International Trade Selective material from International Economics: Theory and Policy chapters 8, 9

1
International TradeSelective material from
International Economics Theory and Policy
chapters 8, 9 and 10 by Paul R. Krugman and
Maurice Obstfeld
2
Costs and Benefits of Tariffs (cont.)
3
Costs and Benefits of Tariffs (cont.)

• Welfare Effect consumer loss producer gain
  government revenue
• Welfare Effect (a b c d) a (c e)
  b d e
• The triangles b and d represent the efficiency
  loss.
• The tariff distorts production and consumption
  decisions producers produce too much and
  consumers consume too little compared to the
  market outcome.
• b is production distortion loss and d is
  consumption distortion loss
• The rectangle e represents the terms of trade
  gain.
• The terms of trade increases because the tariff
  lowers foreign export (domestic import) prices.
• For the small country that cannot significantly
  affect foreign prices, so the cost of tariff
  unambiguously exceeds the benefit.

4
Costs and Benefits of Tariffs (cont.)

• Government revenue from the tariff equals the
  tariff rate times the quantity of imports.
• t PT PT
• QT D2 S2
• Government revenue t x QT c e
• Part of government revenue (rectangle e)
  represents the terms of trade gain, and part
  (rectangle c) represents part of the value of
  lost consumer surplus.
• The government gains at the expense of consumers
  and foreigners.

5
Costs and Benefits of Tariffs (cont.)
6
Export Subsidy (cont.)
7
Export Subsidy (cont.)

• An export subsidy unambiguously produces a
  negative effect on national welfare.
• The triangles b and d represent the efficiency
  loss.
• The tariff distorts production and consumption
  decisions producers produce too much and
  consumers consume too little compared to the
  market outcome.
• The area b c d f g represents the cost of
  government subsidy.
• In addition, the terms of trade decreases,
  because the price of exports falls in foreign
  markets to Ps.

8
US Import Quota on Sugar
9
International FinanceSelective material from
International Economics Theory and Policy
chapters 12, 13,14 and 17 by Paul R. Krugman and
Maurice Obstfeld
10
Determination of the Equilibrium Exchange Rate
11

• R (Ee/ - E/)/E/

12
The Effect of a Rise in the Dollar Interest Rate
13
The Effect of a Rise in the Euro Interest Rate
14
The Effect of an Expected Appreciation of the
Euro
People now expect the euro to appreciate
15
Linking the Money Market to the Foreign
Exchange Market (cont.)
16
Changes in the Domestic Money Supply
17
Changes in the Foreign Money Supply (cont.)
18
Fixed Exchange Rates
19
Economic GrowthSelective material from
Macroeconomics chapters 7 and 8 by N. Gregory
Mankiw
20
The steady state
21
An increase in the saving rate
An increase in the saving rate raises investment
causing k to grow toward a new steady state
22
Prediction

• Higher s ? higher k.
• And since y f(k) , higher k ? higher y .
• Thus, the Solow model predicts that countries
  with higher rates of saving and investment will
  have higher levels of capital and income per
  worker in the long run.

23
The Golden Rule capital stock

• c f(k) ? ?kis biggest where the slope of
  the production function equals the slope of
  the depreciation line

MPK ?
steady-state capital per worker, k
24
The transition to the Golden Rule steady state

• The economy does NOT have a tendency to move
  toward the Golden Rule steady state.
• Achieving the Golden Rule requires that
  policymakers adjust s.
• This adjustment leads to a new steady state with
  higher consumption.

25
The Solow model diagram with population growth
?k s f(k) ? (? n)k
26
The impact of population growth
Investment, break-even investment
(? n1) k
An increase in n causes an increase in break-even
investment,
leading to a lower steady-state level of k.
k1
Capital per worker, k
27
Prediction

• Higher n ? lower k.
• And since y f(k) , lower k ? lower y.
• Thus, the Solow model predicts that countries
  with higher population growth rates will have
  lower levels of capital and income per worker in
  the long run.

28
The Golden Rule with population growth
To find the Golden Rule capital stock, express
c in terms of k c y ? i f
(k ) ? (? n) k c is maximized when
MPK ? n or equivalently, MPK ? ?
n
In the Golden Rule steady state, the marginal
product of capital net of depreciation equals
the population growth rate.
29
Technological progress in the Solow model
?k s f(k) ? (? n g)k
30
Steady-state growth rates in the Solow model with
tech. progress
0
k K/(L?E )
Capital per effective worker
0
y Y/(L?E )
Output per effective worker
g
(Y/ L) y?E
Output per worker
n g
Y y?E?L
Total output
31
The Golden Rule
To find the Golden Rule capital stock, express
c in terms of k c y ? i f
(k ) ? (? n g) k c is maximized
when MPK ? n g or equivalently, MPK
? ? n g
In the Golden Rule steady state, the marginal
product of capital net of depreciation equals the
pop. growth rate plus the rate of tech progress.
32
Calculations
33
Purchasing Power Parity (cont.)

• Purchasing power parity comes in 2 forms
• Absolute PPP purchasing power parity that has
  already been discussed. Exchange rates equal
  price levels across countries.
• E/ PUS/PEU

34
Definitions of Exchange Rates

• Exchange rates are quoted as foreign currency per
  unit of domestic currency or domestic currency
  per unit of foreign currency.
• How much can be exchanged for one dollar? 102/1
• How much can be exchanged for one yen? 0.0098/1
• Exchange rate allow us to denominate the cost or
  price of a good or service in a common currency.
• How much does a Honda cost? 3,000,000
• Or, 3,000,000 x 0.0098/1 29,400

35
Depreciation and Appreciation

• Depreciation is a decrease in the value of a
  currency relative to another currency.
• A depreciated currency is less valuable (less
  expensive) and therefore can be exchanged for
  (can buy) a smaller amount of foreign currency.
• 1/1 ! 1.20/1 means that the dollar has
  depreciated relative to the euro. It now takes
  1.20 to buy one euro, so that the dollar is less
  valuable.
• The euro has appreciated relative to the dollar
  it is now more valuable.

36
Depreciation and Appreciation (cont.)

• Appreciation is an increase in the value of a
  currency relative to another currency.
• An appreciated currency is more valuable (more
  expensive) and therefore can be exchanged for
  (can buy) a larger amount of foreign currency.
• 1/1 ! 0.90/1 means that the dollar has
  appreciated relative to the euro. It now takes
  only 0.90 to buy one euro, so that the dollar
  is more valuable.
• The euro has depreciated relative to the dollar
  it is now less valuable.

37
Depreciation and Appreciation (cont.)

• A depreciated currency is less valuable, and
  therefore it can buy fewer foreign produced goods
  that are denominated in foreign currency.
• How much does a Honda cost? 3,000,000
• 3,000,000 x 0.0098/1 29,400
• 3,000,000 x 0.0100/1 30,000
• A depreciated currency means that imports are
  more expensive and domestically produced goods
  and exports are less expensive.
• A depreciated currency lowers the price of
  exports relative to the price of imports.