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International Economics Theory and Policy 9th Edition Paul R. Krugman, Maurice Obstfeld, Marc J. Melitz - Solutions
Consider a situation similar to that in figure, in which two countries that can produce a good are subject to forward-falling supply curves. In this case, however, suppose that the two countries have the same costs, so that their supply curves are identical.a. What would you expect to be the
It is fairly common for an industrial cluster to break up and for production to move to locations with lower wages when the technology of the industry is no longer rapidly improving—when it is no longer essential to have the absolutely most modern machinery, when the need for highly skilled
Recently, a growing labor shortage has been causing Chinese wages to rise. If this trend continues, what would you expect to see happen to external economy industries currently dominated by China? Consider, in particular, the situation illustrated in Figure How would change takeplace?
In our discussion of labor market pooling, we stressed the advantages of having two firms in the same location: If one firm is expanding while the other is contracting, it’s to the advantage of both workers and firms that they be able to draw on a single labor pool. But it might happen that both
Which of the following goods or services would be most likely to be subject to (1) external economies of scale and (2) dynamic increasing returns? Explain your answers.a. Software tech-support servicesb. Production of asphalt or concretec. Motion picturesd. Cancer researche. Timber harvesting
In perfect competition, firms set price equal to marginal cost. Why can’t firms do this when there are internal economies of scale?
Suppose the two countries we considered in the numerical example on pages 166–169 were to integrate their automobile market with a third country, which has an annual market for 3.75 million automobiles. Find the number of firms, the output per firm, and the price per automobile in the new
Suppose that fixed costs for a firm in the automobile industry (start-up costs of factories, capital equipment, and so on) are $5 billion and that variable costs are equal to $17,000 per finished automobile. Because more firms increase competition in the market, the market price falls as more firms
Go back to the model with firm performance differences in a single integrated market Now assume that a new technology becomes available. Any firm can adopt the new technology, but its use requires an additional fixed-cost investment. The benefit of the new technology is that it reduces a firm’s
In the chapter, we described a situation where dumping occurs between two symmetric countries. Briefly describe how things would change if the two countries had different sizes. a. How would the number of firms competing in a particular market affect the likelihood that an exporter to that market
Which of the following are direct foreign investments?a. A Saudi businessman buys $10 million of IBM stock.b. The same businessman buys a New York apartment building.c. A French company merges with an American company; stockholders in the U.S. Company exchange their stock for shares in the French
For each of the following, specify whether the foreign direct investment is horizontal or vertical; in addition, describe whether that investment represents an FDI inflow or outflow from the countries that are mentioned.a. McDonald’s (a U.S. multinational) opens up and operates new restaurants in
If there are internal economies of scale, why would it ever make sense for a firm to produce the same good in more than one production facility?
Most firms in the apparel and footwear industries choose to outsource production to countries where labor is abundant (primarily, Southeast Asia and the Caribbean)—but those firms do not integrate with their suppliers there. On the other hand, firms in many capital-intensive industries choose to
Consider the example of industries in the previous problem. What would those choices imply for the extent of intra-firm trade across industries? That is, in what industries would a greater proportion of trade occur within firms?
Home’s demand curve for wheat isD = 100 – 20PIts supply curve isS = 20 + 20PDerive and graph Home’s import demand schedule. What would the price of wheat be in the absence of trade?
Now add Foreign, which has a demand curveD* = 80 - 20PAnd a supply curveS* = 40 + 20P.a. Derive and graph Foreign’s export supply curve and find the price of wheat that would prevail in Foreign in the absence of trade.b. Now allow Foreign and Home to trade with each other, at zero transportation
Home imposes a specific tariff of 0.5 on wheat imports.a. Determine and graph the effects of the tariff on the following: (1) the price of wheat in each country; (2) the quantity of wheat supplied and demanded in each country; (3) the volume of trade.b. Determine the effect of the tariff on the
Suppose that Foreign had been a much larger country, with domestic demandD* = 800 - 200P, S* = 400 + 200P.Recalculate the free trade equilibrium and the effects of a 0.5 specific tariff by Home. Relate the difference in results to the discussion of the small country case in the text.
What would be the effective rate of protection on bicycles in China if China places a 50 percent tariff on bicycles, which have a world price of $200, and no tariff on bike components, which together have a world price of $100?
The United States simultaneously limits imports of ethanol for fuel purposes and provides incentives for the use of ethanol in gasoline, which raise the price of ethanol by about 15 percent relative to what it would be otherwise. We do, however, have free trade in corn, which is fermented and
Return to the example of problem 2. Starting from free trade, assume that Foreign offers exporters a subsidy of 0.5 per unit. Calculate the effects on the price in each country and on welfare, both of individual groups and of the economy as a whole, in both countries.
Use your knowledge about trade policy to evaluate each of the following statements:a. “An excellent way to reduce unemployment is to enact tariffs on imported goods.”b. “Tariffs have a more negative effect on welfare in large countries than in small countries.”c. “Automobile manufacturing
The nation of Acirema is “small” and unable to affect world prices. It imports peanut at the price of $10 per bag. The demand curve isD = 400 – 10PThe supply curve isS = 50 + 5P.Determine the free trade equilibrium. Then calculate and graph the following effects of an import quota that limits
If tariffs, quotas, and subsidies each cause net welfare losses, why are they so common, especially in agriculture, among the industrialized countries such as the United States and the members of the European Union?
Suppose that workers involved in manufacturing are paid less than all other workers in the economy. What would be the effect on the real income distribution within the economy if there were a substantial tariff levied on manufactured goods?
For a small country like the Philippines, a move to free trade would have huge advantages. It would let consumers and producers make their choices based on the real costs of goods, not artificial prices determined by government policy; it would allow escape from the confines of a narrow domestic
Which of the following are potentially valid arguments for tariffs or export subsidies, and which are not? Explain your answers.a. “The more oil the United States imports, the higher the price of oil will go in the next world shortage.”b. “The growing exports of off-season fruit from Chile,
A small country can import a good at a world price of 10 per unit. The domestic supply curve of the good isS = 20 + 10PThe demand curve isD = 400 – 5PIn addition, each unit of production yields a marginal social benefit of 10.a. Calculate the total effect on welfare of a tariff of 5 per unit
Suppose that demand and supply are exactly as described in problem 3 but that there is no marginal social benefit to production. However, for political reasons the government counts a dollar’s worth of gain to producers as being worth $3 of either consumer gain or government revenue. Calculate
Suppose that upon Poland’s entering the European Union, it is discovered that the cost of automobile production in Poland is €20,000 while it is €30,000 in Germany. Suppose that the EU, which has a customs union, has an X percent tariff on automobiles and that the costs of production are
There is no point in the United States complaining about trade policies in Japan and Europe. Each country has a right to do whatever is in its own best interest. Instead of complaining about foreign trade policies, the United States should let other countries go their own way, and give up our own
Give an intuitive explanation for the optimal tariff argument.
If governments make trade policies based on national economic welfare, is the problem of trade warfare still represented by a Prisoner€™s dilemma game as in Table? What is the equilibrium solution to the game if governments formulate policy in this way? Would they ever choose the strategy
Recently, the United States has taken action to restrict imports of certain Chinese goods, such as toys containing lead and seafood that doesn’t meet health standards, in order to protect U.S. consumers. Some people have said that this shows a double standard: If we’re willing to restrict goods
Which countries appear to have benefited the most from international trade during the last few decades? What policies do these countries seem to have in common? Does their experience lend support for the infant industry argument or help to argue against it?
Japan’s experience makes the infant industry case for protection better than any theory. In the early 1950s Japan was a poor nation that survived by exporting textiles and toys. The Japanese government protected what at first were inefficient, high-cost steel and automobile industries, and those
A country currently imports automobiles at $8,000 each. Its government believes that, given time, domestic producers could manufacture autos for only $6,000 but that there would be an initial shakedown period during which autos would cost $10,000 to produce domestically.a. Suppose that each firm
India and Mexico both followed import-substitution policies after World War II. However, India went much further, producing almost everything for itself, while Mexico continued to rely on imports of capital goods. Why do you think this difference may have emerged?
What were some of the reasons for the decline in the import-substituting industrialization strategy in favor of a strategy that promotes open trade?
What are the disadvantages of engaging in strategic trade policy even in cases in which it can be shown to yield an increase in a country’s welfare?
If the United States had its way, it would demand that Japan spend more money on basic research in science and less on applied research into industrial applications. Explain why in terms of the analysis of appropriability.
What are the key assumptions that allow strategic trade policy to work in the Brander- Spencer example of Airbus and Boeing?
Suppose that the European Commission asked you to develop a brief on behalf of subsidizing European software development—bearing in mind that the software industry is currently dominated by U.S. firms, notably Microsoft. What arguments would you use? What are the weaknesses in those arguments?
What is the main critique against the WTO with respect to environmental protection? How does the WTO justify its position on trade disputes that involve environmental issues?
France, in addition to its occasional stabs at strategic trade policy, pursues an active nationalist cultural policy that promotes French art, music, fashion, cuisine, and so on. This may be primarily a matter of attempting to preserve a national identity in an increasingly homogeneous world, but
The fundamental problem with any attempt to limit climate change is that the countries whose growth poses the greatest threat to the planet are also the countries that can least afford to pay the price of environmental activism. Explain in terms of the environmental Kuznets curve.
Many countries have value-added taxes-taxes that are paid by producers, but are intended to fall on consumers. (They’re basically just an indirect way of imposing sales taxes.) Such value-added taxes are always accompanied by an equal tax on imports; such import taxes are considered legal because
We stated in this chapter that GNP accounts avoid double counting by including only the value of final goods and services sold on the market. Should the measure of imports used in the GNP accounts therefore be defined to include only imports of final goods and services from abroad? What about
Equation tells us that to reduce a current account deficit a country must increase its private saving, reduce domestic investment, or cut its government budget deficit. Nowadays, some people recommend restrictions on imports from China (and other countries) to reduce the American current account
Explain how each of the following transactions generates two entries—a credit and a debit—in the American balance of payments accounts, and describe how each entry would be classified:a. An American buys a share of German stock, paying by writing a check on an account with a Swiss bank.b. An
A New Yorker travels to New Jersey to buy a $100 telephone answering machine. The New Jersey Company that sells the machine then deposits the $100 check in its account at a New York bank. How would these transactions show up in the balance of payments accounts of New York and New Jersey? What if
The nation of Pecunia had a current account deficit of $1 billion and a nonreserve financial account surplus of $500 million in 2008.a. What was the balance of payments of Pecunia in that year? What happened to the country’s net foreign assets?b. Assume that foreign central banks neither buy nor
Can you think of reasons why a government might be concerned about a large current account deficit or surplus? Why might a government be concerned about its official settlements balance (that is, its balance of payments)?
Do data on the U.S. official settlements balance give an accurate picture of the extent to which foreign central banks buy and sell dollars in currency markets?
Is it possible for a country to have a current account deficit at the same time it has a surplus in its balance of payments? Explain your answer, using hypothetical figures for the current and non reserve financial accounts. Be sure to discuss the possible implications for official international
Suppose that the U.S. net foreign debt is 25 percent of U.S. GDP and that foreign assets and liabilities alike pay an interest rate of 5 percent per year. What would be the drain on U.S. GDP (as a percentage) from paying interest on the net foreign debt? Do you think this is a large number? What if
If you go to the BEA website (www.bea.gov) and look at the Survey of Current Business for July 2010, the table on “U.S. International Transactions,” you will find that in 2009, U.S. income receipts on its foreign assets were $585.2 billion (line 13), while the country’s payments on
Return to the example in this chapter’s final Case Study of how a 10 percent dollar depreciation affects U.S. net foreign wealth (page 316). Show the size of the effect on foreigners’ net foreign wealth measured in dollars (as a percent of U.S. GDP).
We mentioned in the chapter that capital gains and losses on a country’s net foreign assets are not included in the national income measure of the current account. How would economic statisticians have to modify the national income identity (13-1) if they wish to include such gains and losses as
Using the data in the €œMemoranda€ to Table calculate the U.S. 2009 net international investment position with direct investments valued at marketprices.
In Munich a bratwurst costs 5 euro’s; a hot dog costs $4 at Boston’s Fenway Park. At an exchange rate of $1.05/per euro, what is the price of a bratwurst in terms of a hot dog? All else equal, how does this relative price change if the dollar depreciates to $1.25 per euro? Compared with the
Petroleum is sold in a world market and tends to be priced in U.S. dollars. The Nippon Steel Chemical Group of Japan must import petroleum to use in manufacturing plastics and other products. How are its profits affected when the yen depreciates against the dollar?
Calculate the dollar rates of return on the following assets:a. A painting whose price rises from$200,000to$250,000in a year.b. A bottle of a rare Burgundy, Domaine de la Romanée-Conti 1978, whose price rises from $255 to $275 between 2013 and 2014.c. A £10,000 deposit in a London bank in a year
What would be the real rates of return on the assets in the preceding question if the price changes described were accompanied by a simultaneous 10 percent increase in all dollar prices?
Suppose the dollar interest rate and the pound sterling interest rate are the same, 5 percent per year. What is the relation between the current equilibrium $/£ exchange rate and its expected future level? Suppose the expected future$/£exchange rate, $1.52 per pound, remains constant as
Traders in asset markets suddenly learn that the interest rate on dollars will decline in the near future. Use the diagrammatic analysis of this chapter to determine the effect on the current dollar/euro exchange rate, assuming current interest rates on dollar and euro deposits do not change.
We noted that we could have developed our diagrammatic analysis of foreign exchange market equilibrium from the perspective of Europe, with the euro/dollar exchange rate E€/$(= 1/E$/€)on the vertical axis, a schedule vertical at R€ to indicate the euro return on euro deposits, and a
The following report appeared in the New York Times on August 7, 1989 (“Dollar’s Strength a Surprise,” p. D1): But now the sentiment is that the economy is heading for a “soft landing,” with the economy slowing significantly and inflation subsiding, but without a recession. This outlook
Suppose the dollar exchange rates of the euro and the yen are equally variable. The euro, however, tends to depreciate unexpectedly against the dollar when the return on the rest of your wealth is unexpectedly high, while the yen tends to appreciate unexpectedly in the same circumstances. As a U.S.
Does any of the discussion in this chapter lead you to believe that dollar deposits may have liquidity characteristics different from those of other currency deposits? If so, how would the differences affect the interest differential between, say, dollar and Mexican peso deposits? Do you have any
In October 1979, the U.S. central bank (the Federal Reserve System) announced it would play a less active role in limiting fluctuations in dollar interest rates. After this new policy was put into effect, the dollar’s exchange rates against foreign currencies became more volatile. Does our
Imagine that everyone in the world pays a tax of percent on interest earnings and on any capital gains due to exchange rate changes. How would such a tax alter the analysis of the interest parity condition? How does your answer change if the tax applies to interest earnings but not to capital
Suppose the one-year forward $/€ exchange rate is $1.26 per euro and the spot exchange rate is $1.2 per euro. What is the forward premium on euros (the forward discount on dollars)? What is the difference between the interest rate on one-year dollar deposits and that on one-year euro deposits
Europe’s single currency, the euro, was introduced in January 1999, replacing the currencies of 11 European Union members, including France, Germany, Italy, and Spain. Do you think that, immediately after the euro’s introduction, the value of foreign exchange trading in euros was greater or
Multinationals generally have production plants in a number of countries. Consequently, they can move production from expensive locations to cheaper ones in response to various economic developments—a phenomenon called outsourcing when a domestically based firm moves part of its production
Suppose there is a reduction in aggregate real money demand, that is, a negative shift in the aggregate real money demand function. Trace the short-run and long-run effects on the exchange rate, interest rate, and price level.
How would you expect a fall in a country’s population to alter its aggregate money demand function? Would it matter if the fall in population were due to a fall in the number of households or to a fall in the size of the average household?
The velocity of money, V, is defined as the ratio of real GNP to real money holdings, V = Y/(M/P) in this chapter’s notation. Use equation to derive an expression for velocity and explain how velocity varies with changes in R and in Y. What is the relationship between velocity and the exchange
What is the short-run effect on the exchange rate of an increase in domestic real GNP, given expectations about future exchange rates?
Does our discussion of money’s usefulness as a medium of exchange and unit of account suggest reasons why some currencies become vehicle currencies for foreign exchange transactions?
If a currency reform has no effects on the economy’s real variables, why do governments typically institute currency reforms in connection with broader programs aimed at halting runaway inflation? (There are many instances in addition to the Turkish case mentioned in the text. Other examples
Imagine that the central bank of an economy with unemployment doubles its money supply. In the long run, full employment is restored and output returns to its full employment level. On the (admittedly unlikely) assumption that the interest rate before the money supply increase equals the long-run
Between 1984 and 1985, the money supply in the United States increased to $641.0billion from $570.3billion, while that of Brazil increased to 106.1 billion cruzados from 24.4 billion. Over the same period, the U.S. consumer price index rose to 100 from a level of 96.6, while the corresponding index
Continuing with the preceding question, note that the monetary value of output in 1985 was$4,010billion in the United States and 1,418 billion cruzados in Brazil. Refer back to question 3 and calculate velocity for the two countries in 1985. Why do you think velocity was so much higher in Brazil?
In our discussion of short-run exchange rate overshooting, we assumed that real output was given. Assume instead that an increase in the money supply raises real output in the short run (an assumption that will be justified in Chapter 17). How does this affect the extent to which the exchange rate
Figure shows that Japan€™s short-term interest rates have had periods during which they are near or equal to zero. Is the fact that the yen interest rates shown never drop below zero a coincidence, or can you think of some reason why interest rates might be bounded below byzero?
How might a zero interest rate complicate the task of monetary policy?
As we observed in this chapter, central banks, rather than purposefully setting the level of the money supply, usually set a target level for a short-term interest rate by standing ready to lend or borrow whatever money people wish to hold at that interest rate. (When people need more money for a
Suppose Russia’s inflation rate is 100 percent over one year but the inflation rate in Switzerland is only 5 percent. According to relative PPP, what should happen over the year to the Swiss franc’s exchange rate against the Russian ruble?
Discuss why it is often asserted that exporters suffer when their home currencies appreciate in real terms against foreign currencies and prosper when their home currencies depreciate in real terms.
Other things equal, how would you expect the following shifts to affect a currency’s real exchange rate against foreign currencies? a. The overall level of spending doesn’t change, but domestic residents decide to spend more of their income on nontraded products and less on tradables.b.
Large-scale wars typically bring a suspension of international trading and financial activities. Exchange rates lose much of their relevance under these conditions, but once the war is over, governments wishing to fix exchange rates face the problem of deciding what the new rates should be. The PPP
In the late 1970s, Britain seemed to have struck it rich. Having developed its North Sea oil-producing fields in earlier years, Britain suddenly found its real income higher as a result of a dramatic increase in world oil prices in 1979–1980. In the early 1980s, however, oil prices receded as the
Explain how permanent shifts in national real money demand functions affect real and nominal exchange rates in the long run.
In Chapter 6, we discussed the effect of transfers between countries, such as the indemnity imposed on Germany after World War I. Use the theory developed in this chapter to discuss the mechanisms through which a permanent transfer from Poland to the Czech Republic would affect the real
A country imposes a tariff on imports from abroad. How does this action change the long-run real exchange rate between the home and foreign currencies? How is the long-run nominal exchange rate affected?
Imagine that two identical countries have restricted imports to identical levels, but that one has done so using tariffs while the other has done so using quotas. After these policies are in place, both countries experience identical, balanced expansions of domestic spending. Where should the
Explain how the nominal dollar/euro exchange rate would be affected (all else equal) by permanent changes in the expected rate of real depreciation of the dollar against the euro.
Can you suggest an event that would cause a country’s nominal interest rate to rise and its currency to appreciate simultaneously, in a world of perfectly flexible prices?
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