-Wage Labor “The At-Glalzaon Movement “Trade and Wages Revised Liber Standards and Trade Nepsiations Environmeatl and Cull Ieues “The WTO and National Independence ‘Case Study: The Shipbreakers of Along ‘Summary 24s 2 22 252 253 255 256 256 238 21 268 264 2s 261 2 20 21 mm 276 216 on 28 258 237 238 238 Part 3 Exchange Rates and Open-Economy Macroeconomics 12 National Income Accounting and the Balance of Payments “The National Income Accounts ‘Nasional Prt and Natonat lacame ‘Capit Deprsiaton, tration arses, and Th Busines Totes Grose Domestic Produce [National Income Accounting for an Open Economy ‘cowsumation| levestment Government Prcases ‘The Naina Income identity for an Open Eccnoany ‘A Imaginary Open Esononty ‘The Curent Account ad Foreign ndebedess Saving andthe Corent Account Pate and Govenient Saving ‘Case Study: Government Delt Reduction May Not Increase the Current Account Surplus ‘The Balance of Payment Accounts Examples of Paired Transactions “The Fundamental Balance of Papen Hen ‘The Curent Account, Once Again ‘The Capita Account ‘The Fine Account ‘The Statisieal Dierepency Offa Reserve Tnneations Box: The Mystery ofthe Missing Surplus Case Sud: Is the United States the World's Biggest Debtor? Summary 13 Exchange Rates and the Forcign Exchange Market: ‘An Asset Approach [Exchange Rates and International Transactions Domestic and Foreign Prices xchange Rates and Relative Pies ‘The Foreign Exchange Market The Actors Box: A Tale of Two Dollars ‘Chere ofthe Marke ‘Spot Rates and Forvard Rates ‘Contents 293 295, g BESEESEEey 324 325 35 ca 38 9 350 prwiv Contents Foreign Exchange Swaps ature snd Options ‘The Demand for Foreign Currency Assets “Assis ad Asset Returns Risk and Ligity Behinage Ras sn Asiet Rats A Sipe Rule Return, Risk nd Liquid nthe Fseigo Exchange Marks Equilibrium inthe Foreign Exchange Market Interest Pry: The Bsie Equiv Conon nw Changes ibe Cent Exchange Rate Ae! Expsted Retras ‘The Equilibrium Exchange Rae Interest Rates, Expectations, and Equilibrium “The Efe of Changing Interest Rates on the Cue Exchange Rate “The Effec of Changing Expectations op the Curent change Rate ox: The Prile of Forecasting Exchange Rates ‘Summary ‘Appendix: Forward Exchange Rates and Covered. Tnterest Parity Money, Interest Rates, and Exchange Rates ‘Money Defined A Brief Review “Money as Medium of Exchange Money 2 Unit of Account Money asa Store of Value Wha eMonay? ow the Money Supply Is Dewerined ‘The Demand for Money by Individuals ‘Expected Retum Risk Ligsisiy ‘Aggregate Money Demand ‘The Equirium Interest Rate: The Inersction of Money Supply and Demand the Money Sepply ‘Outpt athe Interest Rate “The Money Supply and the Exchange Rate in the Short Run Linking Mone, te Interest Rate, and he Exchange Rte US. Money Supply and he DollaBaro Exchange Rate uope’s Maney Supply andthe DollaBero Brchange Rate “Money, the Price Level, and the Exchange Rafe in the Long Run ‘Merey and Money Prices. “Tne Long Ron Effects of Moncy Supply Changes Empirical Evicence on Money Supplies ab Price Levels 3a 381 300 373 33 a 305 16 Money ane Exchange Rote inthe Long Ra Box: Inflation and Money Supply Gros Inflation and xchange Rate Dynamics ‘Shos-Run Price Rigidity yrsus Lang Rue Pee Flesbity Hox Rfney Supply Grew ea Hyperion a Baia Enchung Rat Oeshaing Sueamary Latin America Price Levels and the Exchange Rate in the Long Run ‘The Law of One Price Purchasing Power Party “The Relationship betweea PPP and the Law of Ove Price [Abroie PPP and Relative PP ‘A Long-Run Exchange Rate Model Based on PPP The Fondamentl Equation of the Monetary preach ‘Ongoing Inauon ees Pay. and PPP ‘The Fisher fort Empirical Evidence on PPP and the Law of One Price Box: Some Meaty Evidence on the Law of One Price Explaining the Problems with PEP. “Trade Baris an Nontratabee Deparures from Free Competition ‘Box: long Kong's Surprisingly High ination Inieronat Difernces io Price Level Messurment ‘PPPin the Short Run ad inthe Lang Run Case Stody: Why Price Levels Are Lower in Poorer Countries Beyond Purchasing Power Party: A General Model of Long-Run Exchange Rates ‘The Real Exchange Rate Box: Stcky Prices andthe Lav of One Price: Evidence from Scandinavian Duty-Free Shops ‘Demand, Supply and te Long-Rut Real Exchange Rate Nominal and Rea Exckange Rates in Long-Run Equilitiam ‘Case Study: Why Has the Yen Kept Rising? International Interest Rate Diferences and the Real Summary “Appendix: The Fisher Eifect, the Interest Rate, ‘and the Exchange Rate under the Flexible-Price Monetary Approach ‘Output and the Exchange Rate in the Short Run Determinants of Aggregate Demand in an Open Ezonomy Contents 316 an 378 an 380 383 aa an aul 42 ay 416 a9 433 aaxvi Contonts Determinants of Consumption Demand Determinants ofthe Caren Account “How Real Exchange Rate Changes Mfc the Curent Account Ho Disposble Income Changes fect the Curent Account "The Equation of Aggregate Demand "The Real Exchange ale and Aggregate Demand Real Income and Aggregate Demand How Output fs Determined in the Short Run, ‘Ouiput Market Equilibrium in the Short Run: ‘TheDD Sehedsle ‘Ovi the Exchange Rate, sad Output Makes Equa Deriving he DD Schedule Factors tha Shift the DD Schedule ‘Asset Market Equilibrium inthe Short Run: The AA Schedule (nip. the Exchange Rate, an Asst Masel Equiv Deriving the A Sebedule Factors that Stil the AA Sched ‘Short-un Equibibrlum for an Open Economy: Putting the DD and Aa Schedules Together ‘Termporary Changes ia Monetary and Fiscal Policy Moetsy Paliy Fiscal Policy Policies to Maintain Full Eploymest Inflation Bias and Other Problems of Policy Formulation Permanent Shits in Menetary and Fiscal Policy ’s Permanent Increase inthe Money Sappiy ‘Adjwsimeat toa Pennant lacicase in the Movey Supply 's Permanent Fea! Expansion “Macroeconomic Plicies and the Current Aceount ox: The Dollar Exchange Rate ad the US. Economic ‘Slowdown of 2000-2001 Gradual Trade Flow Adjustment and Current ‘Account Dynamics The Come Exchange Rate Pas-Throegh sn Infation Summary ‘Appendix I: The £S-LMf Model and the DD-AA Model ‘Appendix I: Intertemporal Trade and Consumption Demand ‘Appendix IIL: The Marshall-Lemner Condition and Empirical Estimates of Trade Rlastiites Fixed Exchange Rates and Foreign Exchange Intervention ‘Why Study Fixed Exchange Rates? a4 435 a 461 464 65 an a5 431 aa ‘Central Bank Intervention and the Money Supaly “The Cental Bk Balance Shee and de Money Sophy Fergn Echngensnetion rte Money Say erin ‘The Balance of Paymeuts ashe Mey Sepply How the Central hank Fives the Pxchange Rate Foreign Exchange Marke Sguiitriom under a ies Esehonge Rate Money Markt Equiibrivn andra Fined Exchage Rate Diagrammatic Anais Stabilization Pofcies with a Fed Exchange Rate ‘Mowat Poi Fecal Paticy ‘Clanges inthe Exchange Rake Ajsien to Fiscal Polley and Exchange Rote Qhangee ‘Case Study: Fixing the Exchange Rate to Esape from a Liquidity Trap Balance of Payments Crises and Capital Bight “Managed Floating and Sterilized Intervention Perfet Asset Substiaabilty and the nefetveniss of Stelized Intervention Box: Menieo's 1994 Balance of Payments Crisis Fovign Exchange Market Eglin wade Inert ‘Ase Sabsttutabiiy “The Elects of Steril Itervention wih Inert, Asset Sehtaabiy [idence onde Bers of Seized nerention ‘The Signaling Effet of atervenion Reserve Currencies in the World Monetary Systema “The Mechasis ofa Reser Coen Standard ‘The Asymmsic Psion ofthe Reserve Center ‘The Gold Standard “The Mechanics ofa Gold Standard ‘Syminotie Monetary Adjurinient vor Gold Sundard Benetis and Drwbuce ofthe Gold Standard The imealic Sandars "The Gold Exchange Standart Summary Appendis I: Equilibrium in the Foreign Exchange Market with Imperfect Asset Substitutability Demand Sopp Buin ‘Appendix Il: The Monetary Approach to the Balance ‘of Payments Appendix Il: The Timing of Balance of Payments Crises Contents x 482 436 487 488 0Contents Part 4 International Macroeconomic Policy 531 ‘The International Monetary System, 1870-1973 532 Macroeconomic Policy Goals in an Open Economy 53 Tera Balance: Fall Bploien and Price Level Sabity a Exel Balance: Te Optinl Level ofthe Cuzet Account 5 International Macroeconomic Pliey under the Gold Standard, 1970-1914 sar ‘Origine ofthe Gold Standard 3 Eternal Baioce uncer the Gold Standard 3 “The Price-Spesie-Flow Mechanism . 38 ‘The Golé Standard "Rules ofthe Game Myth and Realy 539 Bos: Hume versus the Mercant sto Internal Balance under the Gold Standard 54 ase Stuy: The Political Reonomy of Bxchange Rete Regimes: Confit over Ameria’s Monetary Standard During the 1890s S41 “The Interwar Years, 1918-1939 3a ‘Toe GeananHypesnfaion st ‘The ecg Ret to Gold 38 Inerstinal Eonoric Disnepation Su Case Stody: The International Gold Standard sand the Great Depression sis ‘The Bretton Woods System and the International Monetary Fund se (Gols ad Sirstere ofthe IMF 307 Convert 48 Internal and External Balance under the Bretton Woods System $49 “The Changing Maing of External Balance 350 Specalatve Capital Flows and Crises 550 ‘Analyzing Policy Options under the Bretton Woods System 5st Mainisning Itemal Balance 382 Msinsining Exernal Balance 353 Bxpedize-Chanping and Expeniure-Swihing Polis 554 ‘The External Balance Problem of the United States 556 Case Study: The Decline and Fal ofthe Bretton Woods System 557 ‘Worldwide tnflation and the Transition to Floating Rates sot Summary S64 Macroeconomic Policy and Coordination under Floating Exchange Rates S68 ‘The Case for Floating Bxchange Rates so ‘Menstay Policy Autonory 58 Symmery 570 20 Exchange Rates a Asta Steiiers ‘The Case Against Floating Bxchange Rates Discipline Destblizing Spcsttion and Money Matt Diserbances Iojory to tatenaioal Tze and Invesiment Uncoordnated FeonomisPaivie ‘The lesion of Greater Autnorny Case Study: Exchange Rate Experience Between the Oi Shocks, 1973-1980 “Macroeconomie Interdependence under a Floating Rate Cave Sudy: Disinflation, Growth, Crisis, and Recession, 1980-2002 ‘What Has Been Learned Since 1973? Monetary Policy Astonany Symnaity ‘The Exchange Rate aan AuooaticSabitier Discipline Desabilizig Spetlation ItemlionalTade 2nd Ivesinene Policy Cordination ‘Are Fixed Exchange Rates Bven an Option for Most Countries? Directions for Reform Sommers ‘Appendix: International Policy Coordination Failures Optimum Currency Areas and the European Experience Horr the European Single Currency Evolved "European Cuteney Reform Iatives, 1969-1978 “The European Monet Sytem, 1879-1996 ‘German Monetary Drninance and the Cre Theory ofthe EMS ‘The BU "1992" Inaine European Economic sad Monetry Union ‘The Euro and Beonomle Policy inthe Euro Zone ‘The Massie Convergence Citra and the Stbity so Growth Pat ‘Te Bsropean System of Cetra Banks ‘ox: Designing and Naming a New Currency “The Revised Exchange Rate Mestanimn ‘The Theory of Optimura Currency Areas "Economic Inegraten an the Beefs of Fixed Exchange Rate Arex The GG Schedle Economie Iegration ad the Coss ofa Fixed [Exchange Raw Ave: The Lt Schedule Contents xix sn 513 323 sna 15 316 16 610 on os oa 615, 616 ar oe ooxx Contents 2 n “The Decision Jin a Cunency Aree: Pung the GG od UL Setedules Together ‘What Ise Optimum Cureney Ara? Cave Stuy: Ie Europe an Optimum Currency Area? Tow: How Much Trade Do Currency Unions Create? "The Fature of EMU. Summary ‘The Global Capital Market: Performance and Policy Problems “The International Cepital Market and the Gains from Trade Toree Types of Gain ftom Tage Risk Aversion Poni Diversification 2 Motive fr Irrational Asset Tat ‘The Menu of Internation Asses: Debt Vrsus Eity Internsional Banking andthe International Capital Market ‘The Sineture ofthe Intertional Capital Market (Gros ofthe Iverrationl Capital Market Offshore Banking ond Offshore Curency Trosing The Grom of Estocarency Tring Regulating international Banking "The Problem of Bank Flue Diticutes in Regulating Intematons Banking Inversion Regulatory Cooperation Box: The Banco Ambrosiano Colapse Case Strly: The Day the World Almost Ended low Well Has the International Capital Market Performed? “The Extent of Iterations! Pertois Diversification ‘he Extent of lvenemporal Tade Onshore Orfshore lnteest Differentials “Te Eiicincy of the Pociga Exchange Maskst ‘Sammary Developing Countries: Growth, Crisis,and Reform Income, Wealth, and Growth n the Wor'd Keonomy “The Gap Beawoen Rich and Poor Has the Would Income Gap Narowed ovr Tine? ‘Structural Features of Developing Countries Developing Country Borrowing and Debt “The Economics of Capital [tows to Developing Counties “The Prolem of Default ‘Alematve Foon of Capital Ines Latin America: roma Crisis to Uneven Reform Iflaion andthe 1980s Debt Cis atin Aiea ox: The Simple Algebra of Moral Hazard om o% as 68 60 2 536 7 637 638 62 665 686 696 on on on ors 616 on ‘Cave Sus: Argentina’s Beonomic Stagnation Reforms, Capa laws, andthe Retr of Css ast Asia Success and Criss ‘The Fae Asiot Ezanomie Miracle ‘tox: Wha Dat Asia Do Right? ‘Aslan Weaknesses The Asan Finncial Casts Crises i Osher Developing Regions ‘Case Study: Can Curreney Boards Make Fised Bxeliange Rates Credible? Lessons of Developing Country Ceises Reforming the World's Financial “Architecture” Capital Moby 2rd the Tete ofthe Exchange Rat Regine “Props” Messires Coping ith Ces A Confused Fase Summary Mathematical Postscripes Postscript to Chapter 3: The Spesfc Factors Mode! aco Pies, Cots, a Fctor Demands Facer Pee Determination nthe Specie Factors Mol feos of » Change Retative Pees Poststipt to Chapter &: The Factor Proportions Medel ‘The Basi Equvions ine Facto" Proportions Mace! Goods Prices and Factor Prices Factor Supplies ed Outputs Postsript to Chapter 5: The Trading World Economy ‘supply, Denn, nd Equiv Wort Equi Pradusion an Treome Income, Pies, and Ui ‘Supply, Deoae, pd the Sbiity oF Eu ets of Change in Supply and Demand ‘The Method of Carparative Stas Ecanenie Grow ‘The Transfer Problem Twit Postscript to Chapler 6: The Monopoitic Competition Model ‘Postscript to Chapter 21; Risk Aversion and International Portfolio Diversification ‘An Anaya! Deaton ofthe Optimal Porto ‘A Digrammaic Derivation of he Optimal Portolio. ‘The Effecs of Changing Rates of Retr ‘contents oe as or 37 oo 9 oi oo” wdPREFACE Atte sta of he eny-fistcomry,inrnatona specs of ecvencs remain as Inptan and consort eve Ineo decade alone maj creny an fal {rts hvefcked nding cots fom Eat io Latin Americ counts Eup: hve gen up thi tatoa cuenta vor of anon een he ex, fd pring tae and fara inkoge been infos and developing cours verre debate and even pen potest ined by cine tat ceonnie “abl: ton bs worsened worden om pver to olin. Albuogh he Utes Sisesis move ifsuficet han atone wih salt eco, protest Comat ecoromiepocy have ssunes primacy and ow ecto ® prominent place sy sepia o poaes. “nant! pnul development th ward economy ie concen tht hve Fea copied itanalionlccommi fx mare a to eae, uch a be tare of {nao asnont mechs nd the mere ree trade compared wih poe {ime Ar sleyein inertial cones, howe, be iepiay of vet anes es Ted wo nw modes of analysis Thee noble examples of recent progres te ees rare approach to exchange ates, sew cre offen ade aed on inereing {ets an art state rae than compurtive advange nd the interpol io imepaona capil Hows hk hs fen cea bho eng the ene ‘rexel tla” and ex the deerinans of developing ear bore Sng and ct “hee of wing his bck came oa of or experience teaching iran eo somite anceoatites and bases sae sae te inte 1978, We peeied to tor challenge in eacing, Te fs was commute sens he sing inl Fetal avues inthis Jyamis fill Te scant no fo sow bow Ue development of teal ponies aly ts spy edo ean hanging wei ccoomy sd sso cul poblems in inertial econo: ply ‘We fn tht paaned bots did ot adegpntly ret hse challenges Ton en. imematonl enemies textbooks cotton stodnt wh bewidetng ary of seca ‘mel and ssumplons fom whe as lasone are ich exe, Beate many of {howe spec! models ae oumode, sede ae It prized about the resbwordre- arc othe nls, Ar es, any textbooks ter eve gap between he sores guted mata obo covered in cas ad the exling es that dri caren trench so pole seu. Tat gap ts dened anally athe pone of {mematonl eons problems tnt enoliess in ietematons economies cose I ‘This book is our attempt to provide an up-to-date and understandable analytical framme- wo frilutng cent events nd tongng he excement of neato conor iSite siasoom. Ip aayzing toh te re ard monet sides ofthe sabe, ow pproth as teen bull op step by slp simple iid emeverk for emia ing gad edna insights wel ast newest dings ad approaches, T phe ‘Stent gy adn he vadeyng oi of latina conics, We matte There! doce st exch ge y perience qurstons Preface The Place of This Book in the Economics Curriculum ‘Students asinilaeitemationsl economics most readily when iis preseried a a method of analysis vitally ink ocvees inthe word economy. ether han asa boy of abstract theo ems abou sbstract mods. Our gal har heefoe been to res concepts ad ter api ion ite tha deoreial formalism. Azeoringly he book doesnot resepoxe an estensve background in econamies. Students wh have had a course in economic props wil find the book accesible, bur stadens who have taken luther courses in shcvoeconomies o¢ ‘macroeconomic wil id on abundant spply of new material. Specialized appendices and ‘nathemaical postscrips fave bees included to citlenge the most advanced students ‘We follow the standard practieof dividing the book into two halves, devoted to rade and to monetary questions. Although te ade and monetary portions of international ec ‘omnes ae ofan reated as ucla subjects ven witha one textbook, iia themes and ‘methods recut in both subtelds. One example isthe ides of gains fom ted, which Is npoctant in undersiandng te effects of fee eae nace as walla fre trade in goods. {nteratona borrowing and lending provide smother example. The process by which coun. vies rae preset fr future consation is Dest understood in tems of comparative advan ‘age (which s why we trode ithe book's fst haf, bt the resulting insights deepen understanding of the external microeconomic problems of developing ard developed economies alike. We have made ita pont to iltinate connection between the ade sed noneaty eas when they aise ‘ALIhe same ime, we have made sure tha the book's two halves are completely sel ‘contained, Thus, one-semescr course on tide tice ca be based on Chapters 2 though {and a oneseaseser course ot iteration monetary ecaromies canbe based on Chap {ers 12 tough 22. Ifyou adopt the book fra lh year couse covering bah sublet, how ever, you wil find eaten tht does noc leave sudents Wondering Why the principles underlying thee wk on tad teary have Ben dtcared over the winter break, ‘Some Distinctive Features of International Economics: Theory and Policy “This book covers the most important recent developmen in ineratona economics with out shorchangiog the enduring theoretical and Ntorial insights that have traditionally Formed de core of he subject. We have achieved this comprehensivenes by stressing Bow recent theories have evolved from ear finding in response oan evolving world econ0- my. Both the el irae potion of ths book (Chapters 2 through Ind the money portion (Chapters 12 trough 22) are divided ito acore of chapters focused on theory followed by chapters applying the theory to major poiey questions, past and caren Im Chaper | we desribe in some detail how this book address the major themes of International esonomics. Here we emphasize several of the newer topes that previous sutors failed to eat sa sytemmatie way ‘Asset Market Approach to Exchange Rate Determination ‘The modern foreign exchange market and te determination of exchange rates by naion- al interes ates and expectations are atthe center of our account of open-economyxxiv Preface ‘mocroeconomics The main ingredient ofthe macroeconomic model we develop isthe Interest party relation (augmented ler by csk remiums). Among Ue topics we address ting the model are exchange ate “overshooting”: betavior of eal exchange rates: blance- ‘fepayments rises under fixed exchange rates; and the eauses and effects of central bank {erveaton inthe foreign exchange marke, Increasing Retures and Market Structure ‘ater eiseassing the role of comparative advantage in promating wale ai! gains from rade, we move 1 the foatier of research (la Chapter 6) by explaining how incresing fexurs aed prod ilfeentnion affect re sind welfare. Tho models explored inthis is- “raion eapure significant aspect of reality, such as itraindstry trade and sis in tad fatter due to dyrae sale economies The models show, oo tht matally beneficial Frade need nt be based en comparative alvaniage Politics and Theory of Trade Policy Stating in Chaper 3, we ares the effect of wade on income distribution asthe Key poiti= al filo bebind restetons on fee rade. This mmphass makes i clear to staden's Why he fresriptons of he slandard welfare alysis f wade policy sekiom prevall in practice, Chapter || explores he popular nexion tat governments should adopt activist rag policies simed at encouraging sectors of Ue economy seen as erucil. The chapter includes theo retical discussion of uch tad policy bared on seypleidss from game theory, International Macroecanomic Policy Coordination Guralseussion of international monetary experience (Chepters 18, 19,20, and 22) stresses the theme that ferent exchange rae systems have Tet fered policy coordination problems for thee members, Jos ae the competitive gold seramble of he inerwar years Thowed how beggar-iy-neighbor policies can he self-defeating. the curent foot chsh lenges national policymakers to recognize thelr interdependence and formulate policies cooperatively, Chap 19 presen a detailed diction ofthis very topical problem ofthe current system “The World Capital Marlet and Developing Countries [Abroad discussion ofthe world capital marke is given in Chapter 21, which akes up the ‘welfare implications ofinteraional potfolio diversification as wall as problems of pr Adenia superision of offshore nancial nsiutions. Chapter 22 devoted tothe longer ‘growth prospects and tothe specific macroeconomic stabilization ad iteration pro {ome ofindustializing and newly industrialized counties. The chapter reviews emerging market ries al plaesin historical perspective the incersctions among developing coun ley borrowers, developed coustey lenders, and oficial financial instttens soc as the Interaatonal Monetary Fund International Factor Movements In Chapter 7 we emphasize the potential sbstiuability of insertional rade and ier ioral movements of factor of production. A featur inthe chapter is ovr analysis of into ‘atonal borrowing and Wing as nertenporal rade, tats tbe exchange of presen cm Preface ‘sumption for fture consumption. We daw on the eee of this acayss inthe book's ‘second half to trow light onthe macroeconomic imgliclione ofthe euret account New to the Sixth Edition Fortis sinh ein of rermatonal Ecouoncss Theory an Policy we have extnsirely redesigned several chalers, These changes espe bth to wt” suggestions and to some Jmporiantdevelopraems on the theoretic! and pecieal sides of intemational economies. ‘The most fareaching chonges are the Fellow: Chapter 9, The Political Economy of Trade Policy Thie copter now includes the role of special-interest paymsns in influescing poliieal decisions over wade policy. (Coverage ofthe Word Trade Orponization i brought up fo dae. Chapter 11, Controversies in Trade Policy A new tle signals tht this chapter expands is everage beyond its predecessor's focus on sage trae policy. In advan, ‘Chapter 1¥ now eater the recent glcblizaion debste—inclusing the effets of ade on income distrib ad te envionment, a8 well 2 the rol of irrational bor standarcs Chapter 12, National Income Accounting and the Balance of Payments Tie revised Chapter 12 reflects the ew balance of payments accounting conventions adopted by the United States acter conmiris, ‘Chapter 18, The international Monetary System, 1870-1973 This chapter ‘now pays more attention to the politcal esonomy of exchange rate reBimes, using 25 an example the bale ver the golé standard tat dominated American pois inthe hie nineteenth comtury, Chapter 19, Macroeconomic Policy and Coordination under Floating Exchange Rates We hve epsced he Jano cany nel of eer sions wih et ita iszanson ofthe major eto nara pty recuse “ha chang alos te insractr ots aon nora ply ste anton oy techn ea Chapeer 20, Optimum Currency Areas and the European Experience As recently asthe mid-1990s, Europe's vision ofa single curencyTooked like a distant and pposbly unreachable goal. As of 2002, however, mele Buropean counties had replaced {hei national eurencis withthe ero, and others ae poizd to follow. Cheptr 20 has been revised to cover te Fist yeas of experience with the eure ‘Chapter 21, The Global Capital Market: Performance and Policy Probles ‘To make room for more topical material elsewhere in the book, we have steamlined thie hole by removing te dete exposon af Euocucy creation conaned in earerPrefees tn ation oes seca changes, have ped te book in ta ways toms sictaran elvan Ths we eta or sovenge fhe welll of evi inst saree apron maestro cones (Cpe 3) We pte he Sa Smet pty ect ty (ape Ue ss er ete: 7) aden one eft ferent) anos en Yate lee (Chops 20 sade ecouat te cole of Arete ene in 2002 (Chater 2) Learning Features “Tis book incorporates a mamber of speci! leaning Features that will maintain studens" {nest in the presentation and help them master its lessons se tudes See ust t ten comptiad ye tie at pe hod aa ei anced eaves stag fe ppb ee ot, ‘i pvtaegnponen bese nenaion Ce Captioned Diagrams sae co degre ve acompaies by dese capons that ns the CRS ete pe sein eielng ie mtr ‘Summary and Key Terms ial ach enaper closes with summary reeapitulatng the major pons. Key terms and pi Soper olde pe when ey ce node inthe cher and ae sted she en of cee cheer To further ad stadent review of the trateril, key terms ate taliciaed when they appear in the chaper summary Problems : Exc capers flowed by problars intended tet and sly siden! comprehension Tha prcema range om outnecomputtenal dil a “big picture” questions suitable for Tscoom dacasion In many problems we ak todents to pply what hey have larme to {eal-world data or poicy questions. Further Reading For insructors wip prefer to supplement the textbook with outside readings, and for t= {ents fo wish to probe more deply on their own, each chapter hasan annotate bibiog- ‘phy that include established clases 38 wel at vprdae examinations of ecem sues be Prelace Study Gi le, Instructor’s Manual, and Web Site ‘imersavional Economics: Theory and Polisi accompanied by 8 Soy Guide written by Linda 8. Goldberg ofthe Federal Reserve Bank of New York, Michael W, Klein of Tuts Uriverity. and Jay C Shambaugh of Dartmoats Cole. The Suny Guide ade students by Providing a review of centalconceps from the tex, farther ists examples. ad ‘inal practice probes. An Insecier's Manval, also by Linda S. Golders, Michel 'W. Klein, and Jay C. Shambaugh,inclodes chapter overviews, answers fo the eno chp tee problems, and suggestion for lassreom peesnttion of the book's contents Te Sy ‘Guide and tnsructor’s Manual have been updated to flea the changes nthe sinh elton. ‘We ae also pleased to recommend the compasion Web sitet aesorspanyfnternaignal Gconomics, Sixth Edin, a wwwavecom/krupmian_obstfeld. Te sit ofes students selcheck quiets foreach chapte link a sites oialeret nd occasional epates on te ‘coking developmen. All new ote ste for this edit ian animated PowerPon:pro- ‘gram of the ten’ Figures and tabes, prepared by lodanis Pets ofthe University of Florida unde the diretion of Profesor Eis Dinopouos, And also Fetured on he Web site isa brand-new, comprehensive Test Bank forte isnt, prepared by Yochanan Shech murove of the City College ofthe City Unversity of New Yor and the University of Penn sylvania, and Mite! H, Kellman ofthe City Collegeof the Cay Univesity of New York and dhe Gradate Center ofthe City Universi of New York. he Test Bank offers arch ‘ray of multiple-choice ad essay questions, lus mathematical and graphical probles, for each textbook chapter, For those interested in couse management, a Curse Comptes We site aeo avilable. Contact your Addison-Wesley sles representative for tis Acknowledgments (vr primary debi ret Jane ET, he development editor, aed to Sylvia Mallory and Denise Clinton, the econcmics editors in charge of the projec. Jane's dent and kil have been flected in ll sx editions ofthis book: we eanno thank er enough fr her com tributions. Hester Johnsons efor as projet editor are greatly appreciated. We thonk the ‘othe editors who helped make the fist five edition a good ae they were ‘We owe u debt of gratitude to Galina Hole, who painstakingly updated data, checked proof, and critiqued chapers, Annie Wai-Kuen Shun provided sterling assistance. For constrictive suggestions we thak Syed M. Ahsan, Daniel Borer, Petra Geaais, Alan Mt Tayler, Hans Vise, and Mickey Wa ‘We thank the Following reviewers foc thei recommendation and insights: Michael Aap, Brunet Unser, C2 Detajyot Chakrabany, gers University ‘Adhip Chaudhuri, Georgetown University Barbara Craig, bern Cttege Robert Driskill, Yanderbil University Hugh Kelly, tndiona University ‘Michael Kevan, Sama Clara UniversityPreface Shannon Mudd, Thunderbird Anescan Graduate Schoo of Inerational Management ‘Steen Nielsen, Copenhagen Business School Nina Pavenik, Dartmowh Colege Torani Fessas, Livery of Florida ‘Very betpl comments on erie eitions were recived rom the folowing reviewers: Jaleel Abad, Concordia University Myrvin Anthony, University of Statice, UK. Richard Aut, Auburn University Geonge H. Bors, Brown Univers Fransisco Carads-Bravo, American Gradvate Schoo ofInterarional Menagement Jay Pil Chol, Michigan State University Brian Copeland, University of Bris Columbia ‘Ann Davis, Mors College ‘Gopal C. Dersi, Wiliam Paterson University Gerald Epstein, University of Massachtss at mers JoAnne Fesney, Unversi of Colorado, Boulder Rober Foster, American Graduate School of Internation! Management Diana Faguit, Eckerd College Byron Gangaes. University of Hawa at Manoa Ranjeeta Ghia, California Stae Universi, Sen Mercos Neil Gilfedder, Stanford Universtiy Patrick Gormely, Kansas Sate University Bedil tai Hansen, Copenhagen Business School Henk ger, University of Amsterdam ‘vind Jaggi, Frankia & Marshall College Mate Jelavich, Northwest Bssouri State University Patrice Franko Jones, Coby College PrilipR, Jones, Universi of Bath and University of Bristol, UK. Maoreen Kilkenny, Pemsivania State University Fak Koray, Louisiana State University ‘Corinne Krupp, Dik University Bun Song Lee, University Nebraska, Omaha Francis A. Lees, Si Sls Urivesity Rodney D. Ladera, The Universi of Western Ontario Marcel Métete, Yule University Shanon Mitcell, Virginia Commonvelt University Kaz Miyagina, Unversity of Washington ‘Ton M, Mulder, Erasmus Universi: Rotterdam , Wayne Nafoger,Kansos State Universisy “Teruiomo Ozave, Colorado State University Arvind Panagaiya, University of Marland Pretace xxix Donald Schilling, Unversity of iesour, Columbia Ronald M4, Schramm, Colunbia University Craig Schulman, University of Arkansas Yeetsnan Shachmucove, Universi of Pennsonaie Margaret Simpson, Phe College of Willan ard Mary Robert M, ter, Universi of Michigan Rebeeen Taylor, Univesity of Pom, UK. Scat Talor, Universiy of British Columbia Aileen Thompson, Carleton Univesity Sarah Taker, Weber Sua University Ano H.Turonen-Red, Universi o Teves, Austin Dick vander Wal, Free UniversiyofAmuterdam thw ave te mach an ee snes we nd ‘eviewers’ observations invaluable in revising the | viously, we le esponsi bility for its remaining shorteoruings. ea eeeeeeeee err eere peer od Kengman Mouce ObstCHAPTER 1 Introduction Y ‘ou eat uy that che study ofincermational ade and nance is where dhe seine lof economics as we know bez Historians of economic thought often describe the estay“OF he bane of trade” BY the Scotch pioneer Osis Hume a the fest ‘eal exposison ofan economic modet Hue publshed his sy in 1738, almost 20 yea. efore is fend Adam Sit pubshed The Wel ef Nols. And the debates ver Sesh rae poe n the curly ineteznth cenery id much to convert economies FON 2 aicursve. informal eld tothe model-orented subject cas been ever ance. “ee the Sty ofncernaonal economies hes never bea 38 Important a el ow. At the begining ofthe ewengyfst ctr nations are are closely Bnked haagh aden soodt and saves Uregh Rows of money. ough invesunent ln cach thar seanamies than ever Before. And the glotl economy created by these inkags Is «turbulent pice: both poteymakers and boners leaders in every county cluding te United Sates ‘must now take aecoure of whae at sometimes rapid changing economic fortunes lay tround he wor ‘Alookat some bse wade sass ges Us sense of the unprecedented importance ‘finer eccromiereons Figure I+ shows the level of US. export and imports 4 shares of gross domentle produc rom 1959 ro 2000. The most obve fexar of he figures che sharp opward ren n Wack shares nernational trade has roughy wiped in Importares compared withthe econany 383 whole. “Amos 3 obvious is tha whis bth export and imports hve ncrese in Be oe 1990s imporss grew much faster leading toa are excess ct imporss over exports. How was the United Sates abe 1 gay fora those imported goods The arewer 5 Cat the ‘money was supelid by re inflows of apa money invested by forelgners ager. Duy {pecs ofthe booming US. economy flows of eapialon tha sale would once hve been inconeenabe; cow they are taken for grated. Ad #0 the gap between impor: ard ‘export san ineator ofthe pet of growing iteration inkages, mts case the growing Uekages beeween radon opal marke, ‘international economic relations have become cru tothe Unie Sees, ey are even more crud to other navors Figure 1-2 shows the shares of imperes and txpores in GDP fora sample of coueres The Urite States by vrwe of ts sze and he ‘vert ofits resources relies les. onntrational ead chan almost nother counery. etecuapragiiieaat SBOE Bie wtpriesa ecco U5. Nao! cone xyes inp (Berar e's Salome “ 3 2 ie ° eae 5 960 1605 1870«7S MDS SHO. «1085-——2LOO From he 19609 1900 bat expan and ports rore sen a shares of US income Sae 1980.crpor hv Mscsted harp Ri rcengs oan cone in 198 msreerieageapeeriiie cise ge ‘tometer cour trae an iis tobe Uned Sate CHAPTER | Introduction ‘Consequently for the res ofthe word, International economics seven tnore important than eis forthe United Sates, “This book introduces the man concepts and metiods of international economics and ‘usirates them with spleens dravn fom ee real works Much ofthe book s devoted ‘old ideas that are sull as vald as evr: the rneteont-centaryerade theory of David Ricardo and even the eighteeeh-cantury monetary analysi of David Hume resin highly Felovanc co the cwengy-rscentury world ecanamy AK the sume time, we have made 2 speci efoto bring the anaiyss upto te. The global economy ofthe 1990s threw vp ‘any new challenges. rom the baldash agains glbalaaion vo an unprecedented sees of financial crises. Economists were able & app extng analyses to some of these cha ge, Dut they were alo forced to rethink some importaneconespes. Furthermore, new approaches have emerged to ald questions, such a the impacts of changes n menetay and fsa policy We have attempted to convey the kay ideas that have emerged in recent ‘research while sresing the concnuing useless of od deat. © Bivnat is international Economies About! Intemational economics uses the same Fundamental methods of analysis eter branches ‘of economics, because the moves and behavior of individual fe the sme in inten ‘unde as they ae in domestic tarsactions. Gournet fond shop in Ford sll coffe Deans from bath Mexico and Hawai the sequence of evems that ought those beat 0 the sop isnot very diferent, and the imported beans teed a mich shorter stance Yt inter tional economies invalves new and differen concent, hecuse intentional ade and {investment ocear between independent nations. The Utd States and Mexico are sovereign stsies; Florida and Hawt are nor. Mexio's coffee stipmests to lard cou be dtropted ifthe US, goveinment imposed a quoca tha mits imports: Mexican coffee could suddenly bucome cheaper to US. byets ifthe peso were to fl in value agalns the dolla. Neither of those evens can happen in commerce: within the United States borat the Const oF- bcs estraits on inersst nde and all US. slates ue the same cureney ‘The subject mate of iotemational economics, ten consists of iss raised by the spe- cial probiems of economic interaction bewveea soveeign slates, Seven themes recar tvougho¥t the study of interpatioral economies: he gains from trade, the pattern of ae, protectionism, the balance of payments, exchange rae determination, iteration policy vondintion, ind the internatianal capil market. ‘The Gains From Trade [Everybody knows that some iernational rade is benficil—nobody thinks that Norway should grow is own oranges. Many people a skepucal, however, about the benefits of itading for goods thts country could prodce for ize Shouldn't Americans buy Amei- ‘ean goods whenever possible, to help create jobe inthe United Sates? Probably the most important singe insight inal of iteration economies that here ‘te gains from rade—that i, when counties sell goods aed services to each oer, this xchange is almost always co thegnuual benef, The range of circumstances under Which internation trade is boreicial is iach wider Bian most people imagine. Ris common ‘misconception that rade is harmful if there are lrgedspaies between counties in yro- ‘tuetety oF wages. On one side, businessmen in less technologically advanced counties,CHAPTER | Ineroduction sacha ei fen won tht peng hires tration te wil is ier homes andes wet eae ocenpoe: Ontheaer se pope ie saeseaty stance mates whore were eng wager ten fe ans reeSmocesowerge coum wl ng ex sar fing doe Pes ‘cine emery ware “sat sucking oe te Unied Ses weet cores erase operon ith Mesen. “tc tends teens book (Chal 2 demons tht oun con ‘od i et enctvenwhonon af ber mec tan hee pee senesced when pede nti een: soe am comet on By Se erect sess at tue pois nef yang Comms ca es wtes rection aks any hay ue reoucstat re ely Shur wearing 008 wh rofocton make Beary ux of ese tt 3 aan aap erat! uae aly slow cute to specs a go- al Sens gush ging em pease See ogee recon ea gaa of cca teed aie gi ode Ineo pee antral Howie a feng ae a forts fest Se sane erin sinc abr gndy ands he sec 9a cen gee {etn yom i fre pots (chap) ial erin exsangss ike ease aston bn al cones avingeach out #8 wens te ei af come (Gap Tse mobos oe iat nel he a dau pfs sk tom ain Ameria Torn nackes Braten, Cie hn rey in nao! ae we is ie sar se ay RO aa: uth atin ofr es, tr Hea ae il ite aeongofets onthe distibuon of inome. The fect of inde on a be hat lng tos conn sims ava wo hve Foie tt Intemational tade can adversely afet the ewners of esoures that are “specific” 10 duties that compete wih imports, tht, cant find alternative employment in ster induses (Chapter 3) “Trade can lo alles the disinbution of income between broad groups, such as workers ‘and the owners of epial (Chop). “These concerns have moved from the cessroom imo the center of real-word poly debate, aitfas become inetesingly clear that the real wages of less-skilled workers inthe ‘United Stas hve been dclining even hough he county 363 whole is continuing o grow ficher Many commentator atte bis development 1m growing intemaional rade spe lly heap growing exports of manufoeured goods from low-wage counts. ASS ing is la has become an important [sk for iterations! economists and is» major there of wth Chapters and 5, “The Pattern of Trade Economists annot sass the effects of ntemlional ade or recommend changes In z0¥- emvmeat policies toward trade with any confidence unless they know thelr theony is ood hough explain the intesational trade that is acaly observed. Ths temps to explain CHAPTER | troduction ‘ih pars of inlemationa uate—who sells what to whom—have beens major peace pation of inleralora economists Somme sects of the pattern of trade are easy’ to understand. Clinae and resources cieaey explain why Brazil expos coffe and Sac Arabi expos oi Ach ofthe ptt fof wade is more suble. however. Why does Japan export sitomotiles, while We United Sues exports area? Inthe early sneteenth century English ecoramist David Rico ‘offered an explanation of wade tems of international diferences in labor produc. an explanation ta emit a powerol insight (Chapter 2), lo the tweet eonty however, alteraive explanations hae also heen proposed. One ofthe nes influent, bt til cam troversial, links trade pateres to aa infraction betcen the elative supplies of national resources such a api abo, and lr on onesie and he relative ase of these actors 0 the produetion of elferent goods onthe ether. We presen tis theory in Chapter 4. Rece fons ce est the implications of this theory, however, appa shove thal less valid than many had previously thought, More recon tl, some intemstionl economists have ‘proposed theories at sigges substantial radom component in the pater af Inte Vina ade, theories tat are doveloped in Chapter 6, How Much Trade? Ifthe ies of gains fom ude isthe most important theoial concept in ateratenal 20 nomics. the seemimaly eternal debate over how mich trade to allow iets most important policy theme. Soe the emergence of moder nationsstes inthe sixteenth century. 0% roments have worried about the effet of imerational competition onthe prosperity of| domestic indies and have ried either to shield industes from foreign cempetiton by placing lini on imports a to help them in world competition by sabsiizing expen, The single mos consistent mission of ileritionl economics hasbeen t analyz the eects of these so-called protections polcies—and usually, dhough nt always, oerileize protec Unis and sbo dhe advantages of feet intentional tad, “The debate over how much trae to allow took a new direction i the 1990s Since ld Wor I the edvanced democracies, fe by the United States, have pursue a broad policy of removing baniers to intemationl (re his policy reflected the view that fee teade wa force not only for prosprity tala for promoting worl peace. nthe St alf of the 199s several majc re-trde agreemeris were negotiated. The mos notable ere ‘he Noth American Fee Trade Agreement (NAFTA) beeen the United State, Cana, and Mexico, approved in 1993, ard the so-called Uruguay Round agreement establishing the World Trade Organization in 1994 ‘Sines the, howeve, an international polis! movement opposing “globalization” has ‘gained mamy adherens. The movement ahiewed notoriety in 1999, when demonstatrs "epresenting a mix of tradivonl protectionss and new ideologies disrupted a major iter- atonal wade meeting in Seale. 1 nothing else, the aa-plobalizaion movement has forced advocates of fee tae tosek new ways to expsin tet views. ‘As befits both the historical importance and the Curent relevance of the protectionist, Issue, roughly a quater ofthis bookie devotod 10 this subject. Over the years, iteration al economists have developed simple yer perl analytical framework for determining te effec of government policies that aft international trade. This framework net only ‘reds the effets of trade policies, lo alles cost-benefit analyse and defines erieria for éeirining when goverment inervention is good for te economy. We present tisCHAPTER | Inerocuction ‘amework in Chapters 8 and 9 and we ito cuss» numberof policy issues in those chap ers and inthe folowing we. Tn he cal word, however, governments do not necessarily do wh the cost-benefit analysis of economist ells them they sould. This doesnot ean that analysis is useless Economic analysis can help make sense ofthe polis of intentional irae poly, by showing wio benefits and who loses Fam such goverment aeons a5 quotas om ips “and subsidies senports The hey insight ofthis sas is hm confit af interest wihia rations ate esually mote important in determining tae policy tan confers ieterest ‘enon atone Chapters 3 a4 show that iad usually as very song effec on income ‘istbation Within cours, ile Chapters 9 10, and 1 reveal tht the selaive power of ‘ilerem interes groups within counes.rater han sors measus of overall atom les- ‘st is fen the nan determining facor in goveeument policies tovantnternatona ode Balance of Payments 1m 1998 both China and South Korea ran large ade surpluses of abou S40 billion each. In China's ease the trade surplus was nt out ofthe ordinary—the county had beea runing Tage srplses Fr several year. prompting complaints from other coanves, inching the United Stats, hat China was not plying by te eales. So ist good to run a Lradesurpus, nd bad vocun trade deficit? Not according to the South Koreans: her ae splus was forced on them by an economic ancl erisis, and they bitely resented the neces 'y of running that supe “Ths omparaon Highligh theft thats country’s Befance af payment must be placed Inthe content of an economic analysis to uadersand what i nea. I emesges ina sti of specific comtete in dseusig atrmona cat! movements (Chapee 7), in relating interatioral tansaction to national igcore aounsing (Chaplet 12) and in discussing vit. tually every aspect of international monetary policy (Chapters 16 through 22). Like the problem of prctectionism, the balance of payments has become a central issue forthe United Stats because the ation hes run huge tad deicis i every year snee 1982 Exchange Rate Determination “The eur, a new common currency for mast ofthe rations of westen Bure, was into duced on Jansary 1, 1999. On that ay the euro was worth aboot $1.17. Almost immedi- ately, however, the euro began to slide, and in early 2002 it was wocth only about $0.85. ‘This side wos a major embarassmet to European poiticians, though many economists argned thal the sliding euro had actualy been benecil to tbe European economy—and Tha the strong dll had become a problema forthe United Sates ’h key diference between intereational economies apd oer areas of economics i that counties wally have thei om euzences. And asthe example af the eure-dola exchange ‘atlases, the relative values of ctences can changeover me, srmsimes erat “The study of exchange ate determination is aelavely new part of international ec2- omic, foristoriel reasons, Formas! o he twenties centr, exchange ateshave been ‘xed goverment setion ater than determined in the markaplace. Before World War | the vale of the world's major currencies were fixed in terms af pod, while fora genera tion aftr Wor Wa lhe values of mos corencies were fixed in terms ofthe U.S. oli. ‘The analyst ofiteationl monetary systems ta fix exchange rates remains an important subject. Chapters 17 and 18 are deveed tothe working of fixed-rate ystems, Chapter 1910 CHAPTER | Introduction ‘the debate over which system. ined or Meating res, is beter, sl Chater 20 to the eo ‘omies of curency ares uch as the European monetary unio. Forte ine being, how ere, sone ofthe world's most important evehange sss tune mine by ste and the role changing exchange rales rms a ihe center ofthe international economies sory ‘Chapters 13 trax 16 focus onthe modem sheory of Moalingveckange eaten nal Policy Coordination Thntematon economy comps oven mon, ech fee w aes son eo: sonic picks. Unfraty,n sn integer) economy en eu ceo oer litt ronal Fr xmpi vce Osman Boor ‘enero resin 1980 sp too conl he pes ony np of ‘uniaton of Wes a Ea Geman heed pipe eso ot Westen Europ. Diflrncs in gens vera cme ahem ea cna of bees Een wien cunts hve sr gas, hy my sal ees i ey alo curiae Sheps fname ple in taal economics he oped accel dete of harmony siete liettioal ace inal pole of Be ‘rent coun wihot a ert goverment tn ls countes wat oc Forth 4 ees mcationl Wade pls ine boo gored bya inertia mat no she Gent Agreament on Teri and Tae (GATT ed mane ee sonal noting neat fees ane hve bes Me dsoc ‘elon fo his ymin Chap and ok at ter the ce rele oe ae naan aden he werd ecoony can or shoal survive. ‘Wile copeton on nero! aie polices en welesablshe adn, sor ination of iterations! maeroecononi plies 8 ener anders wee ope ati the ist ev yen ave econo erased at all racy tecs or es ono pliecbttnation Norte, tps at ntracona maroconcns ce incon ceuig wt ring fee ne eal wt. Boh een tational macroeconomic ceounaton and he developing expences revo in ‘Chapters 18 and 19. ee i ‘The International Capital Market Daring the 1870s, banks in advanced counties lest large sums to firms and governments a Poorer nations, especialy in Latin America, In 1982, however, hier of easy credit ame toa sudden end when Mexico, then a numberof ether counts, found themselves unable {0 pay the money they owed. The reslhing“Uebt eis” pecsised until 1980. In the 1930s Snvestors once again became willing to pat hundreds of blions of dlls into "emerging ‘arkets” both in Latin America end inthe rapidly growing economies of Asa. All to son, however this investment boom to cee 1 ue Mexicaexperenced another finan ial csi the and of 199 nd much of Asia was caught upin a naive css begins in the summer of 1997 This roller contr history conain many lessons, the most unis. ‘uted of which she growing importance ofthe ntrmationaleaptl market, In any sophisticated ecoromy there isan extensive capital market @ set of arenge- ‘ments by which individuals and firms exchange raney now for promises to pay inthe future. The growing imponance of internatcnal rade since the 1960s has been socom. nied by 2 goth inthe international eaptel market which inks te capital markets oF Incividual counties, Thos inthe 19705 oil-rich Middle Eastern nations placed ther oilCHAPTER | Intenduction events in ans in London or New Yor, and these banks in sum lent maney to gover ments and corporations in Asia and Lavin America. During the 1980s Jepan converted much of the money i earned fem its booming exponts ino investments inthe United ates, including the examen of a growing aumber of US. subsidiaries of lpanese corporations. Internationa capital markers df ia important ways from domestic capi markets “Thay must cope with special egaltons that many counties impose on Tord invesmen Ihey ele sometimes fer opportunities to evade regulations placed on dortstic markets ‘Since the 1960s, age international capil markets have arisen, most notably the remari- tbe London Ewodollar market, a which billions of éollar are exchanged exch day wth but ever touching the United Sttes ‘Some speci sks are astociled with international capital markets. One skis bat of| curacy flucitins: I the ent falls against be llr, US. investors who bought eire bonds suf capital loss—as the many investors who had sumed that Europe's eeu ney would be strong dieovered to ther horce. Aether isk ie that of national def: A ‘ation may simply efi to pay ite debts (pedaps because it cannot), and there may be 0 tllective way forte eredivor obring it to cour ‘The growing importance of iteration coptl makets ad hei new probes demand treater atentin than ever before. This book devotes two capers 0 issues arising from international capital markets: one on the fonetioning of global asset market (Chapter 21) snd ane on foreign borowing by developing counties (Chapter 22). Bhitornational Economics: Trade and Money ‘The economics ofthe international economy canbe divided io two broad sbi: the Huey of interaronel trade snd the sul of invenacional mone: Iterations uae aly sis focuses primarily on the rea aneectons i the interational economy, tha ion those twansctions tt involve a physical movement of goods or a ungible commitment of e alow seca te prodston of Mine if PlPy © yl Osly hen Fey seal 0 ey will bth Eoods be produced hate sighcanc ofthe mba? We inh pein aon this hc apoyo of ces ines of Sine We hve hrf jot deed a a srepeon abuts brn pie nd podscton: The evan il pe lace ne podecn af ches he lap of hese xen aprortay ou iw apc ihe proton of eerie pi of eee yh i habe of nemo ts, Mame wold hove pode bath gods rll ‘a cil posice bot gods elite nive pe of he eq H8 Opa {ey et Sic porn cot eq hea vt er reguremens Inches ond Sine an suman he eatin of es ee absence of eral ae Sina simple hero ae: Ih obsece of ternaonal tae, reese Dre of goer eel late a labor gure [Bsc ina one-Factor World “To describe the pavers and effects of ade between two countries when exc country bas only one factor of predaction is simple. Yet the implications ofthis analysis canbe sur. prising Indeed to thore who have not thought about international (ede many of these Frnpliestions seem to confit wih eommon seve, Even this simples of trade models can ‘offer some importnt guidance on real-world issues, suchas what consis fair interna tional competition and ar iteratonal exchange. ‘Before we get ta thes sues, however, ets ge the medel sted. Suppose tat here are ‘wo counties, One of them we agin eal Heme and the czor ve eal Foreign Each ofthese ‘counties ae one fetor of production (lber) and can produce twa gods, Wie and cheese. Us before, we denote Home's labor force by L aed Ho's unk abo requirements in CHAPTER 2 Labor Productivey and Comparative Advantage ‘wine and cheese production by gy and a, vespostively. For Foreign we will use acomve- ‘et notation throughout this book: When we refer co ye sspec of Forean, we wil use the sme symbol iat we ue for Home. bt with an asterisk, Ths Frsin’s labor fre wil be denoted by 11: Forsige’c unit bor requirments in wine ad cheese willbe denoted by fag, and aj, respectively, nd soo. "o general he uni aborequierents ae fellow any pater. For example, Home could be less productive shen Foreign in wine bat more prdtive fs chase of wee versa, Fr the moment, we make only one arbitrary assunpion tha tyclagn < ahleiy 22) ‘or equivalently that eulote < tate In words, we are assuming tha the rato ofthe labor sequited to produce 0 pound of| theese to tha equied to produce 2 gallon of win slower in Home than isin Foreign, are iy sl we are saying tat Hone’ aie produ inches igh ‘Bux remember tha he ati of wl lor requirements equ to the opportunity cost of cheese in tes of wine; ard remember aso that we defted compsralive advaniage pe ise in terms of such opportunity cout. So the estamption about clative produetiits embodied in equations (2-2) and 2-3) arnouns to saying that Hone hae & comparative advange in cheese One point should be roted immediatly: The condition undor which Home fas this comparative odvanage involves ll four uit abor requirements, pt just two. You might {Bink thao determine who will produce cheese, all you ace todo i compare the to ‘ovrties' unit Ibor requirements in cheese pedi, eycand fe Wage atl bot Home and Foreign will specialize in cheese produc- tion. There wil be no wite production, so that dhe relative sepply cheese will become info “The relative demand curve RD docs not require such exhaustive analysis. The dowaward ope of RD reflects mbstiuaion effets As the elative price of cheese ries, consul {end to purchase lee cheese and mere wine, 0 the relative demand for chese falls. “Toe equiltrim relative price of cheese fs determined by the icerseeion of he relative svpply and restive demand carves, Figure 2-3 shows a relalve demand curve RD that intersects the RS curve at point I, where the elative price of cheese i Betwesn the wo ‘cournies:pretrae prices, Te thease each country specializes inte production ofthe good jn which thas» comparative advaniage: Home prodaces only chess, Foreign only wine CHAPTER 2 Laver Productivity and Comparative Advantage ‘This is no, however. te only posible outcome fhe relevant RD curve were RD! fo example relative supply and relative demand woul inesect on one of the hoizotal ee- liens of RS A point 2 te word cave price f cheese ater tide faye. te sam 98 {be opportuni ost of cheese in ers of wine Home. ‘What the sigaifieance ofthis outcome? If the reaive price of cheese is equal tits ‘ppotunity cat in Hom, tke Home economy eed ot specie in producing either cheese or wine: I ft, t point 2 Horse must be producing both some wine and some cheese we ean infer tis rom te fae thal te eave supply of eese (poi on ha ~zonl ani) iy less tha it would be if Home were in fae completely specializes, Since 2.1Ps is blow ths oppenniy cost of cheese in terms of wine in Foreign, however, Foreign des specialize completely in producing wie. It therefore reins te thet if county ‘oes specialize, wll doo nthe goed in which it has a comparative avantage Let us for the moment eave aside the pessbility that ane of the two contre does a ‘completely specialize, Except in tis ease, the aml result of trade thatthe pice ofa traded good (©. cheese elative to that of another good (wine) ends up somewhere is ‘batweot it prerade levels in the wo counties, ‘The effect of his convergence in relative prices that ach county speilies nthe pro {ection ofthat good in which thas the relatively lower ui labor requirement. The ris in he feltive price of cheese in Home wil lead Home to specialize in the production af cheese, peo dosing at pie F in Figue The fall nthe elaive price of eheese in Foreign wll ea Foreign ospcitze in th prducion of wine, pxhcis poi Fn Figure 2b, ‘The Gains From Trade ‘We have now seem that coustries whose elatve labor produits differ across industries Will specialize i the production of different goods. We next show that both counties Wer Felbiy> ale Bur we just aw that in intecrationl equilibrium, iFneithercounuy produces both goods, we must have Pe/Py > dyoldyy. Tis show that Home can “produce” wine mote ecient ly by making cheaze an wading i than by producing wine dived for isl. Similarly,20 PART | International Trade Theory PEGG ove ‘usnty Sain conan uty Stetmete, Oc (a)teme ‘revrtonel wade slows Home 34 Forel censure arywhere win the colored nes, ‘ich le ona the coun produton posi fronters Forsign can “produce” cheese more efficienily by making Wine and iading Ths is one ‘vay of seeing that both counties gin “Another way to se the muta! gains from wade i 10 examine How made affets each county's possibilities for consumption I the absence of trade, consumption possibliies Sr the same os proton posibilies (he slid ines PF and PYP* in Figure 2-4). Once inde is allowed, however, each economy can consume a differen mix ofcheese and wine feom the mix it produces. Home's consumption possibilities ar indicated by the colored line Fn Figure 2-4, while Foregn’s consumption possibile are indicated by T*F* in Figore 2a Ineach ease ade hs enlnged the range of choice, and therefore it mest make residents of etch county beter off. A. Numerical Example In this section, we use a numerical example to so lal points: ify our understanding of two er “Whee two countries specialize in producing the foods which they havea compar ative advaiage Bosh counees gain rom wade. ‘Comparaive advantage must nat be corfsed with abslure advantage itis compar. ative, not absole, advantage that detacmines who will and should produce & good. ‘Suppose, then, that Home and Foreign have the unit labor requirements illustrated in Table 22 CHAPTER 2 Labor Productvey and Comparative Advantage PA ratte 2-2 | Unc ater Reguremenss Chee Home ‘yc bow per pou ty = Dhow per allon Foreign (8, = G hone per pond {nig = 3 hours pr gallon A striking feature of his tables that Home bas lower anit nbor requirements, that hs higher labor produit, in both industries. Let us leave this observation fora mena, Ihowever, and fous on hepato of tad, “The frat hing we need to doi determine the eativ price of cheese PP. While tye sctalrelaive price depends on demand, we know tha it us le between he eppoctunity ‘cost of eheese inthe two counties, In Home, We have ge Tod ® 2:90 the oppor {y cost of cheese in terms of win in Homes ely = V2. IN FOeigh oe = 6 hy = 3 5 the opportunity cost of choose i 2, In world eal, the relative price af cheese ‘must le between these alues. In our example we azaume thot in world equilibrium & oun of cheese trades for a elton of wine o wold ack xo that PJP = 1 pound of cheese sll forthe same pice a sllon of wine, bth counties will spe= wh wl po: ‘duced in Home, while any good for which e/a, wh will be geadoced In Foreign. ‘We have skeay tnd pth goods in ntssng order ot eqonton 6) Tis rerio fer specs tt wha persis et” it hap dere! oy {he ro ofthe counties age ates, fr All the pods tote eo he et dp Seing rece in Home he ones eight end up eng proce n Fig. he forse a we Wille ina moment ha he alo of wage aes eae ote alin fiber eine fron gd hee his bret pod mayb ed inbath countses) “Table 2-4ofersa numerical example in which Home an orig both consume ad ae able to produce ve goods apples, hana, caving, deen, and ened ‘Toe fst wo cola of saber se-expantny. Then the rao of the Foreign ni lbor eurenent tothe Home ui aor eqeiemen fr ech good sed rely, ee Hone svg arnage tec god, Wee ied the goods nod of Hore rarity advange, ithe Hoe sane Beate it anplesand et foreahag eee a20 PART | International Trade Theory a 2-4 | Home nd Forign Unt Labor Reais ‘eon siete Foigtnttabr "acy cut foment) Regione Gt) Ades) ror 1 Fa rs Soe ‘ ° : cone : 2 : mos ‘ a 2 Eas a > ans scone paes which on opens on te ao of Home a Farcgn ws tac Hamel ve cont emp ay on ir wh i ne ety ihe a fle Wage nd Fen wl ve the advantage nthe oh fc Nees ome wae nese es tat of Fgh oof ome wap Feegn arcane) apes aoe lb pede in Honea eva. aes, on casi Foch ome oop eae tines thf Frag, Home wll rocco bee nd avi, hile Foreign rede es ab ens. ee pcm of eatin tee bh nutes? We cane hts sng te sme mated we wed eater comparing fe aor cast of proding 2 > Jeet couey wiht of ney “pod by prodicing arte god and ‘fang ete dsc pod Ie Hope wage eee esis the Foreign wage (Dt sea Gy Facgns ape tts one th that Hoe), Hae wil port das and Secs” x unto es reqs Taunt of Foe lero pode 8 cx a een abor gen teem ge te, nly pon ous (12+ 3) Iertothe ponen ouside pe te Sis Hae. Foren, Foreign sul ao higher pode long ih Toueewapst mil cox Heme ny 3 potas sna enh ones ae conpe whe 2 peerious wold seo rosie domestica Asi reesei sow ta opal gin foreach te pods ecg pats tunsato heapr nro eenic mort ad rte foo rar hn pode std omental Foren wale 10 hots of Fein abe optics» tai of ples een with wag toy oe of Hane wane wl hie lp Sets fio cam enough toy i al of eles Hone pina ths clenions tows we espa hl heave wape suc How dons heave ogee ele trite? Determining the Relative Wage in the Multigood Mode! nine to ed mel we deerme ev ges by facing Hee ges ‘Eitan us Frsgnwges net in en ing he pee hee eve (Coats deac te oof het cote wags x Wo cond do Cita tne at owe woud po head Foy wine Ine ang Cease at con bdrm ny sere kao erate mee a Eee NGivaade Todeuminewhvewagsnamuligedcernony ve mas, CHAPTER 2. Labor Prodectivity and Comparative Advantage ook behind th relatve demand for goods to he inp relative denn fo labor. This is nota divest demand on fe par of consumers; ater, iia deived demand that esas From the deme for goods proiced with each country’s labor ‘The relative derived demand Fr Hoe bor wil fall wa the ratio of Home vo Fore wages rises, or wo reasons Fis, as Home oboe becomes mote expeasiveeltive 1 Far ign fabor,gondepradoced in Howe also become rlaivsly mare expensive, and workd demand for these goods als Second, as Home wages se, ewer goods willbe produced in Home and more in Foreign. tuner eadacing the dersnd fr Hoe nk We can illsace deseo eects using our numerical example, Suppose We stat with ‘he fllseng sition: The Home wage is inialy 3.8 times the Foreign wage, At th level, Home would produce oppls, bananas, and caviar while Foreign would proguce dates ‘nd encilads. If the relative Home wage wero increase from 3.5 just under 4, say 599. the pattem of specialization would ot change, but as the goods prodsced in Home became relatively more expensive, the eave demand or thete goods would deine ond the lative demand for Home labor would decline wi it. ‘Suppose now Wha the cesive wage were to increase sihly fom 399 42404. This small farther increase in he relative Howe vage Would bring bout a sit inthe pate of specialization. Because itis now cheaper to produce caviar i Foreign than in Home. the Production of caviar shifts from Home to Focign. What doce this imply forthe vlaive ‘enan for Home Iabor? Clearly it implies that asthe ative wage res Grow ite less than 410 ttle more than 4 thee isan abcupt drop inthe relative demane, a Home production of caviar fils to zero and Foreign aequites new fds Ite relative wage ‘contines 0 rie, relative demand for Home labor will gadvaly decline, ten érop off ruply at a relaive wage of 8 at which wage production of bananas shift Foreign We can illustrate the determination of relative wages with a ciagram ike Figure 25, Unlike Figure 2-3, thi diagram doesnot have relative quantities of goods or relative prices of goods on its aes Instead it shows the eat quai of lor andthe elalive weg rate ‘The world demand fr Home laber relative tos ema for Fst aber s shown bythe ‘curve RD, The weil supply of Home labor relative Foelgn labore show by Ue line RS. ‘Tho relative supply of aber i decermined by che lative sizeof Home and Foreign bor forces. Assuming tha the numer of person-hoars available doesnot vary with te wage, ‘he relative wage as no effet on relative labor supply and RS isa vet ic ‘Our discussion ofthe relave demand for labor explins the “stepped” shape of RD. ‘Whenever we increase the wage rate of Home workers relative to Foreign workers, the ol ‘sive demand for gods produced in Home wil decline ant the demand for Hone labor will ecline with i. In ation, the relative demand for Home labor will dropoff abropty| ‘whenever an inerase in the relative Home wage makes a good cheaper to produce in For ign So the cuve alternates between smoothly downward sloping seztions where the pat {em of specialization oes not change and “Aas” where the relative demand shifts abrup- ly because of shifts inthe pattern of specialization. Ax sown i the igure, hoe las” ‘correspond fo relative wages that equal the ratio of Home o Foreign productivity foreach ofthe five goods. ‘The equa relative wage i determined by the intersection of RD and RS As dra, ‘he equilibrium relive wage is 3. A ihis wage, Home produces apples, bana, and ‘caviar while Foreign produces dates and enchlades, The outcamc depends onthe relative size ofthe couniries (which determines the poston of RS) and the relative demand for the gods (hich deterires he shepe and position of RD} »30 PART | International Tee Theory RES siscncencrre wags inarmanygood Rardin model Rela nope rete wages are determined 9 1H by the uerseccon of ie derived rove demand carve {er labor RO wih the live sel BS Ifthe icersecton of RD and RS happens teen one ofthe Hs oth countries produce ‘he good fo whieh he Flat spies. [Bcsing Transport Costs and Nontraded Goods ene al at ley ein le te vt upon co abot henge herp of compare ‘Stag nu nce Decne vnporcon oe Sts the vee Sod nd ttn howee hey tae import mens or te way © a esc eonany acl yay a to hog i mae ese ttf bas pes pons wel nde hte lof oe tres te aligned oct ed iu god ce 1 ids the te tapers oe pl at te wor econony eset ythe mode fe it ston by ey sree mere spe At et er te ns Om Do Couns Modal pe woe tin Home rin Fo, tn eh, inca an en wy setae enn canon st this exeeme: 1. Theexistence of more han one facto of predsion reduces he fendncy toward spe alization (ewe Se in the next wo chapters). bee CHAPTER 2 Labor Productivity and Comparative Advantage 2 Counces sometimes protect indusri from foreign competion (iseussed st ength ‘in Chapers 8 through 1). 3. Iiscosty to tanspont goods and servos, nd in some cases the cos of tansporte= ion is enough fo ead counties ino sell-tlfcieney in cemain sectors. Inthe maligood example ofthe Ts section we fond hat a eave Home wage of 3, Home coud rode apples, bananas, and eave more cedply tan Foes, wile Foreign could pends dates and enchiladas ore cheaply than Home. fh he absence of transport ‘oss, then, Home will export the ist thee goods and import the sto. "Now suppose there isa cost to ransporing goods, and Wha this ranpoet cost is a: fax ration of production cos, say 160 percent. This rnsparation cos wil discourage tie. Constr, for example des, On unt of hs ood requis 6 hours of Hoe labor or |2 hours of Fceiga laborto produce, Ataelatve wage of 3, (2 hows of Forse labor cost only 35 much a 4 hour of Home labor; 9 he sbsence of transport costs Hone imports Aes, Wi [00 parent wanspont eos, however,nnping des would ox the equivalent ‘8 hours of Home fbr, s0 Home will produce the good forts inten, A similar ost comparien shows tht Foreign will id it cheaper to produce its own «via tha import unit of caviar equites3 hous of Home labor to prodnee. Even at relative Howe wage of 3, which makes this he equivalent of 9 hoa Foreign lobor, this is cheaper than the 12 hours Foreign would need to predae cava fr itself Ue ‘shsenee of transport coss, then, Foreign woold fing it cheaper Lo import caviar than to "nuke ic Gomesticaly, Wit a 100 percent cost of wansporation, however, imported caviar ‘wold cost the equivalent of 18 hours of Foreign labor and wel therefore be produced Jocally insta ‘The resol of inroducing tmosport costs inthis example, then, is thet while Home stl ‘exports apples ad banat and impor enchiladas avin and dates become nontraded ‘fonds, whieh each country produces frie. In thisrsarple we have assumed tat anspor cots are the same faction of production cost inal sectors. practice there is wide range of transportation cot, In some eases ‘eansportation is virally impossible: Services such as haircuts and at repair acer be traded iteraionally (ercept where the isa metroplian ace at saddles ber ike Detroit, Michigan-Windsor, Ontario), There i aso Title intemationl tein goods with high weightto-alue ratios, ike erent (Is simply mot worth the transport costo import. ing cement, even if can be produced much more cheaply abroad). Many poods ene vp ‘being nomaded ether because ofthe absence of tong national cox advantages ox because of high irmsparaton ests, ‘The important point is that nations spend a large share of tir income on nortaded 00d This observation is of surprising importance in oar later discussion of international transfers of income (Chapter) nd in merational monetary eeonomice, BEopirical Evidence on the Ricardian Mode! ‘The Ricsrdian model of intratonal wade isan extremely sel too or thaking about the ‘reasons why trade may happen ad about he effets of inematonal rade on naionel Wer fare. Bus the mode a good fit othe eal wodd? Does the Risin oss make aetna ‘reictions about acta nerationa rae ows? uwi a 2 PART 1 International Trade Theory Tre answer sa hewily qualified yes. Cleaey thee area namber of ways in which dhe Ricanian model oakes misleading precision. Fist, as mentand in ovr discussion of nwraed yoots the simple Rieardan model pedis an extreme degree of specialization Th we de ot sbserve inthe real word. Second, the Rkearian model assumes away ise: of ftenaional rade on the stint of come within eouaies, and ts pre- ‘ie that countries as a whole will always gain Frm rade; in practice nervational ade tas stong effects on income dstbaton, which she focus of Chapter 3. Third, te Ricar- tian model sllows no role for differences ia resources among contries a acause of ae, ths ming an important aspest ofthe trading system the fews of Caper, Final the [Ricarlan model neglets the possible ole of economies of scale asa cause of tae, whic teaver it unble fo explain the lange rade ows betveen apparel sitar waions—an ieee discussed in Chapier 6. Th oie of these filings, however, the basic predicion of the Riearian model—shat counts should end o export thoge goods in which dae productivity relatively high— hasbeen siongly confirmed by a nursbe of stadies over the years. ‘Several else teats of the Ricardion model were performed using dats fom the early post-World Wer period compaving Bish with American producivity and ade! This (fas an natal ilminating eamparson. Bish aber productivity was ls than Amer Jean in almost every seater. Thus America had an absolute advantage jn everyth [Nonedieles, the amount of Bris overall export was about as lage as America a the there most have baer some seetor in which Britain had a comparative vantage in spite ofits Tower absolute productivity. The Rardin model woul prec thatthess would be the sectors in which Ameie'sprodetvitysvantage was smallest igure 26 lures te evidence in fava ofthe Ricardian model, using dota presented ina paper by the Hungarian economist Bela Balas in 1963. he figure compares the rato (ofS. to Brkish expont in 1951 with he ato of U.S. to Bash aber productivity for 26 tanufictoring indosties, The productivity caio is measured on the horizontal axis the Capor ratio onthe vertical axis Both axes are given a logarithmic safe; this snot of any base importance, bu tums out o produce a clearer etre. icanian theory would led ws boa 0 expect tha he higher the relatve producti fay ine US. industry, the more likely US. ater than U.K, fms would expod in that Industry, And that is what Figur 2-6 shows. In fet, the seatterplo ies quite close 1.99 ‘pwari-sloping lineal shown inthe Figure, Bearing i mand that he data used for his “Comparison ae like all economic data, subject to substantial measurement rors, the is remarkably cose. ‘ar expeted. the evidence in Figure 24 cafiems he basic insight that rade depends on comparative 0% absolute tanage- At he time to which the data rte, U.S indusry bat ch higher labor productivity thn Bish indusiry—on average about twice as Hh. ‘The commonly held svsconception hat a eoutzy can be competitive ony if tea mach caer counties produativiy, which we discussed erin this chapter, would Have Ted one Te pneing ody 0.0.4, McDoupin itn Pater Rata teense cn A wel bom Mice tho tle we cw re wa Bele as "Ax Eptel Denentatan of Css Caer seen Tcl nae ows on Sw 4 Ange BE, 9p 31-238 weve aba nts Soviet CHAPTER 2 Labor Produtiity and Comparative Advantage FREE icin an Eps ‘Acompradie sty showed at US. Ratt exports were highreaivew Bice US rich cexparen nei in wich she aaa} United rts high este nbar 4 producing Each de reprtents 2 (eren indutey 2 2s 5. oot Ba ke Reso US ean posit to preto US, expr stantage aot The Rian node ls hoe, thang nh psy nny compared ih ges mot neg Cont at acini expr nts rise te pry ms Wigheompaed wit lave oda ned sx, Aske, US. podrtny txcede Bish al 26 sero ed ya) sown a ge 209 Mens ‘Sing Fm 1 0335p, 1 of snrs homes rsa a oes xf ne a Sa A hae ust ne Ur ‘ere ar han UK expo ines vee US poy ange {mews none thn 8 WON. EUS protectins ataniage was Nore cet viene onthe Rican motel hs ben es lau Inpa iss ecu the goin for ean th eng sein eatin! oomies ‘ovr wo gushes nt unc by ine weed tay 908 coor on Sn xtc pote ich ary seas compa Sed. vanes eres owt eee jet 'n noe ec, er ple mos Coots do ot poace spon 0h sea non wat te un bee Sins noe fn et Newrlsthe aesetpis of eine rete Se at at on lyon tn ig Petar topo poi ith ie conn bh hg ifenes in orp ees ems tl coe ian te Pot fer ans aie For cane ot sy nd a hee ea 9 rin apse meng i 990 wa 20 pre oe han or pai tb Ute tae. Bt in hse dats a nds Tapes poe34 eine PART | Internationa Trade Theory was 16 to 2 percent higher than American preuctivty? His not hard to believe that this disparity explained much of Japan’ ability ve export milions of antomodiles othe United Sates. In he ease af automo, one might argue dat the pattern of trade simply reflected absolute vantage: Japan had the highest prodycivity and vos also the worl’ lagest, txporter. The prinsple of comparative advantage way be lustaied bythe ense of word trade in clothing BY any aasure, advanced coos like the United States have higher Tabor proc inthe manafacire of eothng than ney industri countries Like Mexico or China, Bu because th echnolegyof clothing manufacture is eaively simple the productivity advange of eévanced mations inte clothing industry i ess han their ‘Mvantage in many other indestes. Foc example, n 1992 the erage U.S. manefataring ‘worker was probably about five ines as productive asthe average Mexican worker; bu in the elething industry the productivity advantage woe ply’ about 50 percen. The sak 1 that clothing isa major export frm fww-sage to high-wage nations. In som, while (ee economists believe dat the Ricardian model is «fully adequate escipion ofthe causes and consequences of wow ade itso prinsipalimplicstions — that prodectiviy differences play en important fale i ixenatonal ade and hat tis {comparative rather han absolute advantage thal maters—do seem tobe supported by the evidence Summary 1 We examined the Rcordinstdel the simplest model st shows how diferences between counris give rise to trade ad gains for ade. In his model labor isthe only Factor of prediction and counties difler ony inte productivity ef labo indi feret induces 2, Inthe Ricardian model, counties wl export goods that ther labor produces rel tively effet and import goods that her bor produces elstively neice. 0 ‘her word, x counts production pllern i determined by comparative advantage {3 Tatra benefits 3 county can be shown in eter of oo ways Fist, we can think of trade as an indice methed of production. Instead of producing a good fr itself. & country cam prokce snotter good and trade it fr the desired good. The simple ‘model shows that whenever s good i imported itrust be tr hat this niet “pro- Goction" reies less labor than eect production. Seconé we can show that rade enlarges» county's consumption possibile, implying gains rom wade {4 ‘Thedisbution ofthe gains from trade depend cm the eltive prices ofthe goods counties produce. Te deerme thes eve prices itis necessary to look atthe rel ftse word supply and demand for ood. The ative pice implies a relative wage rate a wel "tiny Gab tie. Monfacving Prodi, Wane D159. CHAPTER 2 Labor Productivcy and Comparative Advantage ‘5. The propesiion hat ade is beneficial is unqualified. Thats, theres a eguirement ‘hat a country be"competie” or that he ade be “fi” In parila we can show tat tes commonly held beliefs about ade re rong. Fira county gai from ‘rade even if it as ler produciviy than is trading pastries. Second, leads is beneficial even if foreign industies ave competitive oaly becuse of low Wages. Titd trae is beneficial even ifa county" exports embody mare labor thn its imports, 6, Extending the one factor, w0-good mode! tox word of many commotiies doesnot alter these conclusions. The ony difference is tha it becomes necessary to focls iecly on the relative demand for Inbortedoetmie relative wages rather than (0 work via eave demtud for goods. Also, many-commodlty model can be wred i ilasrate te important poin tht taasprttion costs can give rise to 3 station in which some nontraded goods exis “1. While some of the predictors ofthe Ricardian model are clearly uceaistic. its basic prediiion—ihat counties wil tend to expert gods in which they have rele Lively high productivty—tas boon cxnfrmed by a numberof sis, Koy Terms slot advantage. p15 compre advange, p12 heived cma, 29 ins om ede 919 ‘rea eglisiam saa, p17 ‘ona goods, p31 pporoniy cost. 1 tial quis als 16 pp or pen 26 producien posi esp 12.19 ‘eve dard coe, p.17 rete sly cone. 7 reaive wan, .22 Rice tel, p12 ric labor ogre, 9.2 Problems. 1. Home has 1200 units of labor evsilable, It can produce wo good, apples and Bananas The ai regen in ple rodcton ue bas ro ‘a. Gragh Home's production possiblity fone. ', What isthe opportunity cost of apples in ers of bananas? © Inthe absence oftnde, what would the pice of apples in tems of bananas be? Why? 2, Home sas deseribed in problem 1 There i now also another country Foreign. with ‘labor force of 800, Foreign’ uit abr requirement in apple poductien 5, while io banana production its | 2. Graph Foreign's production possitilty frome, i. Constuet the werd rlaive supply curve 3. Now suppose word elaive demand fakes the following form: Demand for ales ‘demand for bananas = price of bananas/rice of apples | Graph the relative demand curve along wih ih relative supply curve asi PART | International Trade Theory 'b, What isthe equilibdam relative price of apples? Describe the pater of tude 12. Show tht bots Home and Fereign gs from trade. 4 Suppose ha instead of 1200 worker, Home Fa 2400, Fin he equilibrium cba price. What an you say abou he ficiency af world prodecton andthe division of the gains from te between Home nd Foreign inthis case? 5. Sppose that Home has 2400 workers, but they are only las produtire in both industries as we have been assuming. Consiuct the world relative supply curve tn determine the equitium relative price. How do the gins fom trade compare ‘with those inthe case described in problem 4? 6. "Kocean works eatn onl $250 an hou; if we allow Korea wo export as much a it kes tothe Unite Sttes, our workers wil be freed downto the ste eve. You cant iraport a $5 she without importing the $2.50 wage that ges wih it" Dies. +1, Japanese labor prodctiviy is roughly he sire as that ofthe United States i the ‘manufecturing sete (tigher in some industries, lower in oer), while the United ‘States sil considerably more productive in the sevice sector, But most services are noraled. Some analysts habe argued that tis poses pcblem forthe Unite States, Beaute our comparative advantage ies in things we cabo sell on work ‘markets, What ie wrong with his pure? {8 Anyone who hss visited Jopan knows isn incredibly expensive place although Japanese workers eam about these as their U.S, ccuntesparts, the prchasing power oftheir incomes fs about one-third less. Extend your discussion from ques- thon To explin this observation (Hint Think abou wages and the implied pices of nontraded goods) 19, How does the fc thal many goods are nonrided fet the extent of possible gins from wate? 10, We have focused onthe cas of tae involving only two countries Suppose that thece ae many eoantries capable of producing wo goods, and thst each country has taly one feto of production, labor What could we ay about te pate of prodc~ tion and wade inthis ease? (Hine constucing the word relative supply carve.) Further Reading ‘Donald Divi "hsindscy Tide: A Heckscher hls-Rcado Appr Jel of ter Tonal Economics 39 (Never 199), pp. 201-226. recent revival of he Rican fayosch wepleln ae btwer cours wih similar reso, odiger Dens Staley Fiche and Pel Seen, “Camparaive Advanian, Trae and Payment ina canon Model with 3 Conlouun of Gods AtricenEeananic Review 6 {December 1977), pp 623-839. More ree theartest modeling in he Ricaon mods, (Pvtoping te lea of snplying the many-goné Rican model by assuring st the ‘umber f gone iso lege as fer ast contin. ‘oyvana Dost Keith Pain Lue Sate, The Ecoanes of Tenical ange and tena "nal Tate. Brighton Whesichea, 183, Anemia examination ht sat tht ier ‘oral wade a manufac goods is rey eten by ferences in aoe! ehnologicat fnpeenes. (0. A MacDougall. "Betis ed American Expone: A Sut Suggested by the Theory of Con ante Contes Ezoente Jornal (December 1981, p. 687-724; 62 Sepember 1952), CHAPTER 2 Labor Produetivity and Comparative Advantage {p-87-5 nhs onos iy Maco wed enpaavea o S.dUK o ductivity to west the predictions of the Ricardian model ae Joe it Pp aa Eo Llyn re 17 esr end favs wr nos elit moe ners ae avd iw. Thr Pines of es Eern nd Ta Hameed via 195 ‘The ae owe ar he Rien ol Ras a i rk et ped 338 CHAPTERS | fic Factors and Speci Income Distribution A: swe sawn Chapter 2 intereavonl trade can be musa benef tote nations cnenged ie Yee ehroughout hstey government have protected sectors ofthe “conor ftom import competion For example desplets eommiment in pinciple co {fev ede, che Uited States init Imports of texas, sur, and other cormmodties. If trade fg such good ting forthe economy, why is there opposition roa effets! To Understand the poltcs of trade, is necessary 1o look atthe elects of rade, nt just on Touney as whole but onthe dtution af nce within that coun. “The Rcardan mode of Incenationl ade developed in Chapter 2 ilustates the pout beefs rom trade fn thae model tae lead to internaconal specialization, eh ach eountry shifting bor force from industries in which tha boris elatvely ne ‘SExeto indus ich iis reabvely more eine Beeause abort che oly factor of froduction inthe mode and rassimed tobe able co mene freely fam one sty nother dare sno possibilty tat indvdvas wl be burcby wade. The Ricardian mode! thee suet noc oly hac all countries gain rom wade, but tht every indus ado beter of as reat ofmernaonal ade, Beaune rade doce not affect he ditebution ‘tincome inde eal word, howere tad has substancal effects onthe income dsib- ‘hon within each wadng mation, 50 that race the benefits of trade are often sré- eed very uneven “There are two han reasons wy internazonal trade has strong effects on the dsb ion of ncome Fist resources cot move inmedarsy or conlesy Fom one indistry to anathar Second industries der nthe facors of production they demand. si in ce tracof goods data country produces wil orlnarly reduce the demand for some ftors ‘Ot preducuon while raking the demand for exhers. For bth ofthese eeatnsnerntnal tries nora wrambiguouslybanoil af appeared to be in Chapter 2. While trade may Tanefea rauon tr whle,(clten hurts sgueare groups within ce country. at FM the shor “Conader the efects of apa’ rice poly aan allows very ie rie tobe imported even though the scary of and means cat rice much more expensive to produce it Japan than in ether counties (incudng dhe United Stats). There ite queen that fopenas-a hole would ave «higher standard ef ling if fre kmperts of rice were ‘Hore Jopnese rice farmers however would be hur By fee wade Whi he farmers CHAPTER 3 specie Factors and Income Distribution Asse by enport col proba fd ben manhcring oF eee Jo’ plymen: econo, my wad Ind rrghy alent esky td comers Ferermore te ase oe lan tnt rts ov woul Segre pceet ‘ce Rots meet ne are were eat en ‘dt ergrzed pled oppontn scar for mor ane pote gi Fe ‘rade for the nation as a whole, : See ‘reine amis of wae rt go beyond te Redan ode mod a wich tre can afc teome deus Ths cpt’ cones reat el iow pcr eat gee aon a ey ump cer ay Bite specitc Factors Model ‘The specie factors model was developed by Pal Samuelson snd Ronald Jones! Like the simple Rieacdian model, it assumes an economy tht pradces two goods and that can allocate its labor supply between the wo sector, Unlike the Rican noel, weve te specific fctors model allows forthe existence of factors of prodiction besides labor ‘Whereas labor isa mobile factor tat can move between sectors, these cer factor ae sumed io be specifi. Thats, they ean ews only in the proviuction of paniculr goods Assumptions ofthe Modal Imag neanom hata pric vo gd, marta al fa ste of one traf pede however, ecory hse er (Oeil) ae sn tera Menthe se ped wing xl nd er a oth, we a othe a er trap) arte soar ean wedi ee scr wenden ci a pec lca acne a ‘in the production of one good. tH “ewslely How mech eas god ds fe eno pate Te ays ont men fete dpe nh hcl an as een ater strated procon fenton ha ls cua nares talento bse hen ayn xpi sae The ain econ sic inte simaied payee Oy = OylKty on ‘where Qy isthe economy's output of manufactures, K 7s the economy's capital tack, and La ete itr fore employed in manufac, Simi fr fod een wie po 0, = 0, oy "Pa Samat, “hin Was Rip” Sa ou font 79 (717.4584 nt Rol 25, "A Tes Facer Matin Tey. Trae liso aga Btu ale its Pde, ele ‘Pons an rth Asda Nor Hla, gp 3 peter 2”40 PART I International Trade Theory ey WHAT IS A SPECIFIC FACTOR? Inthe mods developed in this chop tog we esse that hee af 16 Atos of prO- ‘ston. land ad eal, which ae permanently tied to particular rectots of the eeosomy, In dvateed cooomles, bowser agrcultral land feceives only a salt part of ational income ‘When economists apply he specifi estore mode to economies like that of tbe United Slates or Frances ty tyFcally thnk of Fctor specifiy fotos permanent condition bt as a mater of tine, Fot example, the vat ase 1 bre eet ad the saming presses used to build eno Boies Cannot be baited foreach her, snd 0 these ‘iorent ne of equipments indi speci Given time, however, Is posible to cedireet, Iroesinent iam av face to brewer vee ‘ees ad 9 na longer sense Boh vt ad Stamping presser can be considered to be (vo manifestations of singe, mobile (ctr ealed capa in practice, then, the dinctionbetwsen spe cite and mobile ator nots shar Tine I question ofthe sees of adjustment, wit tors fore specie te longer tte o fedeploy them tetwote industries So tw spel ae the factors of profeton i the real economy? ‘arkers who have ft general skis as coppostd to highly specifi Waiing, sem 10 be ‘ate mobile sac quite as mobile ns fbor im the del One sel else comes from the time i {ake abr te move tween geogapicHcaions. ‘Ope tient sty finds tht When 8 U.S. ste [ts econo cules, workers quickly begie leaving fr her tes; within six years the nem ployment alls back owe anal swage” ‘hiscompares witha etme of 15020 years for typical specialized machine, and perhaps 50 years fra shopping rill or of builin, ‘Solaris certainly less specific factor chan tot kinds of capital On the ter and, highly Wain workers are preity much suck. with their traf A bran surgeon might have de a prety ood siotni Bu she cant wl careers mati olivier Blanchard and Lawrence Kate, “Regional Evolutions.” Brookings Papers on Economic Act 1981 a where Q, is the economy's oui of food, Tis the economy's supply of land, abd Lis the Tabor fore éevoed to food production. st equal the tots labor supply C= bet he Production Possibilities or the economy as a whole, the labor employed a “The speific factors model assumes that each ofthe specific factors capital and and can be ted te only one seston, manufetives an food, respectively Only labor ean be used in ier sector. Thus to snalyze the economy's production gosiilites, we necd only to ask hho the economy's ix of ext changes as labor is shifted from one sector othe cher. ‘Tis canbe done graphically, st by representing the prodvetion functions 3-1) and G2), then by ping them togeter to derive the prodnstonpossibity fronuer, Figo 3. illusuales the relationship between Ibor input and ouput of manufactures “Toe larges the input of labor, fOr2 given capital supply, the lager wil be output ‘pure 31 the spe of Qy(KiL) represents the marginal produet of labor, thats, the ben to ouput generate by adding one more perzon‘houe However, if Inbor inp is CHAPTER 3 Specite Factors and Income Distribution ERP cen tor autores ‘The more tor dis employed incre production of monet the rp te equ AS area of dng aur however each icestne personhour crete output yes ‘han the prevout oe: thi shows ty the ce hat he crv rele lbbor ips ouput at igh tev of employment uu, (ap by increased without increasing capita a wel there will normally be nisin returns: Because acing a wocker means that each worker has les capital to work with, each ‘sueeesiveierement of labor wil ad fxs to production thn the lst, Diminishing ens ‘ate reflected inthe shape ofthe production function: Qy (KL) gets ater as we move to ‘he sight, indicating thatthe marginal product of labor declines at mare labor fe wed. Figure 32 shows the same information a diferent way. I this gare we directly plo the ‘marginal produto aber as 3 faction ofthe labor employed. (nthe append to this chap fer we show thatthe area under the marginal product eurveeepresens the total output of ‘manufactures ‘4 similar pair f diagrams can represent the production funtion For food. These dia- trams can then be combined i derive the production possiblity ronier forthe economy, ss illusated in Figure 3-3. As we sae in Chaper 2, the production possibility frontier ‘hows what the economy is capable of producing; i this ast shows how much Food it ‘ean produce for any given ouput of matufactures and vice versa. Figure 33 is fourquadrant diagram. Inde lower right quadant we show he produc- ton fet for manufactures iat in Figure 31 Ts ieee we um te igure on its side: A moverentdowinard along the vertical ais represents un increas in the labor input to the manufactures sectg, while a movement tothe ight along the or onl renee an esi te opt of nics he tee ar we show the coresponting production Forti for foe: this par of the Fire is also fipped around, so tat a movement othe left long the herizomal axis indicates an increase infor input to the food sector, while an upward movement along the vertical zx iad ‘ates an increase in fod outpt, The lower let quadrant represent tbe econamy’s allocation of labor. Both quantities ae ‘measured inthe reverse of te usual diretion. A downwaré movement along the vertical axis indicates an inctease in he Isbor employed in manvtictres leftward movement aRetest teteead at a CHAPTER} SpecicFatrantincomeDitrbuien 43 REDE tna voter ortae ty Freer inte Specie ct Motel Temnpalpedatotttorinte agai wi CF Riser monutezres sector el tthe slope 1080 MPL, Greate m. Qptnereannal) Escony ena ‘ofthe producon uncon shown Figure 1 istomer the move bor tho sector employs Wey about Inteoa fe (ieee slong the horizontal axis indicates a increase in labor employed fod. Sine an increase inemployment in 068 setor mus mesn that lee lori available forthe ob, he possible allocations ace indicated bya downward sepig ine. This ine, Ikbeled AA. slopes down- ‘yard at a 45-degree angle thats, i haba slope of ~1-To se why this ln represents the possible labor allocations, roice tht if al labor were erplayed in food prodution. Lp fwovkl equal while Z, would equal O Ione were then to move lnborgratasiy nto the ‘manfectring set, ach preon-hoar moved woud incease Z, hy one ait whi redoe- Ing by one uni, acing & tne with slope of —1, uni al the entire labo supply L was employed in manafatares. Any particular silvia of labor beeen te two Sectors can ator Esoony salen ‘sraruiecues, Foieagaanan etiaber (aa) Eamcreaceg Evmanibchree Prediccon of manicures ad foodie decrmined by he slocaonefabos i over then be represented by pol on Aa, ssh spon 2. "We eat nv se bow to deverine redaction given ay patio lloeton of isbor teen the wo ston Suposs hat he allocation of abr were represented by pin 2a the ower let anon, tha i, wih Ej our in manufcring ane hours in fod “Then we can ust the poset Fonction foreach sector odtermine output vis are produced in manufacturing, Qi fod. Using thes coordinates QQ), pont inthe Upper ight quadan of Figure 33 shows the esulng expt of manoctrs and fod "ote the whole prodvton possity Yoni, we simply imspine repeating hi excrise for many alteratveslcains of labo, We might stat with Woof the aber allo Gated 1 food predation, at pin im the lowe et qd, hen gaa inereas the mount of fbor aed in manuacres until very few workers ae employed In fod, at foin 3 te ceszoding pins nth upper guaran wl ae ou te cre snag From {103% Thus PP inthe wper right quate shows the economy's production poss bilitis forgiven upp ofa, sb, ad esp. Inthe Reardin mods, where bors the only ctr of production, the production 9s sty oni ia straight ine berase te opportunity cos of manufrs fn rms of ‘sefant te alocan fiber beeen scar canbe stated ya poate ne A ‘hich rere combines aber mp to mires nd osd hei phe {oul bor sp Corresponding to prsaarpat ov AA such para ber pat «© marcus (2) ada tor np tod (2) The ciresin he ower abaya, andra represen the pofucton incon for marc nd fod. epecnte sow Amul bor — pele fod rom bed “Fre manuctring or dead curve ies a proportion tome 7 pacar rere i fy bate snag rte ie es than proper saat. Ourput of manfacures ies op of fod a. fiom point {to point 2. Novice two important fats about the results of this shit, Fis though he wage rate rss ities by less than the increas n the pice of manufactures ‘Tis ean be seea by comperng Figures 3-6 and 3-7. In Figute 3-6, which represen the {esals of 10 percent increaze i bth Py and Fe, we saw that w increased by 10 pore 35 tril IPoay , inereaes, w clearly rises by lss—say 5 percent. ‘Second, when only Py ses, in contrat to the ease ofa simultaneous rise Fi a Fy labor shift fram the fod sector othe manvfacturng sector and the uipa of manfostres Fines while thet of fod falls (This why w des not seas much as Ay: Because mans- facturing employment ies, the magical product of labor in that sector fll) "The effect of arse inthe relative peice of manufactures can also be seen dreetly by ooking alte production sibility curve, In Figure 3-2, we show the effers ofthe same rise inthe prise of manufsctures, Which raises the reltive price of manufactures from (2ylPp) to (PT production pois, which is always located where the slope of PP equals minus the relative price, shifts farm 1 to 2, Food output falls and manufactures ‘uiput ses as 2 esl ofthe rie in he relative price of manufactures. Since higher relaive pects of manufactures lead to higher outpat of manufactaresrele- tive to that of food, we can draw a relative supply curve showing Qy/O- a a fonction of lly This relative soppy curve is shown 8 RS in Figure 39. As we showed in Chapter 2, ‘Me cen also drew a relative demere carve, which is lostated by the downward-sloping CHAPTER 3 Specite Factors and Income Distribution “Th economy shee produce tthe pain ons preduction pssry Iron) whae te Hope of FP eins ius the relive pce of ‘mance. Ts an nero a Preuss production 19 mave ova and the rhc aaa ce produccon posses ender correspoaing ogee ouput of manufrs aed lower up cllood line AD. The equilibrium relative price (/P,)! snd output (QQ) ae determined by Ue intersection of RS and RD. Relative Prices and the Distribution of Income ‘So Far we have examined te folowing aspect ofthe specifi actors model: 1) the deter rmination of production possibilities given an economy's rexources and technology and (2) te detemninaton of resource allocation, production, and relative prices in a market ‘economy. Before unin othe effec of imtrationl undo we must consider the effect of changes in relative prices onthe distibation of neome. [Look agains igure 37, which show the effet ofa ise im the pice of manufactures, ‘We have already ate that dhe demand curve fr labor in the manefaturing sec wil shit ‘upward in propenion these in , so tha if Py ese by 10 percent, the curve defined by Fy, MPL also ees by 10 peecnt. We have also seen tha ales the price of food also site by at east 10 percent, will ie by es than A. Thus if manctactatng prices nis by TO pereert, we would expect the wage rate t rise by only, ay, 5 percent. Lets ook at what his outeome implies er the incomes of tre groups: workers, overs ‘of capital, and ots of land. Workers id that hele wage rate hs risen, bat les han in ‘proportion to the rise in Py. Thus their real wage in tems of manulacttes, W/Py, falls, ‘while thir el wage in terms of food, w/P, rises, Given this information, we cannot say ‘whether workers ae beter or worse off ths depeadson the relative importance of man tures and fod in workes" consumption, question that we wll nt pursue further ‘Overers of capital however, are definitly belt off The rel wage rte in tems of an ‘facture has ale, hat the pris of eapal owners in tems of what they produce ies,so PART 1 International Trade Theory Bi arr mn neh pee cars modela higher ctv prie of maraacares wil lead co aminerease the opi of manafacrurer reste wo tht of fod “Tr the eve sup curve RSs pmard sloping abi lave ‘uaries and pie re doerined by beinarscon of RS wih race demand ere RD. Saracen, By, 70) Palate nity (Ou emanates aay “Thats the income of capital owners wl go more than propectonstely with the ise in, Since Fy in turn has Hien relative to 2, tbe income of capitalists Has clearly gone up in terms of bath goods ‘Conversely. landowners ate defintely worse off. They lose fortwo reasons: The reat svage in terms of food rises squeezing tei acome, abd theese in manufactures prices reduces the purchasing power of any given income Bfieornational Trade in the Specific Factors Model Now ih we know how the spesifc factors model works fora single esonamy, we can turn to an analysis of teratonstade, Imagine that two couniies, Japon and Americ, trode with each oter; e's examine the eects of this tade on this welfare, For ae to take plac, te wo courte must ier in the relative pice of manafatures that would prevail inthe absence of ade In Faure 3.9 we saw how Py/P is determined in {single economy i the absence of ade. Japan and America could have ferent relative prices of manufactures either because they differ in dec rlaive demand or because they Giferin their clave supply. We wil assume aay demand diftzences: that is, we asso that at any given yl, relative demand isthe same in the two cours, I-both countries face the sore elaive rice of manofacteres, they will consume food and wanofactares in the same proportions, Thus bot countees will have the same relative demand wurve. We ‘wil therefore focus on diferences in relative supply as the Source of international tate ‘Why might eave supply difer? The counres could have differen technologies, =x in ive Ricardian model, Now that oar model has moxe then one factor of production, J CHAPTER. Specine Factors and Income Distribution MEG alsiowee ie coon scx ‘Aninerense a the opal eck es he arg product of 6 labor in mance: ay en elf arploye Thi ‘es ha demand fo ber in he manuaewrng rector whch ives up the vera woe te Because br i puted mi of te food sector utp of min- aeures nse. tis tp of {e098 s, ‘apa seh, Gerad 5 aera smoriactos. Ly? Arount of Info, (ris tenia howeves, the courses cold also differ in her resources. tis won examining how df= Feteness in esoures ean aflect relative supply. Resources and Relative Supply ‘The basi eionsip between resources and elative supply i srsightorward: A courtey witha lot of apt and ot muck and wil tnd to produce high ratio of manufactures to Food a any eres pices, while a county with ft of and and ot muck capital will do the reverse. Consider what would happea if oe ofthe counties experienced a increase in Ue ‘supply of some resource. Suppose, for example, tht Japon were to increase its capital ‘Hock. The effects of such an erence are shown n Figure 310 ‘ier things equal, an inereas nthe quantity of eaptal would mice the marginal pro- ductivity of labor inthe wanufecring sete, Ths the dem carve for labor in man facturing would sift right from Rx MPL), oP, X MPL;, AL any given prices of manufactures and foed, this increase in demand for manufactaing labor would shi he ‘equilibcium from point Ito point 2. More werkers would be dawn no the manafecuring sector out of the food sector. Manufaciuring ouipot would rit, fortwo reasons: Thre \wouki be more workers inthe sector and they would have moe epital io werk with Food ‘vipat would fll because of reduced labor input. So a any given relative rice of mama- facture, the relative ouput of manufactres woul ise. We therefore conciude that an increase inthe supply of capital woul shit he relative supply core tothe right,52 PART | International Trade Theory etere pce Inde tgeejonsseemet Rao ‘ohare mare api per worker than Aerie America tos more in per weer dan [pen Ase rele re sve api cove fa oe eg St Amari han the ‘conor onde the wot relive spy cM RSyeue Fes between dhe eve ain res. aed dhe elim ‘word ele pre of rant facade by Se ersecon of you With the relate demand ears AD jena-as becween tht lero il hae woul ave prevaled in he ew countries eke absence al ree ules Cu? Dwom ulPey Ccorrespeningly, av incteas n the supply of land would increase foot epi and edocs meat eur eave tops cue woud she. ‘Wht abot the effect fan ness in th bor force? Tiss ess clear ase. To ince employers to bite he atonal Worker the wage rie must all, This wl ed to inerensed employment and ouput of bo manufactures ané food; the eect on elatve comput is ambiguous "Seppo, honee: tht Americ nd Japa Kae the sane ako fre, at Japan as a lrgrsoply of capital than Ammer, wile America Ras alte soply of tad tan Japan Ten the siuaton wil ok ke than Figur 311 Jas eave supply core RS, Ins thigh of Amerie’ cae RS, because Japn's abundance of capital an seasiy land eat to roducea lange qs of manufactures and rsavely ile food at any geen lative rie of manufrs, wheteas he ever ste for Ameria 1 In his mode 38 alway, international trade leads to a convergence of relative prices, iis ted in Fite 3-11 Since relative demand isthe cme in Japan and Amesiea, RD yaya 8 ‘oth each country's eltve demand curve and the werd relative demand curve when ihe two counties rade, RS, ad RS, eepresent the eave suply curves of Japan are Aree, respectively. Japan is assumed tbe relatively wellendowed with capital and poorly ‘evdowed with land, while Ameria isthe exes, 30 RS, listo the ight of BS. The pe- Je and Relative Prices CHAPTER 3 Specific Factors and Income Distribution trade elative peice of manufucares in Sapo, (ys ower thn the petade relative ice in Ameria. (/P,), When the wo counties epen wide they eae an inlgraed word economy whose peo ‘duction oF manufactures and fod isthe sb af he national auputs ofthe two 2008 The worl eave supply of manufactures (ASyyq) His Between the relative supplies inthe lwo counties. The world relative price of manufacture, (B/Pp)yagun therefore les ‘elwen te national poise prices. Trade har inctemed the elve pice of oanuTatres in Jpan and has lowered it in Ameren ‘The Pattern of Trade rade oceusinily because of difernces i eave peices of manufactures, how does {he eomerpence of 7 translate ino pattern of intemational ade? To ans tis ques ‘on, we ned to state Sore basic retonshps anon prices, production, and consumpsin. I country that cannot wae, the output ofa g90d mus equa is consumption. 1 is consaplion of manficiares and D, consmpion of food, tien in a closed economy Dy, — {Qy and Dy = Qp- International trade makes it possible forthe mix of manufactres and ood constmed f differ fom te rr produced, While the amounts of each good that a ouniry consumes and produces may dir, however country cannot spen more than i fears: The value of consumption must be eq to he valve of production. Tha, By H Dy FFG Dp Pa X Oy + Be Op os qution (3-8) van be rearaged to yield the following Dy Or = CalPe) X Oy, ~ By) 09) By ~ Opis the economy's fod imports the amount by wich its coasumpsion of food exceeds is production The igh-and side ofthe equation isthe product ofthe rei Prieof manufactures snd the aroun by hic prodcin of mantctres exceeds con Suinption, that sue economy's exports of maefactures The equation, then, sates that imparts of food equal exports of manufectores times the veative pris of manufacture, Wile ie doesnot tell us Row mich ths economy wil sport or expo, the equation does show thatthe ameunt the economy can afford to impor i ited or constrained, by the amit expots. Equation (3-9) therefore known a a budget constrain Figne 3-12 ilastrates two imporant features of the budge constant fora trading cconomy. Fist, the slope ofthe Budget consti i tinus P/F, the relive price of rranufatues, The reason is that consuming one less unit af manafcires saves the econ ‘omy thsi enough to purchase Fy, exaunie f fod. Second, he budget contain is tangent tote predhtion possibilty frontier atthe point that represents he economy's "ie constr Wa We ae of esting of proton (reset at pense ‘or in als) unto en ents ean Sonoma eh ots led othe Foon nt ‘Sime a hs poiice eet sts ate afer asin C9) eres olde [steal eavig sadn ae ean i Che 7 wih sews an som conan over ine sl eos Be tec gt ip dee 354 PART I. International Trade Theory PERT ERS erep ray Ping opresets he economy production The economy can: Ceasurgon td. Dy Saou attod Cp ‘erpcon mur Be log 3B hat pases hough pene nas 3 Slope ol triste rls rie of marubazres. Gy consungaon of erntncares Dy Salat onaStve, Oy choice of prodoction given the relaive price of manufactures, shown in the Figue as point | “Thats the economy can abway’saflerd 1 consume what ic proces. "We can now use the budget conscsns of Japan and America to const pitere of tho uading elibcm, In Figure 3-13, we show the oatpts, budget cones, nd con Sumption choices of Japan and Arseric at equlbrim peices. In Japan, the rise i the rok lave price of manufactures led ose in tb consumption of food relative to manutae- Tres and fall inthe relative ouput of ood apan produces Qf of fod bu consumes Dj ittherefore becomes 2 manufactures expo and 2 food imperter. In America, the post tae fil in he relative price of manufctres leads a ie inthe consumption of manv- Factres relative to food and fll nthe elative utput of manufactures; America therefore becomes a manufactures imporer anda food exporter. In equilibrium Japan's exports of rmanufactrers must exaclly equal America's imports and Japan's impos of food exactly ‘equal America’s expors. The qualities ae shown by the equality of the to colocea tangles in Figure 313. [Become Distribution andthe Gains From Trade ‘We have seen how production ossibilies are determined by reourees and technology: hhow the choice of wha o produce determined by the rlaive price of manufactores; How changes inthe relative price of manufactures affect the eal incomes of different factors of production, ad how trade affect both relative prices and the economy's buet constrain. Now we ean ask the crucial question: Who gains and who loses from international rade? lh CHAPTER 3 Speciic Factors and Income Distribution 55 Dy, Oy Quantity ot of of Quantity of sans arate nie cy open (op Americe [bpartinpor: ol fod ar eaciy equal ve Arai expertsand Ameren impor of pane fares ara acy egal to aan expos, We begin by aig tow the ella of ptr gous fee, and ten how tate Meche wll ofthe county ssa wile “oases eles fal npn, te ey pois titrate shisha pace of mans and ad Conse ra wa hppa ops We are assuring ta ne enc of trade fgan wool av aslo ree poe of manufrs ha hee of te wor I sth eate, ade whch eds oa cane ses of lave pres wl can ae ay nephew tw peo Secon he rel of vn ns thao caplet of wees apes ec av ambiguus shin hel pesto sed doves ae woe of nA, tefl tae online persue eee The lie pee of ‘natu fal oI Ame ndowoes able of td capil owes wae of thd ele on wakes none an aig “ae gnc euicome thn simple: Te bene the foto tha is specie te export sector each coy at hart te ator peyote iporcconpeing sein Si alg fet onmebe fos ‘Do the gis om tree th sss? One way you mighty to ase this usin vould be sum up hpi ofthe wie nde ses fhe se ad co rth. The rote wis roca st we comowing wel anise Iysabectve hg Seppse ba capa dl pope nhs pet tly an sunPART 1 Intemational Trade Theory ong’ Consumption Possibilities Before eaescconemy pro- Consign 08. ducon and corzumion vero OU HoH Op x poine Yon 2 production posse ont) Aker tind. he economy ca con sure at ay point ons bode commie The orton of be ‘edge constant colored gon consis of sible poss trade comumpdon heen wih Badge anne. Gose==PA/P) ‘onspton ot bods goods o bigher an eth pete pane ‘csumpions| oh froruioces, Oy Seer ‘matures, Oy ‘out of inereased consumption, while landowners ate bors vivant who get immense plow Sure out oft. Then one might wel imagine that rade reduces te foal amount of pleasure in Japan. But he reverse could equally be te, Moret the pot i i outside the province cf wat we normally think of as economic analysis oxy 1o figure ou how such enjoyment Individaas got oa of toe ives. 7 ‘A beter way to assess the overall guns (rom trade is to ask a diferent question: Cons ‘those whe gain rom trade compensate those wh lose, and sl be beter off hemsyes? If 50, then rade potentially a source of gan © everyone. roiescate hat ade is source of potential gin for everyone, we procend in thre steps 1. Fi, we otis that ite asec fade te eon ny woul hae protice vii eeu sd sie tr, The conspron fhe econo i the wbsence crease eete tae tea pon he profictln possiby emer InFigue 31, at rade consumption pit sw spit 2 Non noice tsps erating eonamy 0 consome more of oi gocstnul ate in th ssece of wade The but cosa igs 318 eal be psi combison of fd ad nutes hat he cout coal eS pien he wren pce of antics Pat of ht beget cans — Si pun eclored region —sepeset sain io whch he economy consumes ‘oot bt marae nd foo tan ca ine benef uae Noe Da is foul dent dapat onto sin Da ree rotuetn ard eonsumpin was Supine pec poduton vs apo 20 a iad at fle on CHAPTER 3. Specie Factors and tncome Distribution leton at al tee is evays apt of he budget constrain that allows consumption of more ofboth goods 3. Finally, observe tht if the economy 282 whole consumes moe of both goods. then it posible ia przcple 1 give eoch mdvidual move ofboth goods. This would rate eveyone Dele fl. This shows, her tha iis posible to encre tha everyone is ber of 9 2 sul of rade, OF eoure, everyone igh be sill eter ei they Ra less ‘fone good and more ofthe oer. Pt tis only eeinforees th eaelason tha everyone can poten gain Gor ade, ‘The fundamental eason why tad potentially benefit eon i thai expands the econo choices. Tis expansion of choice means tht itis always posible oredistibule Income in such a way tat evenone gine fom ade! ‘That everyone could gai from wade wnferanaely doesnot mean tht everyone seal- ly does. in tne ea work, he pesenceof loses as wells winners frm rade one ofthe ‘est ipotant reasons why wade isn fee. Bir Po Trae often prodoces losers as wel 2¢ winner. This insight is eos to understanding the considerations that actully determine tae policy in te medeen world economy: Tre Policy is examined in deci in Chairs 8 tough II: itis possible, however. o fake a pre Timinary view at this poi. ‘Thete ate two nays to look at ade policy (or any govermen policy): (1) Given is objectives, what sould the government do? What sits optimal re policy? (2) What ae _overnmens likely odo in practice? The income dstbuton effects of rade re important ‘othe fst way of looking atthe issue and ae crucial othe second ical Economy of Trade: A Preliminary View ‘Optimal Trade Policy Suppose a government wants to maximize the welfare ofits population, Ifeveryone were ‘vac the same i tastes and in income there woul be a stesightorward soliton: The go ‘emment would choose policies Wat make ie epresenttveindvideal a wel off s pos sible. In this homogeneous economy, fre international rade would cleanly serve the gor~ ‘ements objective ‘Wen people are not exactly alike, however, the government's problem i less well Their standard of living. Even ifthe were aware, $8 is nora lage enough sum te provoke ‘people ino organizing protests and writing letters to their congressional epresetatves. “The supat producers stustion isquicediferen. The average sar prodicer pine thot sands of dollars a year rom the import quota, Ferner, s¥garpraguces are organized {nto trade ssosiavons and conperaves thal atively pursue thir ember poitial iner- ‘xs, So the complaints of supa producers abou the effects of imports are loudly and cetfectively expresses. ‘As me wl se in Chapters 8 through (1, the pits of import restriction in he sugar indy ane an extreme example of kid poll process thai commen in ineaionloo Wi PART 1 International Trade Theory wade, That wold rae in general became steadily free from 1945 10 1980 dopsndeé, a6 We ‘ull ee in Chapter 9, ona special set of icumstances thal cortilled what is probaly ax inherent poli! bias against international irae. Summary 1, Internationa ade often has strong effets on the distribution of lcome within coun tic, that itoften produces losers ar well as winner. Income dbuon effects tie foe wo reasons Fatos of predvetion cannot move instanancssly 6 cost- Tesly from one indisiy to another, and changes in an economy’s out mix have differen effects onthe demand for diferent factors of prodvtion. 12. ‘A sefl model f income distribution effects of international rade he speci fe tors model wbich slows fra distinction between general-purpose fetors cha can move between sectors afd fsetoe tat are specific to particlar uses. in ihis mode, Ufercnces in resources con cause counties te have differen reas supply curves, nd has cause ntermational rae. ‘Inthe specific factors model, actors specific fo export seer in each coucty git fra tae, while factors specifi te impont-compsting sectors lose. Mobile factors that con workin either sector may clthar gain of lose. «4 Trade nonetheless produces overall gains i the Himited sense that those who gain ‘Could fn principe compensate those wh Lose while sil erining beer off than before '5, Dow economiss do no gard the eects of intortional trade on income disieb Con as a goed reason (o init hie ade, Ie its distributional effects, rade no i= fereat fos many eer forms of economic change, which ae not normally reputed. Fonthemors, economists Mould prefer vo addres he problem of income dsiibuion Give, ther han by interering with trade flows {6 Noneiles, inthe actual polities of tede policy income dicibuion is oF eri Impotane, Thi is rein portcula Because those who Tse from trade ae usualy much iver informed, eabesive, and organized groxp than those who tin Key Terms edger consis Siishing urs. pt ‘raginalproduc of bo, 40 spot fo, 939 production faetion. 39 odes ors rates, pt ‘pect ator p39 ec fats mode p.39 Problems 1. In 1986. the prize fol an word markets dropped sharply. Since the United States anoil-importing cour, his was widely egarded as goo forthe US, economy. Yet in Texas ang Lovisiana 1986 was a year of economic decline, Why”? CHAPTER 3 Specific Factor and income Distribution 2. Aneccnomy can produce good 1 using labor and capita and good 2 3 and capital and good using labor and land The otal sopaly of Ibori 100 nis. Given the supply of capa the ouput of ‘he two goods dopeeds 00 labor inp as follows Later 1 Output ot Good 1 Labor Input to Good? Output of Gand? 0 90 wo 8 20 525 20 ou 0 3 30 758 0 ais 10 67 0 ous 90 959 109 10 2. Graph th poss tens or god Ia good Bape pin site yi et ‘aril presto abr ites conespomig othe pdton ences Problem 2 are as follows: i Workers Bmployed MPL in eee MPL in Sector? 0 ren 138 20 cid os 20 097 om 0 oa? 099 2 079 ost o om 054 0 089 030 0 066 04s so 063 0483 ico 080 040 1 Suppose atthe pice £00 2 lie o hat of god i 2 Determine graph ically he wage andthe allocation olborbaween he to sectors 1s Using the yraphron for problem 2, eerie te opt ofeach st. Then Usction, ibe, Draw astraight line from Q, whore slope equal that land labor ratio, sch tthe ine OgCs point | mae eon this ie. Silt known and-tsbor vaio in food prediction dtermines the slope of another line, O,F pint must also lie ones line {0,6 steeper than O-C. because, a We sa cvs hero af ad to Ibor higher i {ood than in elth production.) Thus the economy’ esouce allocation is ienifed by he pint which th two fines representing land Ibor ratios eross—here, at point 1? ‘Given the prices of cloth and feod and te supplies of land and labo, then, ts possible to detcenin bow much ofeach sone the ecovemy devotes othe produto ofeach good and thus alo to determine te economy's output ofeach good, The nex question is Fow these outputs change when the economy's resources change "The inal somprising ever is shows in Figure 46, which shows wht happens when te economy's supply of land is increased, holding both goods prices and the Labor supply {faed, With the increwsed supply of land the box is lle. This means that inputs ito food ‘rodsetion can 9 longer be measured from C, (now labeled O}), but must be eased "Bement a and Fed twee ie hos, Wh peste? Tauri ‘Sninbateoe Neteorny secnanin posing alone gd nel in a bo pre tg Renesas earns beets pats cs en ter pos bow nig 308-4 ‘pen te emptiness gods CHAPTER 4 Resources and Trade: The HeckichenOnin Model Laver used nfod predton . : 3 it ! Pert— ~--------- jf ----4, Labor used in oth production © votonasd pay jean pry ‘ooreece B “The soso the tox meatus she economy oa sppae a abr (haraonal ai) rd nd (coral an) Input ite dea procs ae manure rom the lower coer iat to {ood production rm he upparsigt comma Gian th ind bor ai in cloth prodection Tel the cosh induseys employment eure mt ion the ine Ohh ane draw {he origin withthe slope Fl Sry he food indore’ employment of resources mt be on ele OF Teaon sce cn rere ered etn wher he es ii Recor ate vests rng ro ne ram tiara hice sre enien cng pe veteran mem ftw ae ett™ incenang PART | International Trade Theory verano 0 en ue useu % stor stain elt proucn eons "An increase nd spy makes the box epresening the econenys resources lr rescurcs slloceed to fod prodeion mat now be meaured rom O} If goods ries rmsin unchang, tre cus faa prices and lander rat remain che sme, resources allocation moves rom pone {to pene. with more lind and mare ber devoted o food production Te oz Clothing le we op of and rie ore tan properente othe incre nad pp ils tft ences in nd ply. Outi a pit whee th slope the Sdutn postty fons eqs mimi the late pce of lh, Pad he Zomy pots QandO} oflth and oo. Te cane 7 shove proion pos Sitar ater an ioe inn sippy The prion aby Fonte sis ou Cor thas economy cal pode maf ttl and od tha fre. Teo Sr of he one, however, mc gr nthe diection ofed than of elating thrice a bated expandon ef predation posts wich ozus when ie po ‘hein polity foner tot nach marta ote dzectin tan nh te. nis cos te expansions > stongy ne or 00 rosion as uenged late CHAPTER 4 Resources and Trade: The HeckecherOhlin Model Aninereas inch nippy of {and tif the econo pro

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