Solution Manual for Introduction to International Economics , 3rd Edition
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Instructor’s Manual
To Accompany
Introduction to International
Economics
3rd Edition
DOMINICK SALVATORE
Professor of Economics
Fordham University
New York
To Accompany
Introduction to International
Economics
3rd Edition
DOMINICK SALVATORE
Professor of Economics
Fordham University
New York
CONTENTS
Introductory Comments …….…………………………………………………………………...
*Chapter 1: Introduction to the Global Economy ………………………………………….. 1
Part 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 ………………………………. 23
Additional Essays and Problems for Part One ………………………………………………….. 31
Part Two: International Trade Policy
*Chapter 5: Trade Restrictions: Tariffs ……………………………………………………... 36
*Chapter 6: Nontariff Trade Barriers and the Political Economy of Protectionism ………… 43
Additional Essays and Problems for Part Two ………………………………………………… .. 50
Part Three: International Trade and Investment Relations
*Chapter 7: Economic Integration …………………………………………………………... 53
Chapter 8: Growth and Development with International Trade …………………………… 59
Chapter 9: International Resource Movements and Multinational Corporations …………... 66
Additional Essays and Problems for Part Three ………………………………………………… 72
Part 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 …………………………………………………. 85
Additional Essays and Problems for Part Four …………………………………………………. 92
Part Five: Open Economy Macroeconomics
*Chapter 13: Automatic Adjustments with Fixed and Flexible Exchange Rates …………… 94
*Chapter 14: Adjustment Policies …………………………………………………………... 103
Additional Essays and Problems for Part Five ……………………………………………... 110
Part 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 ………………… 119
Additional Essays and Problems for Part Five ……………………………………………….. . 126
* = Core Chapter
Introductory Comments …….…………………………………………………………………...
*Chapter 1: Introduction to the Global Economy ………………………………………….. 1
Part 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 ………………………………. 23
Additional Essays and Problems for Part One ………………………………………………….. 31
Part Two: International Trade Policy
*Chapter 5: Trade Restrictions: Tariffs ……………………………………………………... 36
*Chapter 6: Nontariff Trade Barriers and the Political Economy of Protectionism ………… 43
Additional Essays and Problems for Part Two ………………………………………………… .. 50
Part Three: International Trade and Investment Relations
*Chapter 7: Economic Integration …………………………………………………………... 53
Chapter 8: Growth and Development with International Trade …………………………… 59
Chapter 9: International Resource Movements and Multinational Corporations …………... 66
Additional Essays and Problems for Part Three ………………………………………………… 72
Part 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 …………………………………………………. 85
Additional Essays and Problems for Part Four …………………………………………………. 92
Part Five: Open Economy Macroeconomics
*Chapter 13: Automatic Adjustments with Fixed and Flexible Exchange Rates …………… 94
*Chapter 14: Adjustment Policies …………………………………………………………... 103
Additional Essays and Problems for Part Five ……………………………………………... 110
Part 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 ………………… 119
Additional Essays and Problems for Part Five ……………………………………………….. . 126
* = Core Chapter
INTRODUCTORY COMMENTS
Purpose of this Manual
The purpose of this manual is to facilitate the use of the text by the Instructor. It contains the
detailed outline of each chapter, lecture guides with suggestions on how best to present the material
in each chapter, the answer to the end-of-chapter review questions and problems, and a set of 15
multiple-choice questions with answers for each chapter.
The Instructor who feels that more questions and problems would be useful can consult my small
and popular paperback Theory and Problems of International Economics (4th ed., 1996) in the
Schaum's Outline Series, which includes a wealth of additional multiple-choice questions and
solved problems and the Study Guide prepared for this text by Professor Arthur Raymond of
Muhlenberg College. At the end of each of the six parts of this Manual there are also additional
essays and problems with answers that can be used for class exams.
Course Outlines
Some Instructors might want to skip Chapters 8 and 9, thus leaving 13 chapters (besides the
introductory chapter) – one for each week of the semester, leaving one week for review and the
midterm 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 the
final on all chapters covered at the end of the semester.
A Personal Note to You, the Instructor
I welcome any comment, suggestion, or opinion that you may have on the use of the text. You can
correspond directly with me or through John Wiley, and I will personally acknowledge your letter
and comment on your suggestions. I will, of course, consider your comments for the next Edition of
the text and would gratefully acknowledge any such contribution.
D.S.
Purpose of this Manual
The purpose of this manual is to facilitate the use of the text by the Instructor. It contains the
detailed outline of each chapter, lecture guides with suggestions on how best to present the material
in each chapter, the answer to the end-of-chapter review questions and problems, and a set of 15
multiple-choice questions with answers for each chapter.
The Instructor who feels that more questions and problems would be useful can consult my small
and popular paperback Theory and Problems of International Economics (4th ed., 1996) in the
Schaum's Outline Series, which includes a wealth of additional multiple-choice questions and
solved problems and the Study Guide prepared for this text by Professor Arthur Raymond of
Muhlenberg College. At the end of each of the six parts of this Manual there are also additional
essays and problems with answers that can be used for class exams.
Course Outlines
Some Instructors might want to skip Chapters 8 and 9, thus leaving 13 chapters (besides the
introductory chapter) – one for each week of the semester, leaving one week for review and the
midterm 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 the
final on all chapters covered at the end of the semester.
A Personal Note to You, the Instructor
I welcome any comment, suggestion, or opinion that you may have on the use of the text. You can
correspond directly with me or through John Wiley, and I will personally acknowledge your letter
and comment on your suggestions. I will, of course, consider your comments for the next Edition of
the text and would gratefully acknowledge any such contribution.
D.S.
Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
1-1
*CHAPTER 1
(Core Chapter)
INTRODUCTION
OUTLINE
1.1 We Live in a Global Economy
Case Study 1-1 The Dell and Other PCs Sold in the United States Are Anything But
American!
Case Study 1-2 What Is an “American” Car?
1.2 The Globalization Challenge
Case Study 1-3 Is India’s Globalization Harming the United States?
1.3 International Trade and the Nation’s Standard of Living
Case Study 1-4 Rising Importance of International Trade to the United States
1.4 The International Flow of Labor and Capital
Case Study 1-5 Major Net Exporters and Importers of Capital
1.5 The Subject Matter of International Economics
1.6 Current International Economic Problems
1.7 International Institutions and the World Economy
1.8 Organization of the Text
Appendix: International Trade Data, Sources and Information
A1.1 International Trade Data
A1.2 Sources of Additional International Data and Information
KEY TERMS
Globalization Microeconomics
Anti-globalization movement Macroeconomics
Interdependence Open-economy macroeconomics
International trade policy International finance
Balance of payments World Trade Organization (WTO)
Foreign exchange markets International Monetary Fund (IMF)
Adjustment in the Balance of Payments United Nations (UN)
1-1
*CHAPTER 1
(Core Chapter)
INTRODUCTION
OUTLINE
1.1 We Live in a Global Economy
Case Study 1-1 The Dell and Other PCs Sold in the United States Are Anything But
American!
Case Study 1-2 What Is an “American” Car?
1.2 The Globalization Challenge
Case Study 1-3 Is India’s Globalization Harming the United States?
1.3 International Trade and the Nation’s Standard of Living
Case Study 1-4 Rising Importance of International Trade to the United States
1.4 The International Flow of Labor and Capital
Case Study 1-5 Major Net Exporters and Importers of Capital
1.5 The Subject Matter of International Economics
1.6 Current International Economic Problems
1.7 International Institutions and the World Economy
1.8 Organization of the Text
Appendix: International Trade Data, Sources and Information
A1.1 International Trade Data
A1.2 Sources of Additional International Data and Information
KEY TERMS
Globalization Microeconomics
Anti-globalization movement Macroeconomics
Interdependence Open-economy macroeconomics
International trade policy International finance
Balance of payments World Trade Organization (WTO)
Foreign exchange markets International Monetary Fund (IMF)
Adjustment in the Balance of Payments United Nations (UN)
Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
1-2
LECTURE GUIDE
1. As the first chapter of the book, the general aim here is simply to define the field of study of
international 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 cover
Sections 1-2 and the second class for Sections 3-5. I would spend most of the third class on
Section 6 to identify the major current international economic problems facing the United
States and the world and to show how international economics can suggest ways to solve them.
This should greatly enhance students' motivation.
ANSWERS TO REVIEW QUESTIONS AND PROBLEMS
1. Globalization refers to the openness and the free exchange of goods, services, resources,
technologies, moneys, and ideas around the world. The advantages of globalization are that it
increases efficiency in production and leads to higher income for the nation’s workers.
Globalization often also makes available a greater range of cheaper and or better products to
the nation’s consumers, and provides opportunities for higher returns a greater risk
diversification to the nation’s investors. The disadvantages of globalization is that it often
leads to job losses and lower wages for low-skilled labor in advanced nations and harm (i.e.,
it is a “brain drain” for) the nations of emigration. Financial globalization and unrestricted
capital flows can also lead international financial crises. It is these disadvantages and
negative aspects of globalization have given rise to a strong anti-globalization movement,
which blames globalization for sacrificing human and environmental well-being to the
corporate profits of multinationals.
2. International economic relations differ from interregional (i.e. within a country) economic
relations in that nations usually impose some restrictions on the flow of goods, services, and
factors across their borders, but not interregionally or internally (i.e., not across regions of the
same nation). In addition, international flows are to some extent hampered by differences in
language, customs, and laws. Furthermore, international flows of goods, services, and
resources give rise to payments and receipts in foreign currencies, which change in value
over time.
1-2
LECTURE GUIDE
1. As the first chapter of the book, the general aim here is simply to define the field of study of
international 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 cover
Sections 1-2 and the second class for Sections 3-5. I would spend most of the third class on
Section 6 to identify the major current international economic problems facing the United
States and the world and to show how international economics can suggest ways to solve them.
This should greatly enhance students' motivation.
ANSWERS TO REVIEW QUESTIONS AND PROBLEMS
1. Globalization refers to the openness and the free exchange of goods, services, resources,
technologies, moneys, and ideas around the world. The advantages of globalization are that it
increases efficiency in production and leads to higher income for the nation’s workers.
Globalization often also makes available a greater range of cheaper and or better products to
the nation’s consumers, and provides opportunities for higher returns a greater risk
diversification to the nation’s investors. The disadvantages of globalization is that it often
leads to job losses and lower wages for low-skilled labor in advanced nations and harm (i.e.,
it is a “brain drain” for) the nations of emigration. Financial globalization and unrestricted
capital flows can also lead international financial crises. It is these disadvantages and
negative aspects of globalization have given rise to a strong anti-globalization movement,
which blames globalization for sacrificing human and environmental well-being to the
corporate profits of multinationals.
2. International economic relations differ from interregional (i.e. within a country) economic
relations in that nations usually impose some restrictions on the flow of goods, services, and
factors across their borders, but not interregionally or internally (i.e., not across regions of the
same nation). In addition, international flows are to some extent hampered by differences in
language, customs, and laws. Furthermore, international flows of goods, services, and
resources give rise to payments and receipts in foreign currencies, which change in value
over time.
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
1-3
is 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, a
significant part of its high standard of living depends on it. The United States must import
many commodities that it cannot produce and several needed minerals that it does have. More
important quantitatively to its economic well-being, however, are the many commodities that
the United States could produce domestically but only at relatively higher cost.
6. The immigration of skilled people benefits the United States because it raises the skill level,
average income, and the growth rate of the nation. The cost arises from immigration of
unskilled people and from the job competition which migrants provide to native workers.
7. Capital flows across national boundaries in search of higher returns and to diversify risks.
8. The major international economic problems facing the world today are:
(1) slow growth and high unemployment in advanced nations after “the great recession”;
(2) the rise of trade protectionism in advanced countries in a rapidly globalizing
world;
(3) excessive volatility and large disequilibria in exchange rates;
(4) structural imbalances in advanced economies and insufficient restructuring in
transition economies;
(5) deep poverty in many developing countries, and
(6) resource scarcity, environmental degradation, and climate change.
9. The most important economic international economic and political institutions
are:
(1) The World Trade Organization (WTO), which regulates international trade;
(2) World Bank, which provides loans to developing countries for development programs
aimed at reducing poverty;
1-3
is 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, a
significant part of its high standard of living depends on it. The United States must import
many commodities that it cannot produce and several needed minerals that it does have. More
important quantitatively to its economic well-being, however, are the many commodities that
the United States could produce domestically but only at relatively higher cost.
6. The immigration of skilled people benefits the United States because it raises the skill level,
average income, and the growth rate of the nation. The cost arises from immigration of
unskilled people and from the job competition which migrants provide to native workers.
7. Capital flows across national boundaries in search of higher returns and to diversify risks.
8. The major international economic problems facing the world today are:
(1) slow growth and high unemployment in advanced nations after “the great recession”;
(2) the rise of trade protectionism in advanced countries in a rapidly globalizing
world;
(3) excessive volatility and large disequilibria in exchange rates;
(4) structural imbalances in advanced economies and insufficient restructuring in
transition economies;
(5) deep poverty in many developing countries, and
(6) resource scarcity, environmental degradation, and climate change.
9. The most important economic international economic and political institutions
are:
(1) The World Trade Organization (WTO), which regulates international trade;
(2) World Bank, which provides loans to developing countries for development programs
aimed at reducing poverty;
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
1-4
(2) Trade controversies between the United States, Europe, and Japan and emerging
market economies, such as China, can result in trade restrictions or even trade wars,
which would reduce the volume and the gains from trade and the flow of international
investments and the benefits resulting from them. As an individual, you can be caught
losing your job and a stagnant income.
(3) Excessive exchange rate volatility and misalignments discourage foreign trade and
investments, reduce specialization in production and the benefits from trade, which
means higher prices for your imported goods and services, more expensive travel.
(4) Structural imbalances (excessive and unsustainable trade and budget disequilibria) in
advanced countries and insufficient restructuring in transition economies mean slower
growth than possible as advanced nations try to eliminate or reduce their structural
imbalances and transition economies redouble their efforts to complete the restructure
of their economies. This also means possibly job opportunities for you and stagnant
wages.
(5) Deep poverty in many developing nations in the world mean that the United States and
other rich countries need to provide more foreign aid and open their markets more
widely to the exports of the world’s poorest countries. This can result in your paying
higher taxes and facing more job and income pressures.
(6) Resource scarcity, environmental degradation, and climate change means that the price
of food and raw materials is likely to increase in the future and the United States and
other countries need to spend more to protect the environment and prevent damaging
climate change. All this means higher costs for all of us.
MULTIPLE-CHOICE QUESTIONS
1. Which of the following statements about globalization is false?
a. it increase economic efficiency
b. it cannot be avoided
c. it benefits all people
d. none of the above
2. The anti-globalization movement blames globalization for
a. increasing income inequalities in the world
b. child labor
c. environmental pollution
d. all of the above
3. The criticism of the anti-globalization movement is
a. all wrong
1-4
(2) Trade controversies between the United States, Europe, and Japan and emerging
market economies, such as China, can result in trade restrictions or even trade wars,
which would reduce the volume and the gains from trade and the flow of international
investments and the benefits resulting from them. As an individual, you can be caught
losing your job and a stagnant income.
(3) Excessive exchange rate volatility and misalignments discourage foreign trade and
investments, reduce specialization in production and the benefits from trade, which
means higher prices for your imported goods and services, more expensive travel.
(4) Structural imbalances (excessive and unsustainable trade and budget disequilibria) in
advanced countries and insufficient restructuring in transition economies mean slower
growth than possible as advanced nations try to eliminate or reduce their structural
imbalances and transition economies redouble their efforts to complete the restructure
of their economies. This also means possibly job opportunities for you and stagnant
wages.
(5) Deep poverty in many developing nations in the world mean that the United States and
other rich countries need to provide more foreign aid and open their markets more
widely to the exports of the world’s poorest countries. This can result in your paying
higher taxes and facing more job and income pressures.
(6) Resource scarcity, environmental degradation, and climate change means that the price
of food and raw materials is likely to increase in the future and the United States and
other countries need to spend more to protect the environment and prevent damaging
climate change. All this means higher costs for all of us.
MULTIPLE-CHOICE QUESTIONS
1. Which of the following statements about globalization is false?
a. it increase economic efficiency
b. it cannot be avoided
c. it benefits all people
d. none of the above
2. The anti-globalization movement blames globalization for
a. increasing income inequalities in the world
b. child labor
c. environmental pollution
d. all of the above
3. The criticism of the anti-globalization movement is
a. all wrong
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
1-5
b. all correct
c. is only partly correct
d. is impossible to answer
4. Which of the following products are not produced at all in the United States?
a. coffee, tea, cocoa
b. steel, copper, aluminum
c. petroleum, coal, natural gas
d. typewriters, computers, airplanes
5. International trade is most important to the standard of living of:
a. the United States
b. Switzerland
c. Germany
d. England
6. Over time, the economic interdependence of nations has:
a. grown
b. diminished
c. remained unchanged
d. cannot say
7. A rough measure of the degree of economic interdependence of a nation is given by:
a. the size of the nations' population
b. the ratio of its population to its GDP
c. the ratio of a nation's imports and exports to its GDP
d. all of the above
8. Economic interdependence is greater for:
a. small nations
b. large nations
c.
1-5
b. all correct
c. is only partly correct
d. is impossible to answer
4. Which of the following products are not produced at all in the United States?
a. coffee, tea, cocoa
b. steel, copper, aluminum
c. petroleum, coal, natural gas
d. typewriters, computers, airplanes
5. International trade is most important to the standard of living of:
a. the United States
b. Switzerland
c. Germany
d. England
6. Over time, the economic interdependence of nations has:
a. grown
b. diminished
c. remained unchanged
d. cannot say
7. A rough measure of the degree of economic interdependence of a nation is given by:
a. the size of the nations' population
b. the ratio of its population to its GDP
c. the ratio of a nation's imports and exports to its GDP
d. all of the above
8. Economic interdependence is greater for:
a. small nations
b. large nations
c.
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
1-6
10. International trade theory refers to:
a. the microeconomic aspects of international trade
b. the macroeconomic aspects of international trade
c. open-economy macroeconomics or international finance
d. all of the above
11. Which of the following is not the subject matter of international finance?
a. foreign exchange markets
b. the balance of payments
c. the basis and the gains from trade
d. policies to adjust balance of payments disequilibria
12. International trade is similar to interregional trade in that both must overcome:
a. distance and space
b. trade restrictions
c. differences in currencies
d. differences in monetary systems
13. The opening or expansion of international trade usually affects all members of society:
a. positively
b. negatively
c. most positively but some negatively
d. most negatively but some positively
14. An increase in the dollar price of a foreign currency usually:
a. benefit U.S. importers
b. benefits U.S. exporters
c. benefit both U.S. importers and U.S. exporters
d. harms both U.S. importers and U.S. exporters
15. Which of the following statements with regard to international economics is true?
1-6
10. International trade theory refers to:
a. the microeconomic aspects of international trade
b. the macroeconomic aspects of international trade
c. open-economy macroeconomics or international finance
d. all of the above
11. Which of the following is not the subject matter of international finance?
a. foreign exchange markets
b. the balance of payments
c. the basis and the gains from trade
d. policies to adjust balance of payments disequilibria
12. International trade is similar to interregional trade in that both must overcome:
a. distance and space
b. trade restrictions
c. differences in currencies
d. differences in monetary systems
13. The opening or expansion of international trade usually affects all members of society:
a. positively
b. negatively
c. most positively but some negatively
d. most negatively but some positively
14. An increase in the dollar price of a foreign currency usually:
a. benefit U.S. importers
b. benefits U.S. exporters
c. benefit both U.S. importers and U.S. exporters
d. harms both U.S. importers and U.S. exporters
15. Which of the following statements with regard to international economics is true?
Loading page 10...
Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
2-1
*CHAPTER 2
(Core Chapter)
COMPARATIVE ADVANTAGE
OUTLINE
2.1 Introduction
2.2 Mercantilists’ Views on Trade
Case Study 2-1 Mercantilism Is Alive and Well in the Twenty-First Century
2.3 Trade Based on Absolute Advantage: Adam Smith
2.4 Trade Based on Comparative Advantage: David Ricardo
2.5 Gains from Trade with Comparative Advantage
2.6 Comparative Advantage with Money
Case Study 2-2 The Petition of the Candlemakers
2.7 Comparative Advantage and Opportunity Costs
Case Study 2-3 Labor Productivities and Comparative Advantage
2.8 Production Possibility Frontier with Constant Costs
2.9 Opportunity Costs and Relative Commodity Prices
2.10 Basis and Gains from Trade Under Constant Costs
Appendix: Comparative Advantage with More than Two Commodities and Nations
A2.1 Comparative Advantage with More than Two Commodities
A2.2 Comparative Advantage with More than Two Nations
KEY TERMS
Basis for trade Labor theory of value
Gains from trade Opportunity cost theory
Pattern of trade Production possibility frontier
Mercantilism Constant opportunity cost
Absolute advantage Relative commodity prices
Laissez-faire Complete specialization
Law of comparative advantage
2-1
*CHAPTER 2
(Core Chapter)
COMPARATIVE ADVANTAGE
OUTLINE
2.1 Introduction
2.2 Mercantilists’ Views on Trade
Case Study 2-1 Mercantilism Is Alive and Well in the Twenty-First Century
2.3 Trade Based on Absolute Advantage: Adam Smith
2.4 Trade Based on Comparative Advantage: David Ricardo
2.5 Gains from Trade with Comparative Advantage
2.6 Comparative Advantage with Money
Case Study 2-2 The Petition of the Candlemakers
2.7 Comparative Advantage and Opportunity Costs
Case Study 2-3 Labor Productivities and Comparative Advantage
2.8 Production Possibility Frontier with Constant Costs
2.9 Opportunity Costs and Relative Commodity Prices
2.10 Basis and Gains from Trade Under Constant Costs
Appendix: Comparative Advantage with More than Two Commodities and Nations
A2.1 Comparative Advantage with More than Two Commodities
A2.2 Comparative Advantage with More than Two Nations
KEY TERMS
Basis for trade Labor theory of value
Gains from trade Opportunity cost theory
Pattern of trade Production possibility frontier
Mercantilism Constant opportunity cost
Absolute advantage Relative commodity prices
Laissez-faire Complete specialization
Law of comparative advantage
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
2-2
LECTURE GUIDE
1. This is a long and crucial core chapter and may require four classes to cover adequately.
In the first 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 the
law of comparative advantage using simple numerical examples, as in the text. Both sections are
crucial. Section 5 explains the law of comparative advantage and Section 6 establishes the link
between trade theory and international finance. I find that the numerical explanations before the
graphical 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 would
also 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 be
made optional for the more enterprising students in the class.
ANSWERS TO REVIEW QUESTIONS AND PROBLEMS
1. The mercantilists believed that the way for a nation to become rich and powerful was to
export more than it imported. The resulting export surplus would then be settled by an inflow
of gold and silver and the more gold and silver a nation had, the richer and more powerful it
was. Thus, the government had to do all in its power to stimulate the nation’s exports and
discourage and restrict imports. However, since all nations could not simultaneously have an
export 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 preached
economic 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 restricting
international trade to protect domestic jobs are very similar to the mercantilists arguments
made three or four centuries ago. That is why we can say that “mercantilism is alive and well
in the twenty-first century”. Thus we have to be prepared to answer and demonstrate that
these arguments are basically wrong.
2. According to Adam Smith, the basis for trade was absolute advantage, or one country being
more productive or efficient in the production of some commodities and other countries
being more productive in the production of other commodities.
The gains from trade arise as each country specialized in the production of the commodities
in which it had an absolute advantage and importing those commodities in which the nation
had an absolute disadvantage.
2-2
LECTURE GUIDE
1. This is a long and crucial core chapter and may require four classes to cover adequately.
In the first 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 the
law of comparative advantage using simple numerical examples, as in the text. Both sections are
crucial. Section 5 explains the law of comparative advantage and Section 6 establishes the link
between trade theory and international finance. I find that the numerical explanations before the
graphical 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 would
also 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 be
made optional for the more enterprising students in the class.
ANSWERS TO REVIEW QUESTIONS AND PROBLEMS
1. The mercantilists believed that the way for a nation to become rich and powerful was to
export more than it imported. The resulting export surplus would then be settled by an inflow
of gold and silver and the more gold and silver a nation had, the richer and more powerful it
was. Thus, the government had to do all in its power to stimulate the nation’s exports and
discourage and restrict imports. However, since all nations could not simultaneously have an
export 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 preached
economic 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 restricting
international trade to protect domestic jobs are very similar to the mercantilists arguments
made three or four centuries ago. That is why we can say that “mercantilism is alive and well
in the twenty-first century”. Thus we have to be prepared to answer and demonstrate that
these arguments are basically wrong.
2. According to Adam Smith, the basis for trade was absolute advantage, or one country being
more productive or efficient in the production of some commodities and other countries
being more productive in the production of other commodities.
The gains from trade arise as each country specialized in the production of the commodities
in which it had an absolute advantage and importing those commodities in which the nation
had an absolute disadvantage.
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
2-3
Adam Smith believed in free trade and laissez-faire, or as little government interference with the
economic 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 in
that it showed that even if a nation is less efficient than or has an absolute disadvantage in the
production of all commodities with respect to the other nations, there is still a basis for beneficial
trade for all nations.
The gains from trade arise from the increased production of all commodities that arises when
each country specializes in the production of and exports the commodities of its comparative
advantage and imports the other commodities.
A nation that is less efficient than others will be able to export the commodities of its comparative
advantage by having its wages and other costs sufficiently lower than in other nations so as
to make the commodities of its comparative advantage cheaper in terms of the same currency
with respect to the other nations.
4. a. In case A, the United States has an absolute and a comparative advantage in wheat and the
United Kingdom in cloth.
In case B, the United States has an absolute advantage (so that the United Kingdom has an
absolute disadvantage) in both commodities.
In case C, the United States has an absolute advantage in wheat but has neither an absolute
advantage nor disadvantage in cloth.
In case D, the United States has an absolute advantage over the United Kingdom in both
commodities.
b. In case A, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case B, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case C, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case D, the United States and the United Kingdom have a comparative advantage in neither
commodities.
5. a. The United States gains 1C.
b. The United Kingdom gains 4C.
2-3
Adam Smith believed in free trade and laissez-faire, or as little government interference with the
economic 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 in
that it showed that even if a nation is less efficient than or has an absolute disadvantage in the
production of all commodities with respect to the other nations, there is still a basis for beneficial
trade for all nations.
The gains from trade arise from the increased production of all commodities that arises when
each country specializes in the production of and exports the commodities of its comparative
advantage and imports the other commodities.
A nation that is less efficient than others will be able to export the commodities of its comparative
advantage by having its wages and other costs sufficiently lower than in other nations so as
to make the commodities of its comparative advantage cheaper in terms of the same currency
with respect to the other nations.
4. a. In case A, the United States has an absolute and a comparative advantage in wheat and the
United Kingdom in cloth.
In case B, the United States has an absolute advantage (so that the United Kingdom has an
absolute disadvantage) in both commodities.
In case C, the United States has an absolute advantage in wheat but has neither an absolute
advantage nor disadvantage in cloth.
In case D, the United States has an absolute advantage over the United Kingdom in both
commodities.
b. In case A, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case B, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case C, the United States has a comparative advantage in wheat and the United Kingdom
in cloth.
In case D, the United States and the United Kingdom have a comparative advantage in neither
commodities.
5. a. The United States gains 1C.
b. The United Kingdom gains 4C.
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
2-4
c. 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 the
United Kingdom, while the cost in terms of labor content of producing cloth is 1/3 in the
United 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. Restricting
textile imports would keep U.S. workers from eventually moving into industries in which the
United 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 labor
theory of value, which is not an acceptable theory of value.
The explanation of the law of comparative advantage can be based on the opportunity cost
doctrine, which is an acceptable theory of value.
9. The production possibilities frontier reflects the opportunity costs of producing both
commodities 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 the
commodity plotted along the horizontal axis in relation to the commodity plotted along the
vertical 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 United
Kingdom, 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.
2-4
c. 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 the
United Kingdom, while the cost in terms of labor content of producing cloth is 1/3 in the
United 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. Restricting
textile imports would keep U.S. workers from eventually moving into industries in which the
United 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 labor
theory of value, which is not an acceptable theory of value.
The explanation of the law of comparative advantage can be based on the opportunity cost
doctrine, which is an acceptable theory of value.
9. The production possibilities frontier reflects the opportunity costs of producing both
commodities 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 the
commodity plotted along the horizontal axis in relation to the commodity plotted along the
vertical 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 United
Kingdom, 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’s Introduction to International Economics, 3rd Edition Instructor’s Manual
2-5
Figure 1
Figure 2
2-5
Figure 1
Figure 2
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
2-6
MULTIPLE-CHOICE QUETIONS
1. The Mercantilists did not advocate:
a. free trade
b. stimulating the nation's exports
c. restricting the nations' imports
d. the accumulation of gold by the nation
2. According to Adam Smith, international trade was based on:
a. absolute advantage
b. comparative advantage
c. both absolute and comparative advantage
d. neither absolute nor comparative advantage
2-6
MULTIPLE-CHOICE QUETIONS
1. The Mercantilists did not advocate:
a. free trade
b. stimulating the nation's exports
c. restricting the nations' imports
d. the accumulation of gold by the nation
2. According to Adam Smith, international trade was based on:
a. absolute advantage
b. comparative advantage
c. both absolute and comparative advantage
d. neither absolute nor comparative advantage
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
2-7
7. With reference to the statement in Question 6:
a. Px/Py=1 in nation A
b. Px/Py=3 in nation B
c. Py/Px=1/3 in nation B
d. all of the above
8. With reference to the statement in Question 6, if 3X is exchanged for 3Y:
a. nation A gains 2X
b. nation B gains 6Y
c. nation A gains 3Y
d. nation B gains 3Y
9. With reference to the statement of Question 6, the range of mutually beneficial trade
between nation A and B is:
a. 3Y < 3X < 5Y
b. 5Y < 3X < 9Y
2-7
7. With reference to the statement in Question 6:
a. Px/Py=1 in nation A
b. Px/Py=3 in nation B
c. Py/Px=1/3 in nation B
d. all of the above
8. With reference to the statement in Question 6, if 3X is exchanged for 3Y:
a. nation A gains 2X
b. nation B gains 6Y
c. nation A gains 3Y
d. nation B gains 3Y
9. With reference to the statement of Question 6, the range of mutually beneficial trade
between nation A and B is:
a. 3Y < 3X < 5Y
b. 5Y < 3X < 9Y
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
2-8
c. relative labor productivities and costs in various industries among nations
d. none of the above
14. A difference in relative commodity prices between two nations can be based upon a difference
in:
a. factor endowments
b. technology
c. tastes
d. all of the above
15. In the trade between a small and a large nation:
a. the large nation is likely to receive all of the gains from trade
b. the small nation is likely to receive all of the gains from trade
c. the gains from trade are likely to be equally shared
d. we cannot say
2-8
c. relative labor productivities and costs in various industries among nations
d. none of the above
14. A difference in relative commodity prices between two nations can be based upon a difference
in:
a. factor endowments
b. technology
c. tastes
d. all of the above
15. In the trade between a small and a large nation:
a. the large nation is likely to receive all of the gains from trade
b. the small nation is likely to receive all of the gains from trade
c. the gains from trade are likely to be equally shared
d. we cannot say
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
3-1
*CHAPTER 3
(Core Chapter)
THE STANDARD TRADE MODEL
OUTLINE
3.1 Introduction
3.2 The Production Frontier with Increasing Costs
3.3 The Marginal Rate of Transformation
3.4 Community Indifference Curves
3.5 Equilibrium in Isolation
3.6 The Basis and the Gains from Trade with Increasing Costs
3.7 Equilibrium Relative Commodity Prices with Trade
Case Study 3-1 Specialization and Export Concentration in Selected Countries
3.8 Terms of Trade
3-1
*CHAPTER 3
(Core Chapter)
THE STANDARD TRADE MODEL
OUTLINE
3.1 Introduction
3.2 The Production Frontier with Increasing Costs
3.3 The Marginal Rate of Transformation
3.4 Community Indifference Curves
3.5 Equilibrium in Isolation
3.6 The Basis and the Gains from Trade with Increasing Costs
3.7 Equilibrium Relative Commodity Prices with Trade
Case Study 3-1 Specialization and Export Concentration in Selected Countries
3.8 Terms of Trade
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
3-2
LECTURE GUIDE
1. In the first lecture of Chapter 3, I would cover Sections 1-5 and assign Review Question and
Problems 1-3. Section 3 is the most difficult here and Section 5 is the most important, and so
I 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 and
the demand curves for the commodity from the production frontier and the community
indifference curves. This is the most difficult section, but it is essential because it shows how the
equilibrium-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 3-2
and then going on to discuss the terms of trade. The last section on specialization, trade and
deindustrialization is likely to be of great interest to the students and lead to a great deal of class
discussion. I would make the Appendix optional for more advanced students in the class.
ANSWERS TO REVIEW PROBLEMS AND QUESTIONS
1. a. Increasing opportunity costs arise because resources or factors of production are not
homogeneous (i.e., all units of the same factor are not identical or of the same quality) and
not 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 that
become progressively less efficient or less suited for the production of that commodity. As
3-2
LECTURE GUIDE
1. In the first lecture of Chapter 3, I would cover Sections 1-5 and assign Review Question and
Problems 1-3. Section 3 is the most difficult here and Section 5 is the most important, and so
I 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 and
the demand curves for the commodity from the production frontier and the community
indifference curves. This is the most difficult section, but it is essential because it shows how the
equilibrium-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 3-2
and then going on to discuss the terms of trade. The last section on specialization, trade and
deindustrialization is likely to be of great interest to the students and lead to a great deal of class
discussion. I would make the Appendix optional for more advanced students in the class.
ANSWERS TO REVIEW PROBLEMS AND QUESTIONS
1. a. Increasing opportunity costs arise because resources or factors of production are not
homogeneous (i.e., all units of the same factor are not identical or of the same quality) and
not 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 that
become progressively less efficient or less suited for the production of that commodity. As
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
3-3
3-3
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
3-5
3-5
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
3-6
With trade, Nation 1 specializes in the production of X and produces at B, while Nation 2
specializes in Y and produces at B’ (which coincides with B). By exchanging BC = B’C’ of X
for CE = C’E of Y with each other (see trade triangles BCE and B’C’E’), Nation 1 ends up
consuming at E on indifference curve III (higher than indifference curve I at point A) and
Nation 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 same
period 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 the
trade partner because the trade partner must pay a higher price for its imports in terms of
its exports.
c. This does not necessarily mean that the welfare of the trade partner has decreased because
the deterioration in its terms of trade may have resulted from an increase in productivity
that 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 the
average wage in the United States), but labor productivity is much higher in the United States
and so labor costs are not necessarily higher than in Mexico. In any event, trade can still be
based on comparative advantage.
MULTIPLE-CHOICE QUESTIONS
1. A production frontier that is concave indicates that the nation incurs increasing opportunity
3-6
With trade, Nation 1 specializes in the production of X and produces at B, while Nation 2
specializes in Y and produces at B’ (which coincides with B). By exchanging BC = B’C’ of X
for CE = C’E of Y with each other (see trade triangles BCE and B’C’E’), Nation 1 ends up
consuming at E on indifference curve III (higher than indifference curve I at point A) and
Nation 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 same
period 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 the
trade partner because the trade partner must pay a higher price for its imports in terms of
its exports.
c. This does not necessarily mean that the welfare of the trade partner has decreased because
the deterioration in its terms of trade may have resulted from an increase in productivity
that 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 the
average wage in the United States), but labor productivity is much higher in the United States
and so labor costs are not necessarily higher than in Mexico. In any event, trade can still be
based on comparative advantage.
MULTIPLE-CHOICE QUESTIONS
1. A production frontier that is concave indicates that the nation incurs increasing opportunity
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Salvatore’s Introduction to International Economics, 3rd Edition Instructor’s Manual
3-7
4. Community indifference curves:
a. are negatively sloped
b. are convex to the origin
c. should not cross
d. all of the above
5. 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 the
same indifference curve
b. amount of Y that a nation must give up for one extra unit of X and still remain
on the same indifference curve
c. amount of X that a nation must give up for one extra unit of Y to reach a higher
indifference curve
d. amount of Y that a nation must give up for one extra unit of X to reach a higher
indifference curve
3-7
4. Community indifference curves:
a. are negatively sloped
b. are convex to the origin
c. should not cross
d. all of the above
5. 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 the
same indifference curve
b. amount of Y that a nation must give up for one extra unit of X and still remain
on the same indifference curve
c. amount of X that a nation must give up for one extra unit of Y to reach a higher
indifference curve
d. amount of Y that a nation must give up for one extra unit of X to reach a higher
indifference curve
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