International Economics: Global Markets and Competition

Henry Thompson

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2nd Edition

International

Global Markets and Competition

2nd Edition

Henry Thompson

Auburn University

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Global Markets and Competition

2nd Edition

1|| | World Scientific

N E W JERSEY • LONDO N • SINGAPOR E • BEIJIN G • SHANGHA I • HONG KONG • TAIPE I • CHENNA I

Published by

World Scientific Publishing Co. Pte. Ltd.

5 Toh Tuck Link, Singapore 596224

USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601

UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library.

INTERNATIONAL ECONOMICS (2nd Edition)

Global Markets and Competition

Copyright © 2006 by World Scientific Publishing Co. Pte. Ltd.

All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic

or mechanical, including photocopying, recording or any information storage and retrieval system now known

or to be invented, without written permission from the Publisher.

For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center,

Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required

from the publisher.

ISBN 981-256-346-6 (pbk)

Printed by Fulsland Offset Printing (S) Pte Ltd, Singapore

Preface for the Student

International economics will affect your private and business life. International

economics has moved center stage as countries become more integrated with

trade, foreign investment, and migration. The world is shrinking with better

transportation and telecommunication.

The foreign exchange market is simply the largest market in the world.

Industries expand and collapse in the face of international markets and

competition. The World Trade Organization (WTO), North American Free Trade

Agreement (NAFTA), and European Union (EU) have become a fundamental

form of government.

Protection eases pressures of international competition. Industries seek the

protection of tariffs and quotas, securing their own profit at your expense.

Governments hinder international trade and investment. Government central banks

interfere with the foreign exchange market. Such maneuvers impede international

commerce and lower income.

This text focuses on international markets. An economy is a collection of

interdependent markets, and in international economies are linked across borders.

Comparative advantage is the most important tool for predicting international

production and trade. International supply is based on underlying production

capacity.

International trade is the arbitrage of products from countries where prices

are low and products unique. Arbitrage makes traders profit and distributes

products more economically. The interaction of international supply and de￾mand determines production and trade. The effects of trade depend on the types

of industries, from competition to monopoly.

Trade policy is designed to redistribute income toward favored industries

and groups. Costs of protection outweigh benefits but industry and labor groups

lobby for protection because they gain at everyone's expense and politicians

respond to political support.

The graphs, examples, applications, and problems in the text are essential.

There are hints for even numbered problems. Good luck. I think you will enjoy

International Economics: Global Markets and Competition. Visit the website at

www.auburn.edu/~thomphl where you can find analysis of current events and

links. Contact me at [email protected].

v

Preface for the Instructor

International Economics: Global Markets and Competition is unique:

• a one-term text for students with principles background

• microeconomic models stress positive theory

• advocates free trade, skeptical about government trade policy

• theory advances through partial and general equilibrium

• over 250 boxed examples from the literature

• problems lead students through theory

This text applies the tools of microeconomics and general equilibrium. The

foreign exchange market and balance of payments are integrated throughout the

text. Open economy macroeconomic models are included in the final chapter

stressing micro foundations.

The text does not assume intermediate theory or calculus. Numerous boxed

examples are a central component, introducing tools and concepts.

Technical points are made with examples and graphs, avoiding "formulas"

and algebraic symbols. Classroom presentations should be more general, using

diagrams and algebra.

Problems are designed for learning and were developed in the classroom.

Hints for even numbered problems are in an appendix. Students can be called

on to work problems at the board, increasing their capacity to absorb the material.

You will be surprised at how well your students learn using International

Economics: Global Markets and Competition. The website at www.auburn.edu/

-thomphl can be integrated into classwork. There is analysis of current events

and links to resources. Contact me at [email protected].

Thanks

Numerous students and colleagues have provided suggestions and comments.

Sonja Langby uncovered logical slips, Lijun Chen carefully rechecked Problems,

and Mostafa Malki updated Examples. The excellent staff at World Scientific

Publishing made putting the text together a pleasure.

vii

Contents

Preface for the Student v

Preface for the Instructor vii

MARKETS AND TRADE

1. Markets, Trade, and Comparative Advantage 3

A. International markets 4

B. Excess supply and demand 13

C. The balance of trade 21

D. Comparative advantage and specialization 27

2. Trade with Constant Costs 37

A. Constant opportunity costs of production 38

B. Specialization and gains from trade 47

C. Extensions of constant cost trade theory 53

D. Applications of constant cost trade theory 62

TRADE: GAINS, PROTECTION, AND TERMS

3. Gains from Trade 73

A. Production possibilities and real income 74

B. Specialization and the gains from trade 82

C. Growth and trade 89

D. Industrial trade policy 97

4. Protection 106

A. Tariffs: Taxes on imports 107

B. Quotas and other nontariff barriers 116

C. Protection and production 123

D. Political economy of protection 127

5. Terms of Trade 136

A. Offer curves 137

B. Tariffs and the terms of trade 149

C. Tariff games 156

D. Trade in nonrenewable natural resources 163

PRODUCTION AND TRADE

6. Factor Proportions Production and Trade 179

A. Specific factors and trade 180

B. Production with two factors and two goods 190

C. Four theorems of production and trade 197

D. Applying factor proportions trade theory 207

7. Industrial Organization and Trade 219

A. Price searching firms and trade 220

B. Intraindustry trade 231

C. Oligopolies 237

D. Other causes of trade 244

INTERNATIONAL INTEGRATION

8. International Labor and Capital 259

A. International migration 260

B. International investment 271

C. Migration, foreign investment, and income redistribution 278

D. Migration, international investment, and trade 285

9. Economic Integration 294

A. Multinational firms 296

B. International externalities 302

C. International political economy 308

D. Steps of economic integration 314

INTERNATIONAL MONEY AND MACROECONOMICS

10. Balance of Payments 327

A. Elasticities and the trade balance 328

B. Current and capital accounts 336

C. International deficits and surpluses 342

D. International fiscal and monetary policy 348

11. The Foreign Exchange Market 356

A. Foreign exchange rates 358

B. Managed exchange rates 367

C. Foreign exchange trading 373

D. Exchange risk 380

12. International Financial Markets 389

A. The international credit market 391

B. Foreign exchange and finance 399

Contents xi

C. International money 408

D. Money and international finance 417

13. Open Economy Macroeconomics 426

A. Microeconomic foundations of macroeconomics 426

B. Closed economy macroeconomics 435

C. The open macro economy 448

D. Inflation, the exchange rate, and macro policy 465

Hints and Partial Answers 475

Acronyms 481

References 483

Name Index 495

Subject Index 499

MARKETS AND TRADE