International Economics: Theory and Policy Solution

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Instructor’s Manual
to accompany
Krugman & Obstfeld

International Economics:
Theory and Policy
Sixth Edition

Linda S. Goldberg
Federal Reserve Bank of New York

Michael W. Klein
Tufts University
The Fletcher School of Law and Diplomacy

Jay C. Shambaugh
Dartmouth College

The views presented in this book are those of the authors and need not reflect the views of the Federal Reserve Bank of New York or the Federal Reserve System.

Contents
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
Chapter 9
Chapter 10
Chapter 11

Chapter 12
Chapter 13
Chapter 14
Chapter 15
Chapter 16
Chapter 17
Chapter 18
Chapter 19
Chapter 20
Chapter 21
Chapter 22

page
Contents
iii
Introduction
1
Overview of Section I: International Trade Theory
3
Labor Productivity and Comparative Advantage: The Ricardian Model 7 Specific Factors and Income Distribution
13
Resources and Trade: The Heckscher-Ohlin Model
21
The Standard Trade Model
27
Economies of Scale, Imperfect Competition, and International Trade 35 International Factor Movements
41
Overview of Section II: International Trade Policy
47
The Instruments of Trade Policy
49
The Political Economy of Trade Policy
57
Trade Policy in Developing Countries
65
Controversies in Trade Policy
71
Overview of Section III: Exchange Rates and Open Economy
Macroeconomics
77
National Income Accounting and the Balance of Payments
81
Exchange Rates and the Foreign Exchange Market:
89
An Asset Approach
Money, Interest Rates, and Exchange Rates
101
Price Levels and the Exchange Rate in the Long Run
109
Output and the Exchange Rate in the Short Run
119
Fixed Exchange Rates and Foreign Exchange Intervention
131
Overview of Section IV: International Macroeconomic Policy
141
The International Monetary System, 1870-1973
145
Macroeconomic Policy and Coordination Under
153
Floating Exchange Rates
Optimum Currency Areas and the European Experience
163
The Global Capital Market: Performance and Policy Problems
171
Developing Countries: Growth, Crisis, and Reform
177
Mathematical Postscript
185

ii

CHAPTER 1
INTRODUCTION
Chapter Organization
What is International Economics About?
The Gains from Trade
The Pattern of Trade
Protectionism
The Balance of Payments
Exchange-Rate Determination
International Policy Coordination
The International Capital Market
International Economics: Trade and Money
CHAPTER OVERVIEW
The intent of this chapter is to provide both an overview of the subject matter of international economics and to provide a guide to the organization of the text. It is relatively easy for an instructor to motivate the study of international trade and finance. The front pages of newspapers, the covers of magazines, and the lead reports of television news broadcasts herald the interdependence of the U.S. economy with the rest of the world. This interdependence may also be recognized by students through their purchases of imports of all sorts of goods, their personal observations of the effects of dislocations due to international competition, and their experience through travel abroad.

The study of the theory of international economics generates an understanding of many key events that shape our domestic and international environment. In recent history, these events include the causes and consequences of the large current account deficits of the United States; the dramatic appreciation of the dollar during the first half of the 1980s followed by its rapid depreciation in the second half of the 1980s; the Latin American debt crisis of the 1980s and the Mexico crisis in late 1994; and the increased pressures for industry protection against foreign competition broadly voiced in the late 1980s and more vocally espoused in the first half of the 1990s. Most recently, the financial crisis that began in East Asia in 1997

1

and spread to many countries around the globe and the...
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