Solution Manual for Introduction to International Economics , 3rd Edition

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Instructor’s ManualTo AccompanyIntroduction to InternationalEconomics3rd EditionDOMINICK SALVATOREProfessor of EconomicsFordham UniversityNew York

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CONTENTSIntroductory Comments …….…………………………………………………………………...*Chapter 1:Introduction to the Global Economy …………………………………………..1Part One: International Trade Theory*Chapter 2: Comparative Advantage ……………………………………………………….. 7*Chapter 3: The Standard Trade Model …………………………………………………….. 15*Chapter 4: The Heckscher-Ohlin and Other Trade Theories ………………………………. 23Additional Essays and Problems for Part One ………………………………………………….. 31Part Two: International Trade Policy*Chapter 5: Trade Restrictions: Tariffs ……………………………………………………... 36*Chapter 6: Nontariff Trade Barriers and the Political Economy of Protectionism ………… 43Additional Essays and Problems for Part Two ………………………………………………… .. 50Part Three: International Trade and Investment Relations*Chapter 7: Economic Integration …………………………………………………………... 53Chapter 8: Growth and Development with International Trade …………………………… 59Chapter 9:International Resource Movements and Multinational Corporations …………...66Additional Essays and Problems for Part Three …………………………………………………72Part Four: The Balance of Payments and Exchange Rates*Chapter 10: The Balance of Payments ………………………………………………………74*Chapter 11: Foreign Exchange Markets and Exchange Rates ……………………………… 80*Chapter 12: Exchange Rate Determination …………………………………………………. 85Additional Essays and Problems for Part Four ………………………………………………….92Part Five: Open Economy Macroeconomics*Chapter 13: Automatic Adjustments with Fixed and Flexible Exchange Rates …………… 94*Chapter 14: Adjustment Policies …………………………………………………………... 103Additional Essays and Problems for Part Five ……………………………………………...110Part Six: The Operation of the International Monetary System: Past, Present, and Future*Chapter 15: Flexible versus Fixed Exchange Rates, European Monetary System,and Macroeconomic Policy Coordination ……………………………………. 112*Chapter 16: The International Monetary System: Past, Present, and Future ………………… 119Additional Essays and Problems for Part Five ……………………………………………….. . 126* = Core Chapter

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INTRODUCTORY COMMENTSPurpose of this ManualThe purpose of this manual is to facilitate the use of the text by the Instructor. It contains thedetailed outline of each chapter, lecture guides with suggestions on how best to present the materialin each chapter, the answer to the end-of-chapter review questions and problems, and a set of 15multiple-choice questions with answers for each chapter.The Instructor who feels that more questions and problems would be useful can consult my smalland popular paperbackTheory and Problems of International Economics(4th ed., 1996) in theSchaum's Outline Series, which includes a wealth of additional multiple-choice questions andsolved problems and theStudy Guideprepared for this text by Professor Arthur Raymond ofMuhlenberg College. At the end of each of the six parts of thisManualthere are also additionalessaysand problems with answers that can be used for class exams.Course OutlinesSome Instructors might want to skip Chapters 8 and 9, thus leaving 13 chapters (besides theintroductory chapter)–one for each week of the semester, leaving one week for review and themidterm examination, and one week for review and the final examination.I would give the midterm after Parts One, Two, and Three, which cover international trade, and thefinal on all chapters covered at the end of the semester.A Personal Note to You, the InstructorI welcome any comment, suggestion, or opinion that you may have on the use of the text. You cancorrespond directly with me or through John Wiley, and I will personally acknowledge your letterand comment on your suggestions. I will, of course, consider your comments for the next Edition ofthe text and would gratefully acknowledge any such contribution.D.S.

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Salvatore’sIntroduction to International Economics,3rdEditionInstructor’s Manual1-1*CHAPTER 1(Core Chapter)INTRODUCTIONOUTLINE1.1We Live in a Global EconomyCase Study 1-1 The Dell and Other PCs Sold in the United States Are Anything ButAmerican!Case Study 1-2 What Is an “American” Car?1.2The Globalization ChallengeCase Study 1-3 Is India’s Globalization Harming the United States?1.3International Trade and the Nation’s Standard of LivingCase Study 1-4 Rising Importance of International Trade to the United States1.4The International Flow of Labor and CapitalCase Study 1-5 Major Net Exporters and Importers of Capital1.5The Subject Matter of International Economics1.6Current International Economic Problems1.7International Institutions and the World Economy1.8Organization of the TextAppendix: International Trade Data, Sources and InformationA1.1 International Trade DataA1.2 Sources of Additional International Data and InformationKEY TERMSGlobalizationMicroeconomicsAnti-globalization movementMacroeconomicsInterdependenceOpen-economy macroeconomicsInternational trade policyInternational financeBalance of paymentsWorld Trade Organization (WTO)Foreign exchange marketsInternational Monetary Fund (IMF)Adjustment in the Balance of PaymentsUnited Nations (UN)

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Salvatore’sIntroduction to International Economics,3rdEditionInstructor’s Manual1-2LECTURE GUIDE1.As the first chapter of the book, the general aim here is simply to define the field of study ofinternational economics and point out its importance in today's interdependent world.2.The material in this chapter can be covered in three classes. I would utilize one class to coverSections 1-2 and the second class for Sections 3-5. I would spend most of the third class onSection 6 to identify the major current international economic problemsfacing the UnitedStates and the world and to show how international economics can suggestways to solve them.This should greatly enhance students' motivation.ANSWERS TO REVIEW QUESTIONS AND PROBLEMS1.Globalizationrefers to the openness and the free exchange of goods, services, resources,technologies, moneys, and ideas around the world. Theadvantagesof globalization are that itincreases efficiency in production andleads to higher income for the nation’s workers.Globalization often also makesavailable a greater range of cheaper and or better products tothe nation’sconsumers, and provides opportunities for higher returns a greater riskdiversification to the nation’s investors.Thedisadvantagesof globalization is that it oftenleads to job losses and lower wages for low-skilled labor in advanced nations and harm (i.e.,it is a “braindrain” for) the nations of emigration.Financial globalization and unrestrictedcapital flowscan also lead international financial crises.It is thesedisadvantages andnegative aspects of globalization have given rise toastronganti-globalizationmovement,which blames globalization forsacrificinghuman and environmentalwell-being to thecorporate profits ofmultinationals.2.International economic relations differ frominterregional (i.e. within a country)economicrelationsin thatnations usually impose some restrictions on the flowof goods, services, andfactorsacrosstheir borders, but notinterregionally orinternally(i.e., not across regions of thesame nation).In addition, internationalflows are to some extenthampered bydifferences inlanguage, customs, andlaws. Furthermore, international flows of goods, services, andresources giverise to payments and receipts in foreign currencies, which change in valueovertime.3.A rough measure of the economic relationship among nations, or theirinterdependence, isgiven by the ratio of their imports and exports of goods and services totheir gross domesticproduct (GDP). The imports and exports as a percentage of GDP are much larger for smallindustrial and developing countries than they are forlarge countries.4.The United States relies less on international trade for its high standard of livingthan mostother nations because it is continental in size with immense natural and human resources. Assuch, it can produce with relative efficiency most of the products it needs. Contrast this to theposition of a small nation, such as Switzerland, which can specialize andexport only a smallrange of commoditiesand imports all the others. In general,the larger the nation the smaller

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Salvatore’sIntroduction to International Economics,3rdEditionInstructor’s Manual1-3is its economic interdependence with the rest of the world.5.Even though the United States relies only to a relatively small extent on international trade, asignificant part of its high standard of living depends on it.The United States must importmany commodities that it cannot produce andseveral needed minerals that it does have. Moreimportant quantitatively to itseconomic well-being, however, are the many commodities thatthe United Statescould produce domestically but only at relatively higher cost.6.The immigration of skilled people benefits the United States because it raises theskill level,average income, and the growth rate of the nation. The cost arisesfrom immigration ofunskilled people and from the job competition whichmigrants provide to native workers.7.Capital flows across national boundaries in search of higher returns and todiversify risks.8.The major international economic problems facing the world today are:(1)slow growth and high unemployment in advanced nations after “the greatrecession”;(2)the rise of trade protectionism inadvanced countries in a rapidlyglobalizingworld;(3)excessive volatility and large disequilibria in exchange rates;(4)structural imbalances in advanced economies and insufficient restructuring intransition economies;(5)deep poverty in many developing countries, and(6)resource scarcity, environmental degradation, and climate change.9.The most important economic internationaleconomic and politicalinstitutionsare:(1)TheWorld TradeOrganization (WTO), which regulates international trade;(2)World Bank, whichprovidesloans to developing countries for developmentprogramsaimed atreducingpoverty;(3)International Monetary Fund (IMF),whichoverseesthe conduct ofinternationalfinancial relationsand provides borrowing facilities formember nations intemporarybalance of payments difficulties;(4)United Nations (UN), which seeks tofacilitate cooperation ininternational law,international security,economic development,social progress, and human rightsissues.10.The problems facing the world today affect the United States and you as an individualas follows:(1)Slow growth and high unemployment in advanced nations after “the great recession”means slower growth and higher unemployment for the United States than otherwisein our interdependent world and very likely less job opportunities and stagnant wagesfor you also.

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Salvatore’sIntroduction to International Economics,3rdEditionInstructor’s Manual1-4(2)Trade controversies between the United States, Europe, and Japan and emergingmarket economies, such as China, can result in traderestrictions or even trade wars,which would reduce the volume and the gains from trade and the flow of internationalinvestments and the benefits resulting from them. As an individual, you can be caughtlosing your job and a stagnant income.(3)Excessive exchange rate volatility and misalignments discourage foreign trade andinvestments, reduce specialization in production and the benefits from trade, whichmeans higher prices for your imported goods and services, more expensive travel.(4)Structural imbalances (excessive and unsustainable trade and budget disequilibria) inadvanced countries and insufficient restructuring in transition economies mean slowergrowth than possible as advanced nations try to eliminate or reduce their structuralimbalances and transition economies redouble their efforts to complete the restructureof their economies. This also means possibly job opportunities for you and stagnantwages.(5)Deep poverty in many developing nations in the world mean that the United States andother rich countries need to provide more foreign aid and open their markets morewidely to the exports of the world’s poorest countries. This can result in your payinghigher taxes and facing more job and income pressures.(6)Resource scarcity, environmental degradation, and climate change means that the priceof food and raw materials is likely to increase in the future and the United States andother countries need to spend more to protect the environment and prevent damagingclimate change. All this means higher costs for all of us.MULTIPLE-CHOICE QUESTIONS1.Which of the following statements about globalization isfalse?a.it increase economic efficiencyb.it cannot be avoidedc. it benefits all peopled. none of the above2.The anti-globalization movement blames globalization fora.increasing income inequalities in the worldb.child laborc.environmental pollutiond. all of the above3.The criticism of the anti-globalization movement isa.all wrong

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Salvatore’sIntroduction to International Economics,3rdEditionInstructor’s Manual1-5b.all correctc. is only partly correctd.is impossible to answer4.Which of the following products are not produced at all in the United States?a. coffee, tea, cocoab.steel, copper, aluminumc.petroleum, coal, natural gasd.typewriters, computers, airplanes5.International trade is most important to the standard of living of:a.the United Statesb. Switzerlandc.Germanyd.England6.Over time, the economic interdependence of nations has:a. grownb.diminishedc.remained unchangedd.cannot say7.A rough measure of the degree of economic interdependence of a nation is givenby:a.the size of the nations' populationb.the ratio of its population to its GDPc. the ratio of a nation's imports and exports to its GDPd. all of the above8.Economic interdependence is greater for:a. small nationsb.large nationsc.developed nationsd.developing nations9.International economics deals with:a.the flow of goods, services and payments among nationsb.policies directed at regulating the flow of goods, services and paymentsc.the effects of policies affecting international trade and finance on the welfare ofthe nationd. all of the above

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Salvatore’sIntroduction to International Economics,3rdEditionInstructor’s Manual1-610.International trade theory refers to:a. the microeconomic aspects of international tradeb.the macroeconomic aspects of international tradec.open-economy macroeconomics or international financed.all of the above11. Which of the following isnotthe subject matter of international finance?a.foreign exchange marketsb.the balance of paymentsc. the basis and the gains from traded. policies to adjust balance of payments disequilibria12.International trade is similar to interregional trade in that both must overcome:a. distance and spaceb.trade restrictionsc.differences in currenciesd.differences in monetary systems13.The opening or expansion of international trade usually affects all members ofsociety:a.positivelyb.negativelyc. most positively but some negativelyd. most negatively but some positively14.An increase in the dollar price of a foreign currency usually:a. benefit U.S. importersb. benefits U.S. exportersc.benefit both U.S. importers and U.S. exportersd.harms both U.S. importers and U.S. exporters15.Which of the following statements with regard to international economics istrue?a. it is a relatively new fieldb. it is a relatively old fieldc.most of its contributors were not economistsd.none of the above.

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual2-1*CHAPTER 2(Core Chapter)COMPARATIVE ADVANTAGEOUTLINE2.1Introduction2.2Mercantilists’ Views on TradeCase Study 2-1 Mercantilism Is Alive and Well in the Twenty-First Century2.3Trade Based on Absolute Advantage: Adam Smith2.4Trade Based on Comparative Advantage: David Ricardo2.5Gains from Trade with Comparative Advantage2.6Comparative Advantage with MoneyCase Study 2-2 The Petition of the Candlemakers2.7Comparative Advantage and Opportunity CostsCase Study 2-3 Labor Productivities and Comparative Advantage2.8Production Possibility Frontier with Constant Costs2.9Opportunity Costs and Relative Commodity Prices2.10Basis and Gains from Trade Under Constant CostsAppendix: Comparative Advantage with More than Two Commodities and NationsA2.1 Comparative Advantage with More than Two CommoditiesA2.2 Comparative Advantage with More than Two NationsKEY TERMSBasis for tradeLabor theory of valueGains from tradeOpportunity cost theoryPattern of tradeProduction possibility frontierMercantilismConstant opportunity costAbsolute advantageRelative commodity pricesLaissez-faireComplete specializationLaw of comparative advantageSmall-country case

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual2-2LECTURE GUIDE1.This is a long and crucial core chapter and may require four classes to cover adequately.In thefirst lecture, I would present Sections 1-4 and assign review questions 1-3.2.In the second lecture of Chapter 2, I would concentrate on Sections 5-6 and carefully explain thelaw of comparative advantage using simple numerical examples, as in the text. Both sections arecrucial. Section 5 explains the law of comparative advantage and Section 6 establishes the linkbetween trade theory and international finance. I find that the numerical explanations before thegraphical analysis really helps the student to truly understand the law. The simple lawyer-secretary example should also render the law more immediately relevant to the student. I wouldalso assign Problems 4-7.3.In the third lecture, I would cover Sections 7-9 and assign Problems 8-10.4.In the fourth lecture, I would Section 10 and go over problems 4-10. The appendixes could bemade optional for the more enterprising students in the class.ANSWERS TO REVIEW QUESTIONS AND PROBLEMS1.The mercantilists believed that the way for a nation to become rich and powerful was toexport more than it imported. The resulting export surplus would then be settled by an inflowof gold and silver and the more gold and silver a nation had, the richer and more powerful itwas. Thus, the government had to do all in its power to stimulate the nation’s exports anddiscourage and restrict imports. However, since all nations could not simultaneously have anexport surplus and the amount of gold and silver was fixed at any particular point in time,one nation could gain only at the expense of other nations. The mercantilists thus preachedeconomic nationalism, believing that national interests were basically in conflict.Adam Smith, on the other hand, believed that free trade would make all nations better off.All of this is relevant today because many of the arguments made in favor of restrictinginternational trade to protect domestic jobs are very similar to the mercantilists argumentsmade three or four centuries ago. That is why we can say that “mercantilism is alive and wellin the twenty-first century”. Thus we have to be prepared to answer and demonstrate thatthese arguments are basically wrong.2.According to Adam Smith, the basis for trade was absolute advantage, or one country beingmore productive or efficient in the production of some commodities and other countriesbeing more productive in the production of other commodities.The gains from trade arise as each country specialized in the production of the commoditiesin which it had an absolute advantage and importing those commodities in which the nationhad an absolute disadvantage.

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual2-3Adam Smith believed in free trade and laissez-faire, or as little government interference with theeconomic system as possible. There were to be only a few exceptions to this policy of laissez-faire and free trade. One of these was the protection of industries important for national defense.3.Ricardo’s law of comparative advantage is superior to Smith’s theory of absolute advantage inthat it showed that even if a nation is less efficient than or has an absolute disadvantage in theproduction of all commodities with respect to the other nations, there is still a basis for beneficialtrade for all nations.The gains from trade arise from the increased production of all commodities that arises wheneach country specializes in the production of and exports the commodities of its comparativeadvantage and imports the other commodities.A nation that is less efficient than others will be able to exportthe commodities of its comparativeadvantage by having its wages and other costs sufficiently lower than in other nations so asto make the commodities of its comparative advantage cheaper in terms of the same currencywith respect to the other nations.4.a. In case A, the United States has an absolute and a comparative advantage in wheat and theUnited Kingdom in cloth.In case B, the United States has an absolute advantage (so that the United Kingdom has anabsolute disadvantage) in both commodities.In case C, the United States has an absolute advantage in wheat but has neither an absoluteadvantage nor disadvantage in cloth.In case D, the United States has an absolute advantage over the United Kingdom in bothcommodities.b. In case A, the United States has a comparative advantage in wheat and the United Kingdomin cloth.In case B, the United States has a comparative advantage in wheat and the United Kingdomin cloth.In case C, the United States has a comparative advantage in wheat and the United Kingdomin cloth.In case D, the United States and the United Kingdom have a comparative advantage in neithercommodities.5.a. The United States gains 1C.b. The United Kingdom gains 4C.

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual2-4c.3C < 4W < 8C.d.The United States would gain 3C while the United Kingdom would gain 2C.6.a. The cost in terms of labor content of producing wheat is 1/4 in the United States and 1 in theUnited Kingdom, while the cost in terms of labor content of producing cloth is 1/3 in theUnited States and 1/2 in the United Kingdom.b.In the United States, Pw=$1.50 and Pc=$2.00.c.In the United Kingdom, Pw=£1.00 and Pc=£0.50.7.The United States has a comparative disadvantage in the production of textiles. Restrictingtextile imports would keep U.S. workers from eventually moving into industries in which theUnited States has a comparative advantage and in which wages are higher.8.Ricardo’s explanation of the law of comparative is unacceptable because it is based on the labortheory of value, which is not an acceptable theory of value.The explanation of the law of comparative advantage can be based on the opportunity costdoctrine, which is an acceptable theory of value.9.The production possibilities frontier reflects the opportunity costs of producing bothcommodities in the nation.The production possibilities frontier under constant costs is a (negatively sloped) straight line.The absolute slope of the production possibilities frontier reflects or gives the price of thecommodity plotted along the horizontal axis in relation to the commodity plotted along thevertical axis.10.a. See Figure 1.b.In the United States Pw/Pc=3/4, while in the United Kingdom, Pw/Pc=2.c.In the United States Pc/Pw=4/3, while in the United Kingdom Pc/Pw=1/2.d.See Figure 2.The autarky points are A and A' in the United States and the United Kingdom, respectively.The points of production with trade are B and B' in the United States and the UnitedKingdom, respectively.The points of consumption are E and E' in the United States and the United Kingdom,respectively. The gains from trade are shown by E > A for the U.S. and E' > A' for the U.K.

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual2-5Figure 1Figure2

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual2-6MULTIPLE-CHOICE QUETIONS1.The Mercantilists didnotadvocate:a.free tradeb.stimulating the nation's exportsc.restricting the nations' importsd.the accumulation of gold by the nation2.According to Adam Smith, international trade was based on:a. absolute advantageb.comparative advantagec.both absolute and comparative advantaged.neither absolute nor comparative advantage3.What proportion of international trade is based on absolute advantage?a.allb.mostc. somed. none4.The commodity in which the nation has the smallest absolute disadvantage is the commodityof its:a.absolute disadvantageb.absolute advantagec.comparative disadvantaged.comparative advantage5.If in a two-nation (A and B), two-commodity (X and Y) world, it is established that nationA has a comparative advantage in commodity X, then nation B must have:a.an absolute advantage in commodity Yb.an absolute disadvantage in commodity Yc.a comparative disadvantage in commodity Yd. a comparative advantage in commodity Y6.If with one hour of labor time nation A can produce either 3X or 3Y while nation B canproduce either 1X or 3Y (and labor is the only input):a.nation A has a comparative disadvantage in commodity Xb.nation B has a comparative disadvantage in commodity Yc. nation A has a comparative advantage in commodity Xd.nation A has a comparative advantage in neither commodity

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual2-77. With reference to the statement in Question 6:a.Px/Py=1 in nation Ab.Px/Py=3 in nation Bc.Py/Px=1/3 in nation Bd. all of the above8.With reference to the statement in Question 6, if 3X is exchanged for 3Y:a. nation A gains 2Xb. nation B gains 6Yc.nation A gains 3Yd.nation B gains 3Y9.With reference to the statement of Question 6, the range of mutually beneficial tradebetween nation A and B is:a.3Y < 3X < 5Yb.5Y < 3X < 9Yc. 3Y < 3X < 9Yd. 1Y < 3X < 3Y10.If domestically 3X=3Y in nation A, while 1X=1Y domestically in nation B:a.there will be no trade between the two nationsb.the relative price of X is the same in both nationsc.the relative price of Y is the same in both nationsd. all of the above11.Ricardo explained the law of comparative advantage on the basis of:a. the labor theory of valueb.the opportunity cost theoryc.the law of diminishing returnsd.all of the above12.The Ricardian trade model has been empiricallya. verifiedb.rejectedc.not testedd.tested but the results were inconclusive13.The Ricardian model was tested empirically in terms of differences ina.relative labor productivities costs in various industries among nationsb.relative labor costs in various industries among nations

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual2-8c. relative labor productivities and costs in various industries among nationsd. none of the above14.A difference in relative commodity prices between two nations can be based upon adifferencein:a.factor endowmentsb.technologyc.tastesd. all of the above15.In the trade between a small and a large nation:a. the large nation is likely to receive all of the gains from tradeb. the small nation is likely to receive all of the gains from tradec.the gains from trade are likely to be equally sharedd.we cannot say

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual3-1*CHAPTER 3(Core Chapter)THE STANDARD TRADE MODELOUTLINE3.1Introduction3.2The Production Frontier with Increasing Costs3.3The Marginal Rate of Transformation3.4Community Indifference Curves3.5Equilibrium in Isolation3.6The Basis and the Gains from Trade with Increasing Costs3.7Equilibrium Relative Commodity Prices with TradeCase Study 3-1 Specialization and Export Concentration in Selected Countries3.8Terms of TradeCase Study 3-2 The Terms of Trade of the G-7 CountriesCase Study 3-3 The Terms of Trade of Developed and Developing Countries3.9Specialization, Trade and DeindustrializationCase Study 3-4 Job Losses in High U.S. Import-Competing IndustriesCase Study 3-5 International Trade and Deindustrialization in the United States, the EuropeanUnion, and JapanAppendix: The Equilibrium Relative Commodity Price with Trade and the Terms of TradeA3-1 The Equilibrium Relative Commodity Price with Trade, with Demand and SupplyA3-2 Offer Curves and the Terms of TradeKEY TERMSIncreasing opportunity costsEquilibrium relative commodityMarginal rate of transformation (MRT)prices with tradeCommunity indifference curveIncomplete specializationMarginal rate of substitution (MRS)Terms of tradeAutarkyDeindustrializationEquilibrium relative commodity price inOffer curveisolationReciprocal demand curve

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual3-2LECTURE GUIDE1.In the first lecture of Chapter 3, I would cover Sections 1-5 and assign Review Question andProblems 1-3. Section 3 is the most difficult here and Section 5 is the most important, and soI would spend a bit more time covering them.2.In the second lecture, I would cover Sections 6 and 7. Section 6 presents the basic trade model,and is essential for the student to master it completely. Section 7 derives the supply curve andthe demand curves for the commodity from the production frontier and the communityindifference curves. This is the most difficult section, but it is essential because it shows how theequilibrium-relative commodity price is determined with specialization in production and trade.3.In the third lecture, I would cover the rest of the chapter, starting with Case Studies 3-1 and 3-2and then going on to discuss the terms of trade. The last section on specialization, trade anddeindustrialization is likely to be of great interest to the students and lead to a great deal of classdiscussion. I would make the Appendix optional for more advanced students in the class.ANSWERS TO REVIEW PROBLEMS AND QUESTIONS1.a.Increasing opportunity costs arise because resources or factors of production are nothomogeneous (i.e., all units of the same factor are not identical or of the same quality) andnot used in the same fixed proportion or intensity in the production of all commodities.This means that as the nation produces more of a commodity, it must utilize resources thatbecome progressively less efficient or less suited for the production of that commodity. Asa result, the nation must give up more and more of the second commodity to release justenough resources to produce each additional unit of the first commodity (i.e., it facesincreasing costs).b.In the real world, the production frontiers of different nations will usually differ because ofdifferences in factor endowments and technology.2.a.See Figure 1 on the next page.b.The slope of the transformation curve increases as the nation produces more of X anddecreases as the nation produces more of Y. These reflect increasing opportunity costs asthe nation produces more of X or Y.3.a.See Figure 2.b.Nation 1 has a comparative advantage in X and Nation 2 in Y.c.If the relative commodity price line in autarky has equal slope in both nations. This is rare.4.a.See Figure 3. Points B and B’ are the production points in Nations 1 and 2, respectively, withspecialization and trade and E and E’ are the consumption points.b.Nation 1 gains by the amount by which community indifference curve III (point E) is aboveindifference curve I (point A). Nation 2 gains to the extent that community indifference curveIII’ (point E’) is above indifference curve I’ (point A).

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual3-3

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual3-45.a. The equilibrium-relative commodity price in isolation is the relative price that prevails inthe nation without trade or in autarky.b.The equilibrium-relative commodity price in isolation for the commodity plotted along thehorizontal axis is given by the (absolute) slope of the tangent of the production frontier andthe community indifference curve at the point of production and consumption in the nationin isolation.c.The nation with the lower equilibrium relative commodity price in isolation or autarky hasa comparative advantage in the commodity measured along the commodity axis and acomparative disadvantage in the commodity measured along the vertical axis.6.See Figure 4 on the next page.Supply curveAFBfor commodityXin Nation 1 (SX) in the left bottom panel is derivedFrom production pointsAFB, respectively, atPA(not shown in the figure) <PF<PBon theproduction frontier of Nation 1 in the top panel. Nation 1’s demand curveAHEin the leftbottom panel (DX) is derived, respectively, from tangency points of community indifferencesand trade lines at pointsA,HandEin the top panel.SXandDXfor Nation 2 in the rightpanel are derived in an analogous way.From both bottom panels, we see that only atPB=PB’ would the quantity of exports ofcommodityXsupplied by Nation 1 exactly match the quantity demanded of imports ofcommodityXof Nation 2. Thus,PB=PB’ is the equilibrium relative commodity prices withtrade.7.a. The reason for incomplete specialization under increasing costs is that as each nationspecializes in the production of the commodity of its comparative advantage, the relativecommodity price in each nation moves toward each other (i.e., become less unequal) untilthey are identical in both nations. At that point, it does not pay for either nation to continueto expand the production of the commodity of its initial comparative advantage. This occursbefore either nation has completely specialized in production.b. Under constant costs, each nation specializes completely in production of the commodity ofits comparative advantage (i.e., produces only that commodity). The reason is that since itpays for the nation to obtain some of the commodity of its comparative disadvantage fromthe other nation, then it pays for the nation to get all of the commodity of its comparativedisadvantage from the other nation (i.e., to specialize completely in the production of thecommodity of its comparative advantage).8.See Figure 5.Nations 1 and 2 have identical production frontiers (shown by a single curve) but differenttastes (indifference curves). In isolation, Nation 1 produces and consumes at pointAandNation 2 at pointA’. SincePA<PA’, Nation 1 has a comparative advantage inXand Nation 2inY.

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual3-5

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual3-6With trade, Nation 1 specializes in the production of X and produces at B, while Nation 2specializes in Y and produces at B’ (which coincides with B). By exchanging BC = B’C’ of Xfor CE = C’E of Y with each other (see trade triangles BCE and B’C’E’), Nation 1 ends upconsuming at E on indifference curve III (higher than indifference curve I at point A) andNation 2 consumes at on indifference curve III’ (higher than indifference curve I’ at point A’).9.a. If the terms of trade of a nation improved from 100 to 110 over a given period of time,the terms of trade of the trade partner would deteriorate by about 9 percent over the sameperiod of time [(100-110)/110 =-0.09 =0.9%].b.A deterioration in the terms of trade of the trade partner can be said to be unfavorable to thetrade partner because the trade partner must pay a higher price for its imports in terms ofits exports.c.This does not necessarily mean that the welfare of the trade partner has decreased becausethe deterioration in its terms of trade may have resulted from an increase in productivitythat is shared with the other nation.10.It is true that Mexico's wages are much lower than U.S. wages (they are about one fifth of theaverage wage in the United States), but labor productivity is much higher in the United Statesand so labor costs are not necessarily higher than in Mexico. In any event, trade can still bebased on comparative advantage.MULTIPLE-CHOICE QUESTIONS1.A production frontier that is concave indicates that the nation incurs increasing opportunitycosts in the production of:a.commodity X onlyb.commodity Y onlyc. both commoditiesd. neither commodity2.The marginal rate of transformation (MRT) of X for Y refers to:a.the amount of Y that a nation must give up to produce each additional unit of Xb.the opportunity cost of Xc.the absolute slope of the production frontier at the point of productiond. all of the above3.Which of the following isnota reason for increasing opportunity costs:a. technology differs among nationsb.factors of production are not homogeneousc.factors of production are not used in the same fixed proportion in the production of allcommoditiesd.for the nation to produce more of a commodity, it must use resources that are less andless suited in the production of the commodity

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual3-74.Community indifference curves:a.are negatively slopedb.are convex to the originc.should not crossd. all of the above5.The marginal rate of substitution (MRS) of X for Y in consumption refers to the:a.amount of X that a nation must give up for one extra unit of Y and still remain on thesame indifference curveb. amount of Y that a nation must give up for one extra unit of X and still remainon thesame indifference curvec.amount of X that a nation must give up for one extra unit of Y to reach a higherindifference curved.amount of Y that a nation must give up for one extra unit of X to reach a higherindifference curve6.Which of the following statements istruewith respect to the MRS of X for Y?a.it is given by the absolute slope of the indifference curveb.declines as the nation moves down an indifference curvec.rises as the nation moves up an indifference curved. all of the above7.Which of the following isnottrue for a nation that is in equilibrium in isolation?a. it consumes inside its production frontierb.it reaches the highest indifference curve possible with its production frontierc.the indifference curve is tangent to the nation's production frontierd.MRT of X for Y equals MRS of X for Y, and they are equal to Px/Py8.If the internal Px/Py is lower in nation 1 than in nation 2 without trade:a.nation 1 has a comparative advantage in commodity Yb.nation 2 has a comparative advantage in commodity Xc. nation 2 has a comparative advantage in commodity Yd. none of the above9.If actual Px/Py exceeds the equilibrium relative Px/Py with tradea.the nation exporting commodity X will want to export more of X than at equilibriumb.the nation importing commodity X will want to import less of X than at equilibriumc.Px/Py will fall toward the equilibrium Px/Pyd. all of the above

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual3-810.With free trade under increasing costs:a.neither nation will specialize completely in production if both nations are largeb.at least one nation will consume above its production frontierc.a small nation will always gain from traded. all of the above11.Which of the following statements is true?a.a nation’s demand curve of a commodity is derived from production points on the nation’sproduction frontier.b.a nation’s supply curve for a commodity is derived from community indifference curvesand trade linesc. the price of the nation’s import commodity will fall as a result of international traded.none of the above12.At a relative commodity price above equilibriuma.the quantity demand of imports exceeds the quantity supplied of exportsb.the relative price of the commodity will risec. the commodity price will falld. none of the above13.If the terms of trade increase in a two-nation world, those of the trade partner:a. deteriorateb.improvec.remain unchangedd.any of the above14.A deterioration of a nation's terms of trade causes the nation's welfare to:a.deteriorateb.improvec.remain unchangedd. any of the above15.Mutually beneficial trade cannot occur if production frontiers are:a.equal but tastes are notb.different but tastes are the samec.different and tastes are also differentd. the same and tastes are also the same.

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual4-1*CHAPTER 4(Core Chapter)THE HECKSCHER-OHLIN AND OTHER TRADE THEORIESOUTLINE4.1Introduction4.2Factor Endowments and the Heckscher-Ohlin Theory4.3The Formal Heckscher-Ohlin ModelCase Study 4-1 Relative Resource Endowments and the Comparative Advantage of VariousCountries4.4Factor-Price Equalization and Income DistributionCase Study 4-2 Has International Trade Increased U.S. Wage Inequalities?4.5Empirical Tests of the Heckscher-Ohlin Theory4.6Economies of Scale and International TradeCase Study 4-3 The New International Economies of Scale4.7Trade Based on Product DifferentiationCase Study 4-4 Growth of Intra-Industry Trade4.8Technological Gap and Product Cycle ModelsCase Study 4-5: The World’s Most Competitive Economies4.9Transportation Costs and International Trade4.10Environmental Standards and International TradeAppendix The Specific-Factors Model and Intra-Industry Trade ModelsA4.1 The Specific-Factors ModelA4.2 A Model of Intra-Industry TradeKEY TERMSRelative factor pricesInternational economies of scaleHeckscher–Ohlin (H–O) theoryDifferentiated productsHeckscher–Ohlin (H–O) theoremIntra-industry tradeFactor-proportions or factor-endowment theoryTechnological gap modelFactor–price equalization theoremProduct cycle modelStolper-Samuelson theoremTransportation costsSpecific-factors modelNontraded goods and services

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual4-2Leontief paradoxEnvironmental standardsIncreasing returns to scaleMonopolistic competitionLECTURE GUIDE1.This is one of the most important and difficult chapters in the book. It is also a long chapter andrequires four lectures to cover adequately.2.In the first lecture, I would cover sections 1-3. Section 3 is one of the most important sections inthe book because it presents the H-O model. I would proceed slowly and carefully in explainingFigure 4.1 and compare it to the standard trade model of Figure 3.4.3.In the second lecture, I would cover sections 4 and 5. Section 4 on the factor-price equalizationtheorem and income distribution is a difficult section. Case Study 4-2 should be of great interestto the students and give rise to a great deal of class discussion.4.In third lecture, I would cover sections 6-7, paying a great deal of attention to section 7on tradein differentiated products.5.In fourth lecture, I would cover the rest of the chapter.ANSWERS TO REVIEW QUESTIONS AND PROBLEMS1.a. The Heckscher–Ohlin (H-0) theorem postulates that a nation will export thosecommodities whose production requires the intensive use of the nation’s relativelyabundant andcheap factor and import the commodities whose production requires theintensive useof the nation’s relatively scarce and expensive factor. In short, the relativelylabor-richnation exports relatively labor-intensive commodities and imports therelativelycapital-intensive commodities.b.Heckscher and Ohlin identify the relative difference in factor endowments amongnationsas the basic determinant of comparative advantage and international trade.c.The H-O Theory represent an extension of the standard trade model because it explainsthe basis for comparative advantage (classical economists, such as Ricardo had assumedit) and examines the effect of international trade on factor prices and income distribution(which classical economists had left unanswered).2.See Figure 1 on the next page.a. The factor–price equalization theorem postulates that international trade will bring aboutthe equalization of the returns to homogeneous or identical factors across nations.b. The Stopler-Samuelson theorem postulates that free international trade reduces the realincome of the nation’s relatively scarce factor and increases the real income of the nation’srelatively abundant factor.

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual4-3

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual4-4c.The specific-factors model postulates that the opening of trade (1) benefits thespecificfactorused in the production of the nation’s export commodity, (2) harmsthe specific factor used inthe production of the nation’s import-competing industry,and (3) leads to an ambiguouseffect (i.e., it may benefit or harm) the mobile factor.d.Trade acts as a substitute for the international mobility of factors of production initseffect on factor prices. With perfect mobility, laborwould migrate from the low-wagenation to the high-wage nation until wages in the two nations are equalized.Similarly,capital would move from the low-interest to the high-interest nation untilthe rate ofinterest was equalized in the two nations.4.a. The Leontief paradox refers to the original Leontief’s finding that U.S. importsubstituteswere more K-intensive than U.S. exports. This was the opposite of whatthe H-O theorempostulated.b.The Leontief paradox was resolved by including human capital into thecalculations andexcluding industries based on natural resources. Recent researchusing data on manysectors,for many countries, over many years, and consideringthatcountries could specialize in aparticular subset or group of commodities thatwere bestsuited to their specific factorendowments, provides strong support forthe H-O theorem.c.The Hecksher-Olhin theory remains the centerpiece of modern trade theory forexplaininginternational trade today. To be sure, there are other forces (such aseconomies of scale,product differentiation, and technological differences acrosscountries) that provideadditionalreasons and explanations for some internationaltrade not explained by the basic H-O model.These other trade theories complementthe basic H-O model in explaining the pattern ofinternational trade in the worldtoday.5.International trade with developing economies, especially newly industrializingeconomies (NIEs),contributed in two ways to increased wage inequalities betweenskilled and unskilled workers inthe United States during the past two decades. Directly,by reducing the demand for unskilledworkers as a result of increased U.S. imports oflabor-intensive manufactures and, indirectly, byspeeding up the introduction of labor-saving innovations, which further reduced the U.S.demand for unskilled workers.International trade, however, was onlya small cause of increasedwage inequalities in theUnited States. The most important cause was technological change.6.a. Economies of scale refer to the production situation where output growsproportionatelymore than the increase in inputs or factors of production. For example,output may morethan double with a doubling of inputs.b.Even if two nations were identical in every respect, there is still a basis for mutuallybeneficial trade based on economies of scale. When each nation specializes in theproduction ofone commodity, the combined total world output of both commoditieswill be greater thanwithout specialization when economies of scale are present.With trade, each nationthen shares in these gains.c.The new international economies of scale refers to the increase in productivityresultingfrom firms purchasing parts and components from nations where theyaremade cheaper and better, and by establishingproduction facilities abroad

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Salvatore’sIntroduction to International Economics, 3rdEditionInstructor’s Manual4-57. a. Product differentiation refers to products that are similar, but not identical. Intra-industrytrade refers to trade in differentiated products, as opposed to inter-industrytrade incompletely different products.b.Intra-industry trade arises in order to take advantage of important economies ofscale inproduction. That is, with intra-industry trade each firm or plant in industrialcountries canspecialize in the production of only one, or at most a few, varietiesand styles of the sameproduct rather than many different varieties and styles of aproduct and achieve economiesof scale.c.With few varieties and styles, more specialized and faster machinery can bedevelopedfor a continuous operation and a longer production run. The nation thenimports othervarieties and styles from other nations. Intra-industry trade benefitsconsumers because ofthe wider range of choices (i.e., the greater variety ofdifferentiated products) available atthe lower prices made possible by economies ofscale in production.8.a.According to the technological gap model, a firm exports a new product untilimitators incountries take away its market. In the meantime, the innovating firmwill have introduced anew product or process.b.The criticism of the technological gap model are that it does not explain the size oftechnological gaps and does not explore the reason for technological gaps arising inthe first place,or exactly how they are eliminated over time.c.The five stages of the product cycle model are: the introduction of the product,expansion ofproduction for export, standardization and beginning of productionabroad through imitation,foreign imitators underselling the nation in third markets,and foreigners underselling theinnovating firms in their home market as well.9.See Figure 2 on page 25.10.A nation with lower environmental standards can use the environment as a resourceendowment or as a factor of production in attracting polluting firms from abroad andachieving a comparative advantage in the production of polluting goods and services.This can lead totrade disputes with nations with more stringent environmentalstandards.MULTIPLE-CHOICE QUESTIONS1.The H-O model extends the classical trade model by:a.explaining the basis for comparative advantageb.examining the effect of trade on factor pricesc. both a and bd. neither a nor b2.A nation is said to have a relative abundance of K if it has a:a.greater absolute amount of K

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