Solutions manual
Ch. 1
Introduction
Ch. Organization
What Is International Economics About?
The_ Gains from Trade
The_ Pattern of Trade
How Much Trade?
Balance of Payments
Exchange Rate Determination
International Policy Coordination
The_ International Capital Market
International Economics: Trade and Money
Ch. Overview
The_ intent of this ch. is to provide both an overview of the_ subject matter of international economics and to
provide a_ guide to the_ organization of the_ text. It is relatively easy for an instructor to motivate the_ study of
international trade and finance. The_ front pages of newspapers, the_ covers of magazines, and
the_ lead reports on television news broadcasts herald the_ interdependence of the_ U.S. economy with the_
rest of the_ world. This interdependence may also be recognized by students through the_ir purchases of
imports of all sorts of goods, the_ir personal observations of the_ effects of dislocations due to international
competition, and the_ir experience through travel abroad.
The_ study of the_ the_ory of international economics generates an understanding of many key events that
shape our domestic and international environment. In recent history, the_se events include the_ causes and
consequences of the_ large current account deficits of the_ United States; the_ dramatic appreciation of the_
dollar during the_ first half of the_ 1980s followed by its rapid depreciation in the_ second half of the_ 1980s;
the_ Latin American debt crisis of the_ 1980s and the_ Mexican crisis in late 1994; and the_ increased pressures
for industry protection against foreign competition broadly voiced in the_ late 1980s and more vocally
espoused in the_ first half of the_ 1990s. The_ financial crisis that began in East Asia in 1997 and spread to
many countries around the_ globe and the_ Economic and Monetary Union in Europe highlight the_ way in
which various national economies are linked and how important it is for us to understand the_se connections.
The_se global linkages have been highlighted yet again with how a_ bust in the_ American housing market
rapidly spread throughout the_ world, turning into a_ global financial crisis through linkages across
international capital markets. At the_ same time, protests at global economic meetings and a_ rising wave of
protectionist rhetoric have highlighted opposition to globalization. The_ text material will enable students to
understand the_ economic context in which such events occur.
1
,Solutions manual
Ch. 1 of the_ text presents data demonstrating the_ growth in trade and the_ increasing importance of
international economics. This ch. also highlights and briefly discusses seven the_mes that arise throughout
the_ book. The_se the_mes are (1) the_ gains from trade, (2) the_ pattern of trade, (3) protectionism, (4) the_
balance of payments, (5) exchange rate determination, (6) international policy coordination, and (7) the_
international capital market. Students will recognize that many of the_ central policy debates occurring today
come under the_ rubric of one of the_se the_mes. Indeed, it is often a_ fruitful heuristic to use current events
to illustrate the_ force of the_ key the_mes and arguments that are presented throughout the_ text.
2
,Solutions manual
Ch. 2
World Trade: An Overview
Ch. Organization
Who Trades with Whom?
Size Matters: The_ Gravity Model
Using the_ Gravity Model: Looking for Anomalies
Impediments to Trade: Distance, Barriers, and Borders
The_ Changing Pattern of World Trade
Has the_ World Gotten Smaller?
What Do We Trade?
Service Offshoring
Do Old Rules Still Apply?
Summary
Ch. Overview
Before entering into a_ series of the_oretical models that explain why countries trade across borders and the_
benefits of this trade (Ch. s 3–11), Ch. 2 considers the_ pattern of world trade that we observe today. The_ core
idea of the_ ch. is the_ empirical model known as the_ gravity model. The_ gravity model is based on the_
observations that (1) countries tend to trade with nearby economies and (2) trade is proportional to country
size. The_ model is called the_ gravity model, as it is similar in form to the_ physics equation that describes
the_ pull of one body on anothe_r as proportional to the_ir size and distance.
The_ basic form of the_ gravity equation is Tij A_ Yi Yj/Dij. The_ logic supporting this equation is that large
countries have large incomes to spend on imports and produce a_ large quantity of goods to sell as exports.
This means that the_ larger that eithe_r trade partner is, the_ larger the_ volume of trade between the_m. At
the_ same time, the_ distance between two trade partners can substitute for the_ transport costs that the_y
face as well as proxy for more intangible aspects of a_ trading relationship such as the_ ease of contact for firms.
This model can be used to estimate the_ predicted trade between two countries and look for anomalies in trade
patterns. The_ text shows an example where the_ gravity model can be used to demonstrate the_ importance
of national borders in determining trade flows. According to many estimates, the_ border between the_ United
States and Canada has the_ impact on trade equivalent to roughly 1,500–2,500 miles of distance. Othe_r
factors such as tariffs, trade agreements, and common language can all affect trade and can be incorporated into
the_ gravity model.
3
, Solutions manual
The_ ch. also considers the_ way trade has evolved over time. Although people often feel that globalization in
the_ modern era is unprecedented, in fact, we are in the_ midst of the_ second great wave of globalization.
From the_ end of the_ 19th century to World War I, the_ economies of different countries were quite connected,
with trade as a_ share of GDP higher in 1910 than in 1960. Only recently have trade levels surpassed pre–
World War I trade. The_ nature of trade has changed, though. The_ majority of trade is in manufactured goods
with agriculture and mineral products making up less than 20 percent of world trade. Even developing
countries now primarily export manufactures. A_ century ago, more trade was in primary products as nations
tended to trade for things that literally could not be grown or found at home. Today,
the_ motivations for trade are varied, and the_ products we trade are increasingly diverse. Despite increased
complexity in modern international trade, the_ fundamental principles explaining trade at the_ dawn of the_
global era still apply today. The_ ch. concludes by focusing on one particular expansion of what is “tradable”—
the_ increase in services trade. Modern information technology has expanded greatly what can be traded as
the_ person staffing a_ call center, doing your accounting, or reading your X-ray can literally be halfway around
the_ world. Although service outsourcing is still relatively rare, the_ potential for a_ large increase in service
outsourcing is an important part of how trade will evolve in the_ coming decades. The_ next few ch. s will
explain the_ the_ory of why nations trade.
Answers to Textbook questions
1. We saw that not only is GDP important in explaining how much two countries trade, but also, distance is
crucial. Given its remoteness, Australia faces relatively high costs for transporting imports and exports,
the_reby reducing the_ attractiveness of trade. Because Canada has a_ border with a_ large economy
(the_ United States) and Australia is not near any othe_r major economy, it makes sense that Canada
would be more open and Australia more self-reliant.
2. Mexico is quite close to the_ United States, but it is far from the_ European Union (EU), so it makes sense
that it trades largely with the_ United States. Brazil is far from both, so its trade is split between the_ two.
Mexico trades more than Brazil in part because it is so close to a_ major economy (the_ United States)
and in part because it is a_ member of a_ trade agreement with a_ large economy (NAFTA). Brazil is
farthe_r away from any large economy and is in a_ trade agreement with relatively small countries.
3. No, if every country’s GDP were to double, world trade would not quadruple. Consider a_ simple example
with only two countries: A_ and B. Let country A_ have a_ GDP of $6 trillion and B have a_ GDP of $4
trillion. Furthe_rmore, the_ share of world spending on each country’s production is proportional to each
country’s share of world GDP (stated differently, the_ exponents on GDP in Equation 2-2, a_ and b, are
both equal to 1). Thus, our example is characterized by the_ table below:
Country GDP Share of World
Spending
A_ $6 trillion 60%
B $4 trillion 40%
Now let’s compute world trade flows in this example. Country A_ has an income of $6 trillion and spends 40
percent of that income on country B’s production. Thus, exports from country B to country A_ are equal to
$6 trillion 40% $2.4 trillion. Country B has an income of $4 trillion and spends 60 percent of this on
country A_’s production. Thus, exports from country A_ to country B are equal to $4 trillion 60% $2.4
trillion. Total world trade in this simple model is $2.4 $2.4 $4.8 trillion.
4
Ch. 1
Introduction
Ch. Organization
What Is International Economics About?
The_ Gains from Trade
The_ Pattern of Trade
How Much Trade?
Balance of Payments
Exchange Rate Determination
International Policy Coordination
The_ International Capital Market
International Economics: Trade and Money
Ch. Overview
The_ intent of this ch. is to provide both an overview of the_ subject matter of international economics and to
provide a_ guide to the_ organization of the_ text. It is relatively easy for an instructor to motivate the_ study of
international trade and finance. The_ front pages of newspapers, the_ covers of magazines, and
the_ lead reports on television news broadcasts herald the_ interdependence of the_ U.S. economy with the_
rest of the_ world. This interdependence may also be recognized by students through the_ir purchases of
imports of all sorts of goods, the_ir personal observations of the_ effects of dislocations due to international
competition, and the_ir experience through travel abroad.
The_ study of the_ the_ory of international economics generates an understanding of many key events that
shape our domestic and international environment. In recent history, the_se events include the_ causes and
consequences of the_ large current account deficits of the_ United States; the_ dramatic appreciation of the_
dollar during the_ first half of the_ 1980s followed by its rapid depreciation in the_ second half of the_ 1980s;
the_ Latin American debt crisis of the_ 1980s and the_ Mexican crisis in late 1994; and the_ increased pressures
for industry protection against foreign competition broadly voiced in the_ late 1980s and more vocally
espoused in the_ first half of the_ 1990s. The_ financial crisis that began in East Asia in 1997 and spread to
many countries around the_ globe and the_ Economic and Monetary Union in Europe highlight the_ way in
which various national economies are linked and how important it is for us to understand the_se connections.
The_se global linkages have been highlighted yet again with how a_ bust in the_ American housing market
rapidly spread throughout the_ world, turning into a_ global financial crisis through linkages across
international capital markets. At the_ same time, protests at global economic meetings and a_ rising wave of
protectionist rhetoric have highlighted opposition to globalization. The_ text material will enable students to
understand the_ economic context in which such events occur.
1
,Solutions manual
Ch. 1 of the_ text presents data demonstrating the_ growth in trade and the_ increasing importance of
international economics. This ch. also highlights and briefly discusses seven the_mes that arise throughout
the_ book. The_se the_mes are (1) the_ gains from trade, (2) the_ pattern of trade, (3) protectionism, (4) the_
balance of payments, (5) exchange rate determination, (6) international policy coordination, and (7) the_
international capital market. Students will recognize that many of the_ central policy debates occurring today
come under the_ rubric of one of the_se the_mes. Indeed, it is often a_ fruitful heuristic to use current events
to illustrate the_ force of the_ key the_mes and arguments that are presented throughout the_ text.
2
,Solutions manual
Ch. 2
World Trade: An Overview
Ch. Organization
Who Trades with Whom?
Size Matters: The_ Gravity Model
Using the_ Gravity Model: Looking for Anomalies
Impediments to Trade: Distance, Barriers, and Borders
The_ Changing Pattern of World Trade
Has the_ World Gotten Smaller?
What Do We Trade?
Service Offshoring
Do Old Rules Still Apply?
Summary
Ch. Overview
Before entering into a_ series of the_oretical models that explain why countries trade across borders and the_
benefits of this trade (Ch. s 3–11), Ch. 2 considers the_ pattern of world trade that we observe today. The_ core
idea of the_ ch. is the_ empirical model known as the_ gravity model. The_ gravity model is based on the_
observations that (1) countries tend to trade with nearby economies and (2) trade is proportional to country
size. The_ model is called the_ gravity model, as it is similar in form to the_ physics equation that describes
the_ pull of one body on anothe_r as proportional to the_ir size and distance.
The_ basic form of the_ gravity equation is Tij A_ Yi Yj/Dij. The_ logic supporting this equation is that large
countries have large incomes to spend on imports and produce a_ large quantity of goods to sell as exports.
This means that the_ larger that eithe_r trade partner is, the_ larger the_ volume of trade between the_m. At
the_ same time, the_ distance between two trade partners can substitute for the_ transport costs that the_y
face as well as proxy for more intangible aspects of a_ trading relationship such as the_ ease of contact for firms.
This model can be used to estimate the_ predicted trade between two countries and look for anomalies in trade
patterns. The_ text shows an example where the_ gravity model can be used to demonstrate the_ importance
of national borders in determining trade flows. According to many estimates, the_ border between the_ United
States and Canada has the_ impact on trade equivalent to roughly 1,500–2,500 miles of distance. Othe_r
factors such as tariffs, trade agreements, and common language can all affect trade and can be incorporated into
the_ gravity model.
3
, Solutions manual
The_ ch. also considers the_ way trade has evolved over time. Although people often feel that globalization in
the_ modern era is unprecedented, in fact, we are in the_ midst of the_ second great wave of globalization.
From the_ end of the_ 19th century to World War I, the_ economies of different countries were quite connected,
with trade as a_ share of GDP higher in 1910 than in 1960. Only recently have trade levels surpassed pre–
World War I trade. The_ nature of trade has changed, though. The_ majority of trade is in manufactured goods
with agriculture and mineral products making up less than 20 percent of world trade. Even developing
countries now primarily export manufactures. A_ century ago, more trade was in primary products as nations
tended to trade for things that literally could not be grown or found at home. Today,
the_ motivations for trade are varied, and the_ products we trade are increasingly diverse. Despite increased
complexity in modern international trade, the_ fundamental principles explaining trade at the_ dawn of the_
global era still apply today. The_ ch. concludes by focusing on one particular expansion of what is “tradable”—
the_ increase in services trade. Modern information technology has expanded greatly what can be traded as
the_ person staffing a_ call center, doing your accounting, or reading your X-ray can literally be halfway around
the_ world. Although service outsourcing is still relatively rare, the_ potential for a_ large increase in service
outsourcing is an important part of how trade will evolve in the_ coming decades. The_ next few ch. s will
explain the_ the_ory of why nations trade.
Answers to Textbook questions
1. We saw that not only is GDP important in explaining how much two countries trade, but also, distance is
crucial. Given its remoteness, Australia faces relatively high costs for transporting imports and exports,
the_reby reducing the_ attractiveness of trade. Because Canada has a_ border with a_ large economy
(the_ United States) and Australia is not near any othe_r major economy, it makes sense that Canada
would be more open and Australia more self-reliant.
2. Mexico is quite close to the_ United States, but it is far from the_ European Union (EU), so it makes sense
that it trades largely with the_ United States. Brazil is far from both, so its trade is split between the_ two.
Mexico trades more than Brazil in part because it is so close to a_ major economy (the_ United States)
and in part because it is a_ member of a_ trade agreement with a_ large economy (NAFTA). Brazil is
farthe_r away from any large economy and is in a_ trade agreement with relatively small countries.
3. No, if every country’s GDP were to double, world trade would not quadruple. Consider a_ simple example
with only two countries: A_ and B. Let country A_ have a_ GDP of $6 trillion and B have a_ GDP of $4
trillion. Furthe_rmore, the_ share of world spending on each country’s production is proportional to each
country’s share of world GDP (stated differently, the_ exponents on GDP in Equation 2-2, a_ and b, are
both equal to 1). Thus, our example is characterized by the_ table below:
Country GDP Share of World
Spending
A_ $6 trillion 60%
B $4 trillion 40%
Now let’s compute world trade flows in this example. Country A_ has an income of $6 trillion and spends 40
percent of that income on country B’s production. Thus, exports from country B to country A_ are equal to
$6 trillion 40% $2.4 trillion. Country B has an income of $4 trillion and spends 60 percent of this on
country A_’s production. Thus, exports from country A_ to country B are equal to $4 trillion 60% $2.4
trillion. Total world trade in this simple model is $2.4 $2.4 $4.8 trillion.
4
