International

Economics
Sixteenth Edition

Thomas A. Pugel
New York University
Brief Contents
1 International Economics Is 21 International Lending and
Different 1 Financial Crises 502
2 The Basic Theory Using Demand and 22 How Does the Open Macroeconomy
Supply 13 Work? 539
3 Why Everybody Trades: Comparative 23 Internal and External Balance
Advantage 31 with Fixed Exchange Rates 565
4 Trade: Factor Availability and Factor 24 Floating Exchange Rates and
Proportions Are Key 47 Internal Balance 603
5 Who Gains and Who Loses from 25 National and Global Choices:
Trade? 66 Floating Rates and the
6 Scale Economies, Imperfect Alternatives 628
Competition, and Trade 88
APPENDIXES
7 Growth and Trade 117
A The Web and the Library: International
8 Analysis of a Tariff 137 Numbers and Other Information 655
9 Nontariff Barriers to Imports 160 B Deriving Production-Possibility
10 Arguments for and against Curves 659
Protection 192 C Offer Curves 664
11 Pushing Exports 222 D The Nationally Optimal Tariff 667
12 Trade Blocs and Trade Blocks 252 E Accounting for International
13 Trade and the Environment 275 Payments 673
14 Trade Policies for Developing F Many Parities at Once 677
Countries 309 G Aggregate Demand and Aggregate
15 Multinationals and Migration: Supply in the Open Economy 680
International Factor Movements 334 H Devaluation and the Current Account
16 Payments among Nations 370 Balance 690
17 The Foreign Exchange Market 389
SUGGESTED ANSWERS TO
18 Forward Exchange and International ODD-NUMBERED QUESTIONS
Financial Investment 405
AND PROBLEMS 694
19 What Determines Exchange
Rates? 433 REFERENCES 731
20 Government Policies toward the
Foreign Exchange Market 464 INDEX 743
xix
Contents

Chapter 1 Chapter 3
International Economics Is Different 1 Why Everybody Trades: Comparative
Four Controversies 1 Advantage 31
U.S. Exports of Natural Gas 1 Adam Smith’s Theory of Absolute
Immigration 4 Advantage 32
China’s Exchange Rate 5 Case Study Mercantilism: Older Than Smith—
Euro Crisis 7 and Alive Today 33
Economics and the Nation-State 11 Ricardo’s Theory of Comparative
Factor Mobility 11 Advantage 35
Different Fiscal Policies 12 Ricardo’s Constant Costs and the
Different Moneys 12 Production-Possibility Curve 38
Focus on Labor Absolute Advantage
Chapter 2 Does Matter 40
The Basic Theory Using Demand Extension What If Trade Doesn’t
and Supply 13 Balance? 42
Summary 43
Four Questions about Trade 14 Key Terms 44
Demand and Supply 14 Suggested Reading 44
Demand 14 Questions and Problems 44
Consumer Surplus 16
Case Study Trade Is Important 17 Chapter 4
Supply 18
Trade: Factor Availability and Factor
Producer Surplus 19
Global Crisis The Trade Mini-Collapse Proportions Are Key 47
of 2009 20 Production with Increasing Marginal Costs 48
A National Market with No Trade 22 What’s Behind the Bowed-Out Production-Possibility
Two National Markets and the Opening Curve? 48
of Trade 22 What Production Combination Is Actually
Free-Trade Equilibrium 24 Chosen? 50
Effects in the Importing Country 25 Community Indifference Curves 51
Effects in the Exporting Country 27 Production and Consumption Together 53
Which Country Gains More? 27 Without Trade 53
Summary: Early Answers to the Four Trade With Trade 54
Questions 28 Focus on China The Opening of Trade and
Key Terms 28 China’s Shift Out of Agriculture 56
Suggested Reading 29 Demand and Supply Curves Again 58
Questions and Problems 29 The Gains from Trade 58

xx
 Contents xxi

Trade Affects Production and Chapter 6

Consumption 59 Scale Economies, Imperfect Competition,
What Determines the Trade Pattern? 60 and Trade 88
The Heckscher–Ohlin (H–O) Theory 61
Summary 62 Scale Economies 89
Key Terms 63 Internal Scale Economies 90
Suggested Reading 63 External Scale Economies 91
Questions and Problems 63 Intra-Industry Trade 92
How Important Is Intra-Industry Trade? 93
What Explains Intra-Industry Trade? 94
Chapter 5 Monopolistic Competition and Trade 95
Who Gains and Who The Market with No Trade 97
Loses from Trade? 66 Opening to Free Trade 98
Basis for Trade 99
Who Gains and Who Loses within Extension The Individual Firm in Monopolistic
a Country 66 Competition 100
Short-Run Effects of Opening Trade 67 Gains from Trade 103
The Long-Run Factor-Price Response 67 Oligopoly and Trade 104
Three Implications of the H–O Theory 69 Substantial Scale Economies 105
The Stolper–Samuelson Theorem 69 Oligopoly Pricing 105
Extension A Factor-Ratio Paradox 70 Extension The Gravity Model
The Specialized-Factor Pattern 72 of Trade 106
The Factor-Price Equalization Theorem 72 External Scale Economies and Trade 109
Does Heckscher–Ohlin Explain Actual Trade Summary: How Does Trade Really
Patterns? 73 Work? 111
Factor Endowments 74 Key Terms 114
Case Study The Leontief Paradox 75 Suggested Reading 114
International Trade 76 Questions and Problems 114
What are the Export-Oriented
and Import-Competing Factors? 78 Chapter 7
The U.S. Pattern 78
Growth and Trade 117
The Canadian Pattern 79
Patterns in Other Countries 79 Balanced Versus Biased Growth 118
Focus on China China’s Exports and Growth in Only One Factor 120
Imports 80 Changes in the Country’s Willingness
Do Factor Prices Equalize to Trade 121
Internationally? 82 Case Study The Dutch Disease and
Focus on Labor U.S. Jobs and Foreign Deindustrialization 123
Trade 83 Effects on the Country’s Terms of Trade 124
Summary: Fuller Answers to the Four Trade Small Country 124
Questions 84 Large Country 124
Key Terms 85 Immiserizing Growth 126
Suggested Reading 85 Technology and Trade 128
Questions and Problems 85 Individual Products and the Product Cycle 129
xxii Contents

Focus on Labor Trade, Technology, and Case Study Carrots Are Fruit, Snails Are Fish,
U.S. Wages 130 and X-Men Are Not Humans 178
Openness to Trade Affects Growth 131 Domestic Content Requirements 179
Summary 132 Government Procurement 180
Key Terms 133 How Big Are the Costs of Protection? 181
Suggested Reading 134 As a Percentage of GDP 181
Questions and Problems 134 As the Extra Cost of Helping Domestic
Producers 182
Chapter 8 International Trade Disputes 183
America’s “Section 301”: Unilateral Pressure 183
Analysis of a Tariff 137
Focus on China China in the WTO 184
Global Governance WTO and GATT: Tariff Dispute Settlement in the WTO 186
Success 138 Summary 187
A Preview of Conclusions 140 Key Terms 188
The Effect of a Tariff on Domestic Suggested Reading 189
Producers 140 Questions and Problems 189
The Effect of a Tariff on Domestic
Consumers 142 Chapter 10
The Tariff as Government Revenue 145
Arguments for and against
The Net National Loss from a Tariff 145
Extension The Effective Rate of Protection 148 Protection 192
Case Study They Tax Exports, Too 150 The Ideal World of First Best 193
The Terms-of-Trade Effect and a Nationally The Realistic World of Second Best 194
Optimal Tariff 152 Government Policies toward Externalities 196
Summary 156 The Specificity Rule 196
Key Terms 157 Promoting Domestic Production
Suggested Reading 157 or Employment 197
Questions and Problems 157 The Infant Industry Argument 201
How It Is Supposed to Work 201
Chapter 9 How Valid Is It? 202
Focus on Labor How Much Does It Cost to
Nontariff Barriers to Imports 160
Protect a Job? 204
Types of Nontariff Barriers to Imports 160 The Dying Industry Argument and Adjustment
The Import Quota 162 Assistance 206
Quota versus Tariff for a Small Country 162 Should the Government Intervene? 206
Global Governance The WTO: Beyond Trade Adjustment Assistance 207
Tariffs 164 The Developing Government (Public Revenue)
Global Crisis Dodging Protectionism 167 Argument 208
Ways to Allocate Import Licenses 168 Other Arguments for Protection: Noneconomic
Extension A Domestic Monopoly Prefers Objectives 209
a Quota 170 National Pride 209
Quota versus Tariff for a Large Country 172 National Defense 210
Voluntary Export Restraints (VERs) 173 Income Redistribution 210
Other Nontariff Barriers 175 The Politics of Protection 211
Product Standards 175 The Basic Elements of the Political–Economic
Case Study VERs: Two Examples 176 Analysis 211
 Contents xxiii

When Are Tariffs Unlikely? 212 North America Becomes a Bloc 262
When Are Tariffs Likely? 213 NAFTA: Provisions and Controversies 263
Applications to Other Trade-Policy Patterns 214 NAFTA: Effects 264
Case Study How Sweet It Is (or Isn’t) 215 Rules of Origin 265
Summary 217 Trade Blocs among Developing Countries 266
Key Terms 219 Trade Embargoes 267
Suggested Reading 219 Summary 272
Questions and Problems 219 Key Terms 273
Suggested Reading 273
Chapter 11 Questions and Problems 273
Pushing Exports 222
Chapter 13
Dumping 222
Trade and the Environment 275
Reacting to Dumping: What Should
a Dumpee Think? 225 Is Free Trade Anti-Environment? 275
Actual Antidumping Policies: What Is Is the WTO Anti-Environment? 280
Unfair? 226 Global Governance Dolphins, Turtles,
Proposals for Reform 229 and the WTO 282
Case Study Antidumping in Action 230 The Specificity Rule Again 284
Export Subsidies 233 A Preview of Policy Prescriptions 285
Exportable Product, Small Exporting Country 234 Trade and Domestic Pollution 287
Exportable Product, Large Exporting Country 236 Transborder Pollution 290
Switching an Importable Product into an The Right Solution 291
Exportable Product 237 A Next-Best Solution 293
WTO Rules on Subsidies 238 NAFTA and the Environment 294
Should the Importing Country Impose Global Environmental Challenges 295
Countervailing Duties? 239 Global Problems Need Global Solutions 295
Case Study Agriculture Is Amazing 242 Extinction of Species 296
Strategic Export Subsidies Could Be Good 244 Overfishing 298
Global Governance Dogfight at the WTO 246 CFCs and Ozone 299
Summary 248 Greenhouse Gases and Global Warming 300
Key Terms 249 Summary 305
Suggested Reading 249 Key Terms 306
Questions and Problems 250 Suggested Reading 306
Questions and Problems 306
Chapter 12
Trade Blocs and Trade Blocks 252 Chapter 14
Trade Policies for Developing
Types of Economic Blocs 252
Countries 309
Is Trade Discrimination Good or Bad? 253
The Basic Theory of Trade Blocs: Which Trade Policy for Developing
Trade Creation and Trade Diversion 255 Countries? 311
Other Possible Gains from a Trade Bloc 258 Are the Long-Run Price Trends Against
The EU Experience 259 Primary Producers? 313
Case Study Postwar Trade Integration in Case Study Special Challenges of
Europe 260 Transition 314
xxiv Contents

International Cartels to Raise Primary-Product Effects on the Government Budget 361

Prices 319 External Costs and Benefits 361
The OPEC Victories 319 Case Study Are Immigrants a Fiscal Burden? 362
Classic Monopoly as an Extreme Model for Cartels 320 What Policies to Select Immigrants? 364
The Limits to and Erosion of Cartel Power 322 Summary 365
The Oil Price Increase since 1999 323 Key Terms 367
Other Primary Products 324 Suggested Reading 367
Import-Substituting Industrialization (ISI) 324 Questions and Problems 367
ISI at Its Best 325
Experience with ISI 326 Chapter 16
Exports of Manufactures to Industrial Payments among Nations 370
Countries 329
Accounting Principles 370
Summary 330
A Country’s Balance of Payments 371
Key Terms 331
Current Account 371
Suggested Reading 331
Financial Account 373
Questions and Problems 331
Official International Reserves 374
Statistical Discrepancy 375
Chapter 15 The Macro Meaning of the Current Account
Multinationals and Migration: Balance 375
International Factor Movements 334 The Macro Meaning of the Overall
Balance 380
Foreign Direct Investment 335 The International Investment Position 381
Multinational Enterprises 337 Euro Crisis International Indicators Lead the
FDI: History and Current Patterns 338 Crisis 383
Why Do Multinational Enterprises Exist? 340 Summary 385
Inherent Disadvantages 341
Key Terms 386
Firm-Specific Advantages 341
Suggested Reading 386
Location Factors 342
Questions and Problems 386
Internalization Advantages 343
Oligopolistic Rivalry 344 Chapter 17
Taxation of Multinational Enterprises’
The Foreign Exchange Market 389
Profits 344
Case Study CEMEX: A Model Multinational The Basics of Currency Trading 390
from an Unusual Place 345 Case Study Brussels Sprouts a New
MNEs and International Trade 347 Currency: € 392
Should the Home Country Restrict FDI Using the Foreign Exchange Market 393
Outflows? 349 Case Study Foreign Exchange
Should the Host Country Restrict FDI Trading 394
Inflows? 350 Interbank Foreign Exchange Trading 395
Focus on China China as a Host Country 352 Demand and Supply for Foreign Exchange 396
Migration 354 Floating Exchange Rates 397
How Migration Affects Labor Markets 357 Fixed Exchange Rates 399
Should the Sending Country Restrict Current Arrangements 400
Emigration? 360 Arbitrage within the Spot Exchange
Should the Receiving Country Restrict Market 401
Immigration? 361 Summary 402
 Contents xxv

Key Terms 402 The Law of One Price 441

Suggested Reading 402 Absolute Purchasing Power Parity 441
Questions and Problems 403 Relative Purchasing Power Parity 442
Case Study PPP from Time to Time 443
Chapter 18 Case Study Price Gaps and International
Income Comparisons 444
Forward Exchange and International Relative PPP: Evidence 446
Financial Investment 405 The Long Run: The Monetary Approach 449
Exchange-Rate Risk 405 Money, Price Levels, and Inflation 449
The Market Basics of Forward Foreign Money and PPP Combined 450
Exchange 406 The Effect of Money Supplies on an Exchange
Hedging Using Forward Foreign Exchange 407 Rate 451
Speculating Using Forward Foreign Exchange 408 The Effect of Real Incomes on an Exchange
Extension Futures, Options, and Swaps 410 Rate 451
International Financial Investment 412 Exchange-Rate Overshooting 452
International Investment with Cover 413 How Well Can We Predict Exchange
Covered Interest Arbitrage 415 Rates? 455
Covered Interest Parity 416 Four Ways to Measure the Exchange
International Investment without Cover 417 Rate 457
Case Study The World’s Greatest Investor 420 Summary 459
Does Interest Parity Really Hold? Empirical Key Terms 460
Evidence 422 Suggested Reading 461
Evidence on Covered Interest Parity 422 Questions and Problems 461
Evidence on Uncovered Interest Parity 423
Case Study Eurocurrencies: Not (Just) Euros Chapter 20
and Not Regulated 424
Government Policies toward the Foreign
Global Crisis and Euro Crisis Covered
Interest Parity Breaks Down 426
Exchange Market 464
Evidence on Forward Exchange Rates and Two Aspects: Rate Flexibility and Restrictions
Expected Future Spot Exchange Rates 428 on Use 465
Summary 428 Floating Exchange Rate 466
Key Terms 430 Fixed Exchange Rate 466
Suggested Reading 430 What to Fix to? 467
Questions and Problems 430 When to Change the Fixed Rate? 467
Defending a Fixed Exchange Rate 469
Chapter 19 Defense through Official
What Determines Exchange Intervention 470
Defending against Depreciation 470
Rates? 433
Defending against Appreciation 472
A Road Map 435 Temporary Disequilibrium 474
Exchange Rates in the Short Run 436 Disequilibrium That Is Not Temporary 475
The Role of Interest Rates 437 Exchange Control 477
The Role of the Expected Future Spot Exchange International Currency Experience 480
Rate 438 The Gold Standard Era, 1870–1914
The Long Run: Purchasing Power Parity (One Version of Fixed Rates) 481
(PPP) 440 Interwar Instability 484
xxvi Contents

The Bretton Woods Era, 1944–1971 (Adjustable Causes and Amplifiers 530
Pegged Rates) 486 Euro Crisis National Crises, Contagion, and
Global Governance The International Resolution 532
Monetary Fund 487 Summary 534
The Current System: Limited Anarchy 492 Key Terms 536
Summary 496 Suggested Reading 536
Key Terms 498 Questions and Problems 536
Suggested Reading 499
Questions and Problems 499 Chapter 22
How Does the Open Macroeconomy
Chapter 21 Work? 539
International Lending and Financial The Performance of a National
Crises 502 Economy 539
A Framework for Macroeconomic
Gains and Losses from Well-Behaved Analysis 540
International Lending 503 Domestic Production Depends on Aggregate
Taxes on International Lending 506 Demand 541
International Lending to Developing Trade Depends on Income 543
Countries 506 Equilibrium GDP and Spending
The Surge in International Lending, 1974–1982 507
Multipliers 543
The Debt Crisis of 1982 508
Equilibrium GDP 543
The Resurgence of Capital Flows in the 1990s 509
The Spending Multiplier in a Small Open
The Mexican Crisis, 1994–1995 510
Economy 545
The Asian Crisis, 1997 512
Foreign Spillovers and Foreign-Income
The Russian Crisis, 1998 512
Repercussions 547
Global Governance Short of Reserves? Call A More Complete Framework:
1-800-IMF-LOAN 513
Three Markets 549
Argentina’s Crisis, 2001–2002 516
The Domestic Product Market 550
Financial Crises: What Can and Does Go The Money Market 552
Wrong 517 The Foreign Exchange Market (or Balance
Waves of Overlending and Overborrowing 517
of Payments) 554
Extension The Special Case of Sovereign Three Markets Together 557
Debt 518
The Price Level Does Change 558
Exogenous International Shocks 520
Trade Also Depends on Price
Exchange-Rate Risk 520
Competitiveness 559
Fickle International Short-Term Lending 520
Summary 560
Global Contagion 521
Key Terms 562
Resolving Financial Crises 522 Suggested Reading 563
Rescue Packages 522
Questions and Problems 563
Debt Restructuring 523
Reducing the Frequency of Financial Chapter 23
Crises 525 Internal and External Balance with Fixed
Bank Regulation and Supervision 526
Exchange Rates 565
Capital Controls 527
Global Financial and Economic Crisis 528 From the Balance of Payments to the Money
How the Crisis Happened 528 Supply 566
 Contents xxvii

From the Money Supply Back to the Global Crisis Liquidity Trap! 616
Balance of Payments 569 Case Study Can Governments Manage the
Sterilization 572 Float? 619
Monetary Policy with Fixed Exchange Global Crisis Central Bank Liquidity
Rates 574 Swaps 622
Fiscal Policy w ith Fixed Exchange Summary 623
Rates 575 Key Terms 625
Perfect Capital Mobility 578 Suggested Reading 625
Shocks to the Economy 580 Questions and Problems 625
Internal Shocks 580
International Capital-Flow Shocks 580
International Trade Shocks 582 Chapter 25
Imbalances and Policy Responses 584 National and Global Choices: Floating
Internal and External Imbalances 584 Rates and the Alternatives 628
Case Study A Tale of Three Countries 586
Key Issues in the Choice of Exchange-
A Short-Run Solution: Monetary–Fiscal Mix 589
Rate Policy 629
Surrender: Changing the Exchange
Effects of Macroeconomic Shocks 629
Rate 591
Case Study What Role for Gold? 631
How Well Does the Trade Balance Respond
The Effectiveness of Government Policies 635
to Changes in the Exchange Rate? 594
Differences in Macroeconomic Goals, Priorities,
How the Response Could Be Unstable 595
and Policies 636
Why the Response Is Probably Stable 596
Controlling Inflation 637
Timing: The J Curve 597
Real Effects of Exchange-Rate Variability 639
Summary 598
National Choices 641
Key Terms 600
Extreme Fixes 643
Suggested Reading 601
Currency Board 643
Questions and Problems 601
“Dollarization” 644
The International Fix—Monetary Union 645
Chapter 24 Exchange Rate Mechanism 646
Floating Exchange European Monetary Union 647
Rates and Internal Balance 603 Summary 652
Key Terms 653
Monetary Policy with Floating Exchange Suggested Reading 653
Rates 604 Questions and Problems 654
Fiscal Policy with Floating Exchange
Rates 607
Shocks to the Economy 609
Internal Shocks 609
APPENDIXES
Case Study Why Are U.S. Trade Deficits
So Big? 610
A The Web and the Library:
International Capital-Flow Shocks 612 International Numbers and Other
International Trade Shocks 613 Information 655
Internal Imbalance and Policy B Deriving Production-Possibility
Responses 614 Curves 659
International Macroeconomic Policy
Coordination 615 C Offer Curves 664
xxviii Contents

D The Nationally Optimal Tariff 667 Suggested Answers to Odd-Numbered

Questions and Problems 694
E Accounting for International
Payments 673 References 731
F Many Parities at Once 677
Index 743
G Aggregate Demand and Aggregate
Supply in the Open Economy 680
H Devaluation and the Current Account
Balance 690