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International Trade

Purpose of Course  showclose

This course will provide you with an analytical framework for the study of international trade.  Historically, international trade has played a critical role in enabling countries to grow, develop, and become economically powerful.  Through international trade in goods and services, the economies of different countries are more closely linked to one another now than ever before.  At the same time, the world economy is more turbulent now than it has been in decades.  Keeping up with the shifting international environment has become a central concern in business strategy and national economic policy.  This course uses the same fundamental methods of analysis deployed in other branches of economics, as the motives and behavior of individuals and firms remain the same whether they are in the context of international trade or domestic transactions.  You will learn, however, that international trade introduces an entirely new and different set of concerns as well.

This course will cover a broad array of relevant topics.  We will explore both theoretical models and empirical studies as we seek to determine a model that best fits “real world” data.  This course will frequently compare and contrast competing theories concerning the nature of international trade and the gains or losses thereof.  We will work to understand the economic intuition behind technically demanding models and define the assumptions behind various theories before evaluating how well those models fit actual trading economies.  We will also explore the relevance and policy implications of various theories/models, especially in terms of growth, income distribution, and development.

Course Information  showclose

Welcome to ECON307.  Below, please find general information on the course and its requirements.
 
Course Designers: Joy Zhao and Michael McPherson
 
Primary Resources: This course is composed of a range of different free online materials.  However, the course makes primary use of the following materials:
Course Requirements: To successfully complete this course, you will need to work through each unit and all of its assigned materials.  Pay special attention to Units 1 and 2 as these lay the groundwork for understanding the more exploratory material in latter units.  You will also need to complete:
  • Unit 1 Assessments
  • Unit 2 Assessments
  • Unit 3 Assessments
  • Unit 4 Assessments
  • The Final Exam
Note that you will only receive an official grade on your Final Exam.  However, in order to adequately prepare for this exam, you will need to work through the course materials and the assessments listed above.
 
In order to “pass” this course, you will need to earn a 70% or higher on the Final Exam.  Your score on the exam will be tabulated as soon as you complete it.  If you do not pass the exam, you may take it again.
 
Time Commitment: This course should take you a total of 142 hours to complete. Each unit includes a “time advisory” that lists the amount of time you are expected to spend on each subunit.  These should help you plan your time accordingly.  It may be useful to take a look at these time advisories and determine how much time you have over the next few weeks to complete each unit and then set goals for yourself.  For example, Unit 1 should take you 42.25 hours to complete.  Perhaps you can sit down with your calendar and decide to complete subunit 1.1 (a total of 4.75 hours) on Monday night; subunit 1.2 (a total of 5.25 hours) on Tuesday night; and so forth.
 
Tips/Suggestions: Take comprehensive notes as you study each resource in this course.  These notes will serve as a useful review as you study for your Final Exam. 

Learning Outcomes  showclose

Upon successful completion of this course, the student will be able to:
  • Distinguish between international trade and international finance.
  • Discuss the importance of trade in the world and how this has changed over the past decades.
  • Describe the current world trading system and the basic rules underlying this system.
  • Explain and discuss historic, current, and emerging economic models in the United States and around the world.
  • Discuss recent developments in the field of international macroeconomics.
  • Use an analytical framework to examine contemporary international economic issues.
  • Discuss international trade and the issues arising from the globalization of markets.
  • Discuss the concepts of foreign exchange, its importance to individuals, businesses, and the performance of national economies, and how foreign exchange markets work.
  • Analyze policy issues related to international trade.
  • Describe the legal system governing international economic transactions and international economic relations.
  • Answer the four trade questions: “Why do countries trade?,” “How does trade affect production and consumption in each country?,” “Which country gains from trade?,” and “Within each country, who are the gainers and losers from opening trade?”

Course Requirements  showclose

In order to take this course, you must:

√    Have access to a computer.

√    Have continuous broadband Internet access.

√    Have the ability/permission to install plug-ins or software (e.g. Adobe Reader or Flash).

√    Have the ability to download and save files and documents to a computer.

√    Have the ability to open Microsoft files and documents (.doc, .ppt, .xls, etc.).

√    Have competency in the English language.

√    Have read the Saylor Student Handbook.

√    Have completed the following courses from “The Core Program” of the Economics discipline: ECON201 and ECON202.

Preliminary Information

  • International Economics: Theory and Policy

    You will be prompted to read sections of this book throughout the course.  You may choose to download the text in full now and skip to the appropriate section as prompted by the resource boxes below, or you can simply download the specific sections of the text assigned as you progress through each resource box below.

    Link: International Economics: Theory and Policy (PDF)

    Terms of Use: This text was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-Share-Alike 3.0 License without attribution as requested by the work’s original creator or licensee.

Unit Outline show close


Expand All Resources Collapse All Resources
  • Unit 1: International Trade Theory  

    Countries engage in international trade for two basic reasons, each of which contributes to the country’s gain from trade.  First, countries trade because they are different from one another.  Nations, like individuals, can benefit from their differences by reaching agreements in which each party contributes its strengths and focuses on producing goods in which each is especially efficient.  Second, countries trade to achieve economies of scale in production.  That is, if each country produces only a limited range of goods, it can produce each of these goods at a larger scale and hence more efficiently than if it tried to produce everything.  In the real world, patterns of international trade reflect the interaction of both of these motives. 

    This unit will help you develop the tools you need to understand how differences between countries give rise to trade between them and why this trade is mutually beneficial.  After a brief introduction to the general topic of international trade, we will begin by analyzing how comparative advantage acts as a trade pattern determinant.  You will also be introduced to the Ricardian model of trade.  The unit will then discuss capital as a factor of production, covering the Heckscher-Ohlin model of trade.  We will investigate which factors gain and lose from trade in the short-run as well as in the long-run before learning how economies of scale, technology, demand, and transport costs contribute to patterns of trade.  The unit will conclude with a discussion of the reasons behind intra-industry trade, taking note of what new trade theories have to say about it.

    Time Advisory   show close
    Learning Outcomes   show close
  • 1.1 Introduction  

    Note: In this subunit, we will discuss the distinction between international and domestic economic issues, explain the seven themes that recur in international economics and discuss their significance, and distinguish between the trade and monetary aspects of international economics.

  • 1.1.1 What Is International Economics about?  

    Note: This topic is covered by the reading and web media assigned below subunit 1.1.  In particular, focus on the text below the heading “What Is International Economics?” in Chapter 1, Section 1 of International Economics: Theory and Policy.

  • 1.1.2 Gains from Trade  

    Note: This topic is covered by the reading and web media assigned below subunit 1.1. 

  • 1.1.3 Patterns of Trade  

    Note: This topic is covered by the reading and web media assigned below subunit 1.1.  

  • 1.1.4 The Effects of Government Policies on Trade  

    Note: This topic is covered by the reading and web media assigned below subunit 1.1.  

  • 1.1.5 International Finance Topics  

    Note: This topic is covered by the reading and web media assigned below subunit 1.1.

  • 1.1.6 International Trade versus International Finance  

    Note: This topic is covered by the reading and web media assigned below subunit 1.1.

  • 1.2 World Trade: An Overview  

    Note: This subunit will explain why the value of trade between any two countries depends on the size of those countries' economies.  It will also discuss how distance and borders reduce trade, describe the fluctuations in the traded share of international production, and examine why there have been two ages of globalization.  This unit will also discuss how the mix of internationally-traded goods and services has changed over time. 

  • 1.2.1 The Largest Trading Partners of the US  

    Note: This topic is covered by the reading and web media assigned below subunit 1.2.

  • 1.2.2 Gravity Model  

    Note: This topic is covered by the reading and web media assigned below subunit 1.2.

  • 1.2.3 Borders and Trade Agreements  

    Note: This topic is covered by the reading and web media assigned below subunit 1.2.

  • 1.2.4 Globalization, Then and Now  

    Note: This topic is covered by the reading and web media assigned below subunit 1.2.

  • 1.2.5 Changing Composition of Trade  

    Note: This topic is covered by the reading and web media assigned below subunit 1.2.

  • 1.2.6 Multinational Corporations and Outsourcing  

    Note: This topic is covered by the reading and web media assigned below subunit 1.2.

  • 1.3 Labor Productivity and Comparative Advantage: The Ricardian Model  

    Note: In this subunit, we will learn how the Ricardian model (the most basic model of international trade) works and how it illustrates the principle of comparative advantage.  We will also demonstrate gains from trade and refute common fallacies about international trade.  Finally, we will take a look at empirical evidence that wages reflect productivity and that trade patterns reflect relative productivity.

  • 1.3.1 Opportunity Costs and Comparative Advantage  

    Note: This topic is covered by the resources assigned below subunit 1.3.

  • 1.3.2 A One Factor Ricardian Model  

    Note: This topic is covered by the resources assigned below subunit 1.3.

  • 1.3.3 Production Possibilities  

    Note: This topic is covered by the resources assigned below subunit 1.3.

  • 1.3.4 Gains from Trade  

    Note: This topic is covered by the resources assigned below subunit 1.3. 

  • 1.3.5 Wages and Trade  

    Note: This topic is covered by the resources assigned below subunit 1.3.

  • 1.3.6 Misconceptions about Comparative Advantage  

    Note: This topic is covered by the resources assigned below subunit 1.3. 

  • 1.3.7 Transportation Costs and Non-Traded Goods  

    Note: This topic is covered by the resources assigned below subunit 1.3. 

  • 1.3.8 Empirical Evidence  

    Note: This topic is covered by the resources assigned below subunit 1.3. 

  • 1.4 Resources, Comparative Advantage, and Income Distribution  

    Time Advisory: This sub-unit will take approximately 8 hours and 15 minutes to complete.

    Note: In this subunit, we will learn how differences in resources can lead to international trade, discuss why trade creates both losers and winners, and define gains from trade when there are losers. We will also discuss the reasons why trade is a politically contentious issue and weigh arguments for free trade in light of the fact that owners of scarce factors are predicted to be worse off without compensation.

  • 1.4.1 Production Possibilities  

    Note: This topic is covered by the resources assigned below subunit 1.4.
     

  • 1.4.2 Relationship between Goods Prices, Factor Prices and Factor Levels  

    Note: This topic is covered by the resources assigned below subunit 1.4. 

  • 1.4.3 Relationship between Goods Prices, Factor Prices, Factor Levels and Output Levels  

    Note: This topic is covered by the resources assigned below subunit 1.4. 

  • 1.4.4 Trade in the Heckscher-Ohlin Model  

    Note: This topic is covered by the resources assigned below subunit 1.4. 

  • 1.4.5 Factor Price Equalization  

    Note: This topic is covered by the resources assigned below subunit 1.4. 

  • 1.4.6 Income Distribution and Income Inequality  

    Note: This topic is covered by the resources assigned below subunit 1.4. 

  • 1.4.7 Empirical Evidence  

    Note: This topic is covered by the resources assigned below subunit 1.4.
     

  • 1.5 The Standard Trade Model  

    Note: This subunit will demonstrate how the components of the standard trade model, production possibilities frontiers, isovalue lines, and indifference curves fit together in order to illustrate how trade patterns are established by a combination of supply-side and demand-side factors.  We will also discuss how changes in the terms of trade, economic growth, and transfers between nations affect the welfare of nations engaged in international trade. Then, we will examine the effects that tariffs and subsidies have on trade patterns and the welfare of trading nations as well as on the distribution of income within countries.

  • 1.5.1 Measuring the Values of Production and Consumption  

    Note: This topic is covered by the resources assigned below subunit 1.5.

  • 1.5.2 Welfare and Terms of Trade  

    Note: This topic is covered by the resources assigned below subunit 1.5.

  • 1.5.3 Effects of Economic Growth  

    Note: This topic is covered by the resources assigned below subunit 1.5.

  • 1.5.4 Effects of International Transfers of Income  

    Note: This topic is covered by the resources assigned below subunit 1.5.

  • 1.5.5 Effects of Import Tariffs and Export Subsidies  

    Note: This topic is covered by the resources assigned below subunit 1.5.

  • 1.5.6 Income Distribution  

    Note: This topic is covered by the resources assigned below subunit 1.5.

  • 1.6 Economies of Scale, Imperfect Competition, and International Trade  

    Note: In this subunit, we will describe why international trade often occurs due to increasing returns to scale and imperfect competition.  We will also identify the source of intra-industry trade and determine how it differs from inter-industry trade.  Then, we will detail the “dumping” arguments used by domestic industries as a basis for protectionism and explain the relationship between dumping and price discrimination.  Lastly, we will discuss the role of external economies and knowledge spillovers in shaping comparative advantage and international trade patterns.

  • 1.6.1 Types of Economies of Scale  

    Note: This topic is covered by the lecture and reading assigned below subunit 1.6. 

  • 1.6.2 Types of Imperfect Competition  

    Note: This topic is covered by the lecture and reading assigned below subunit 1.6.

  • 1.6.3 Monopolistic Competition and Trade  

    Note: This topic is covered by the lecture and reading assigned below subunit 1.6.

  • 1.6.4 Inter-Industry Trade and Intra-Industry Trade  

    Note: This topic is covered by the lecture and reading assigned below subunit 1.6.

  • 1.6.5 Dumping  

    Note: This topic is covered by the lecture and reading assigned below subunit 1.6.

  • 1.6.6 External Economies of Scale and Trade  

    Note: This topic is covered by the lecture and reading assigned below subunit 1.6.

  • 1.7 International Factor Movements  

    Note: In this subunit, we will discuss the causes of as well as the winners and losers in migration and labor mobility between nations; describe the concept of intertemporal comparative advantage and explain how it relates to international capital flows, international lending, and foreign investment; and examine theories that seek to explain the existence of multinational firms and the motivation behind foreign direct investment across economies.

  • 1.7.1 International Labor Mobility  

    Note: This topic is covered by the resources assigned below subunit 1.7. 

  • 1.7.2 International Borrowing and Lending  

    Note: This topic is covered by the resources assigned below subunit 1.7. 

    • Lecture: TED Talks: “Ngozi Okonjo-Iweala on Aid Versus Trade”

      Link: TED Talks: “Ngozi Okonjo-Iweala on Aid Versus Trade” (Adobe Flash)
       
      Instructions: This is an optional lecture and not a requirement of the course.  Please watch this guest lecture's views on how aid has benefitted other nations and how it can particularly benefit Africa. 
       
      Viewing this video and pausing to take notes should take approximately 30 minutes to watch. 
       
      Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

  • 1.7.3 Foreign Direct Investment and Multinational Firms  

    Note: This topic is covered by the resources assigned below subunit 1.7.

  • Unit 2: International Trade Policy  

    The previous unit answered the question, “Why do nations trade?” by describing the causes and effects of international trade and the functioning of a trade world economy.  While this question is interesting in and of itself, its answer is much more interesting if it helps us answer the question: “What should a nation’s trade policy be?” 

    In this unit, we will begin our investigation of trade policy issues by analyzing the implications of tariffs for trade and welfare.  We will then move on to non-tariff barriers and their implications before concluding with a discussion of the arguments for restricting trade and an overview of the political economy of trade policy.

    Time Advisory   show close
    Learning Outcomes   show close
  • 2.1 The Instruments of Trade Policy  

    Note: In this subunit, we will evaluate the costs and benefits of tariffs, their welfare effects, and winners and losers from tariff policies. We will also discuss what export subsidies and agricultural subsidies are, and explain how they affect trade in agriculture in the United States and the European Union. Then, we will explain the effect of voluntary export restraints on both importing and exporting countries, and describe how the welfare effects of voluntary export restraints compare with tariff and quota policies.

  • 2.1.1 Partial Equilibrium Analysis of Tariffs: Supply, Demand, and Trade in a Single Industry  

    Note: This topic is covered by the resources assigned below subunit 2.1. 

  • 2.1.2 Costs and Benefits of Tariffs  

    Note: This topic is covered by the resources assigned below subunit 2.1.

  • 2.1.3 Export Subsidies  

    Note: This topic is covered by the resources assigned below subunit 2.1.

  • 2.1.4 Import Quotas  

    Note: This topic is covered by the resources assigned below subunit 2.1.

  • 2.1.5 Voluntary Export Restraints  

    Note: This topic is covered by the resources assigned below subunit 2.1.

  • 2.1.6 Local Content Requirements  

    Note: This topic is covered by the resources assigned below subunit 2.1.

  • 2.2 The Political Economy of Trade Policy  

    Note: In this subunit, we will articulate arguments for free trade that go beyond the conventional “gains from trade” line or reasoning; evaluate national welfare arguments against free trade; examine the theory and evidence behind "political economy" views of trade policy; explain how international negotiations and agreements have promoted world trade; and discuss the special issues raised by preferential trade agreements.

  • 2.2.1 The Cases for Free Trade  

    Note: This topic is covered by the resources assigned below subunit 2.2.

  • 2.2.2 The Cases against Free Trade  

    Note: This topic is covered by the resources assigned below subunit 2.2.

  • 2.2.3 Political Models of Trade Policy  

    Note: This topic is covered by the resources assigned below subunit 2.2.

  • 2.2.4 International Negotiations of Trade Policy and the World Trade Organization  

    Note: This topic is covered by the resources assigned below subunit 2.2.

  • 2.3 Trade Policy in Developing Countries  

    Note: In this subunit, we will recapitulate the case for protectionism as it has been historically practiced in developing countries and discuss import-substitution-led industrialization and the "infant industry" argument.  Then, we will summarize the basic ideas behind "economic dualism" and its relationship to international trade. We will also explore the recent economic history of various East Asian countries, including Taiwan and South Korea, and detail the relationship between their rapid economic growth and their participation in international trade.

    • Lecture: Pearson Education: Krugman and Obstfeld's International Economics: Theory and Policy: “Chapter 10: Trade Policy in Developing Countries” Lecture Notes

      Link: Pearson Education: Krugman and Obstfeld's International Economics: Theory and Policy: “Chapter 10: Trade Policy in Developing Countries” (Microsoft PowerPoint)
       
      Also available in:
       
      PDF
       
      Instructions: When you click on the link above, you will be directed to Krugman and Obstfeld's “Chapter 10: Trade Policy in Developing Countries” lecture notes.  Please click “PowerPoint version” or “Acrobat version” in the upper left corner of the webpage to download the entire lecture notes as a PPT file or as a PDF file.  To cover the topics in sub-subunits 2.3.1-2.3.3, please read all of the slides for Chapter 10.
       
      Studying this lecture should take approximately 2 hours to complete. 
       
      Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

    • Reading: AEI Press’s version of Sarath Rajapatirana’s Trade Policies of Developing Countries

      Link: AEI Press’s version of Sarath Rajapatirana’s Trade Policies of Developing Countries (PDF)
       
      Instructions: When you click on the link above, you will be directed to Sarath Rajapatirana’s Trade Policies of Developing Countries.  Please click “Download file” in the middle of the webpage to download the entire paper as a PDF file, and read the text in its entirety.  This reading covers the topics outlined in sub-subunits 2.3.1-2.3.3.  You will notice that the reading is not organized as the sections below are, but you will learn the material you need to know regardless.
       
      This reading should take approximately 4 hours to complete. 
       
      Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

      The Saylor Foundation does not yet have materials for this portion of the course. If you are interested in contributing your content to fill this gap or aware of a resource that could be used here, please submit it here.

      Submit Materials

    • Reading: Foreign Policy in Focus: Aileen Kwa’s “WTO and Developing Countries”

      Link: Foreign Policy in Focus: Aileen Kwa’s “WTO and Developing Countries” (PDF)

      Instructions: Read this brief summary of the World Trade Organization’s effect on developing countries.

      Reading this article and taking notes should take you approximately 15 minutes.

      Terms of use: This resource is licensed under a Creative Commons Attribution 3.0 Unported License. It is attributed to the Institute for Policy Studies, and the original version can be found here.

  • 2.3.1 Import Substituting Industrialization  

    Note: This topic is covered by the resources assigned below subunit 2.3.

  • 2.3.2 Trade Liberalization since 1985  

    Note: This topic is covered by the resources assigned below subunit 2.3.

  • 2.3.3 Export Oriented Industrialization  

    Note: This topic is covered by the resources assigned below subunit 2.3.

  • 2.4 Controversies in Trade Policy  

    Note: In this subunit, we will summarize the more sophisticated arguments for interventionist trade policy, especially those related to externalities and economies of scale.  We will also evaluate the claims of the anti-globalization movement concerning trade effects on workers, labor standards, and the environment.  We will conclude by discussing the role of the WTO as a forum for resolving trade disputes and addressing the tension between the rulings of the WTO and individual national interests.

  • 2.4.1 Arguments for “Activist” Trade Policies  

    Note: This topic is covered by the resources assigned below subunit 2.4.

  • 2.4.2 Arguments Concerning Trade and People  

    Note: This topic is covered by the resources assigned below subunit 2.4. 

  • Unit 3: Exchange Rates and Open-Economy Macroeconomics  

    The previous units were concerned primarily with the problem of making the best use of the world’s scarce productive resources at a single point in time.  In this unit, we shift our focus and ask: How can economic policy ensure that factors of production are fully employed?  And what determines how an economy’s capacity to produce goods and services changes over time?  We will learn how the interactions between national economies influence the worldwide pattern of macroeconomic activity.  We will also discuss the role of trade in growth and welfare in an open economy, the causes and consequences of factor mobility, as well as the role of multinationals.

    Time Advisory   show close
    Learning Outcomes   show close
  • 3.1 National Income Accounting and the Balance of Payments  

    Note: In this subunit, we will discuss the concept of the current account balance, use the current account balance to extend national income accounting to open economies, and apply national income accounting to the interaction between saving, investment, and net exports.  We will also describe the balance of payments accounts, learning the relationship between that balance and the current account balance.  Then, we will relate the current account to changes in a country's net foreign wealth.

  • 3.1.1 National Income Accounts  

    Note: This topic is covered by the resources assigned below subunit 3.1. 

  • 3.1.2 National Savings, Investment, and the Current Account  

    Note: This topic is covered by the resources assigned below subunit 3.1.

  • 3.1.3 Balance of Payments Accounts  

    Note: This topic is covered by the resources assigned below subunit 3.1. 

  • 3.2 Exchange Rates and the Foreign Exchange Market: An Asset Approach  

    Note: In this subunit, we will relate exchange rate changes to changes in the relative prices of countries' exports, describe the structure and functions of the foreign exchange market, use exchange rates to calculate and compare returns on assets denominated in different currencies, apply the interest parity condition to find equilibrium exchange rates, and identify the effects that interest rates and expectation shifts have on exchange rates.

  • 3.2.1 The Basics of Exchange Rates  

    Note: This topic is covered by the resources assigned below subunit 3.2.

  • 3.2.2 Exchange Rates and the Prices of Goods  

    Note: This topic is covered by the resources assigned below subunit 3.2.

  • 3.2.3 The Foreign Exchange Markets  

    Note: This topic is covered by the resources assigned below subunit 3.2.

  • 3.2.4 The Demand for Currency and Other Assets  

    Note: This topic is covered by the resources assigned below subunit 3.2.

  • 3.2.5 A Model of Foreign Exchange Markets  

    Note: This topic is covered by the resources assigned below subunit 3.2. 

  • 3.3 Money, Interest Rates, and Exchange Rates  

    Note: In this subunit, we will discuss the national money markets in which interest rates are determined, learn how monetary policy and interest rates feed into the foreign exchange market, and distinguish between the economy's long-run position and its short-run position (in which money prices and wages are sticky).  We will also explain how price levels and exchange rates respond to monetary factors in the long run.  Then, we will outline the relationship between the short-run and long-run effects of monetary policy and explain the concept of short-run exchange rate overshooting.

  • 3.3.1 What Is Money?  

    Note: This topic is covered by the reading assigned below subunit 3.3.

  • 3.3.2 Control of the Supply of Money  

    Note: This topic is covered by the reading assigned below subunit 3.3.

  • 3.3.3 The Demand for Money  

    Note: This topic is covered by the reading assigned below subunit 3.3.

  • 3.3.4 A Model of Real Money Balances and Interest Rates  

    Note: This topic is covered by the reading assigned below subunit 3.3.

  • 3.3.5 A model of Real Money Balances, Interest Rates, and Exchange Rates  

    Note: This topic is covered by the reading assigned below subunit 3.3.

  • 3.3.6 Long Run Effects of Changes in Money on Prices, Interest Rates, and Exchange Rates  

    Note: This topic is covered by the reading assigned below subunit 3.3.

  • 3.4 Price Levels and the Exchange Rate in the Long Run  

    Note: In this subunit, we will explain the purchasing power parity theory of exchange rates and the theory's relationship to international goods-market integration.  We will also describe how monetary factors (such as ongoing price level inflation) affect exchange rates in the long run, discuss the concept of the real exchange rate, and demonstrate factors that affect real exchange rates and relative currency prices in the long run.  Then, we will explain the relationship between international real interest rate differences and expected changes in real exchange rates.

  • 3.4.1 Law of One Price  

    Note: This topic is covered by the resources assigned below subunit 3.4.

  • 3.4.2 Purchasing Power Parity  

    Note: This topic is covered by the resources assigned below subunit 3.4.

  • 3.4.3 Long Run Model of Exchange Rates: Monetary Approach  

    Note: This topic is covered by the resources assigned below subunit 3.4.

  • 3.4.4 Relationship between Interest Rates and Inflation: Fisher Effect  

    Note: This topic is covered by the resources assigned below subunit 3.4.

  • 3.4.5 Shortcomings of Purchasing Power Parity  

    Note: This topic is covered by the resources assigned below subunit 3.4.

  • 3.4.6 Long Run Model of Exchange Rates: Real Exchange Rate Approach  

    Note: This topic is covered by the resources assigned below subunit 3.4.

  • 3.4.7 Real Interest Rates  

    Note: This topic is covered by the resources assigned below subunit 3.4.

  • 3.5 Output and the Exchange Rate in the Short Run  

    Note: This subunit will explain the role of the real exchange rate in determining the aggregate demand for a country's output.  We will also learn how an open economy's short-run equilibrium can be analyzed as the intersection of an asset market equilibrium schedule (AA) and an output market equilibrium schedule (DD).  Then, we will explore how monetary and fiscal policies affect the exchange rate and national output in the short run, describe and interpret the long-run effects of permanent macroeconomic changes, and explain the relationship among macroeconomic policies, the current account balance, and the exchange rate.

  • 3.5.1 Determinants of Aggregate Demand in the Short Run  

    Note: This topic is covered by the resources assigned below subunit 3.5.

  • 3.5.2 A Short Run Model of Output Market Equilibrium  

    Note: This topic is covered by the resources assigned below subunit 3.5.

  • 3.5.3 A Short Run Model of Asset Market Equilibrium  

    Note: This topic is covered by the resources assigned below subunit 3.5.

  • 3.5.4 A Short Run Model for both Output Market Equilibrium and Asset Market Equilibrium  

    Note: This topic is covered by the resources assigned below subunit 3.5.

  • 3.5.5 Effects of Temporary and Permanent Changes in Monetary and Fiscal Policies  

    Note: This topic is covered by the resources assigned below subunit 3.5.

  • 3.5.6 Adjustment of the Current Account over Time  

    Note: This topic is covered by the resources assigned below subunit 3.5.

  • 3.5.7 IS-LM Model  

    Note: This topic is covered by the resources assigned below subunit 3.5.

  • 3.6 Fixed Exchange Rates and Foreign Exchange Rates  

    Note: This unit will demonstrate how a central bank must manage monetary policy so as to fix its currency's value in the foreign exchange market.  We will also analyze the relationship between the central bank's foreign exchange reserves, its purchases and sales in the foreign exchange market, and the money supply.  Then, we will explain how monetary, fiscal, and sterilized intervention policies affect the economy under a fixed exchange rate, discuss causes and effects of balance of payments crises, and describe how alternative multilateral systems for pegging exchange rates work.

  • 3.6.1 Balance Sheets of Central Banks  

    Note: This topic is covered by the resources assigned below subunit 3.6.

  • 3.6.2 Intervention in the Foreign Exchange Market and the Money Supply  

    Note: This topic is covered by the resources assigned below subunit 3.6.

  • 3.6.3 How the Central Bank Fixes the Exchange Rate  

    Note: This topic is covered by the resources assigned below subunit 3.6.

  • 3.6.4 Monetary and Fiscal Policies under Fixed Exchange Rates  

    Note: This topic is covered by the resources assigned below subunit 3.6.

  • 3.6.5 Financial Market Crises and Capital Flight  

    Note: This topic is covered by the resources assigned below subunit 3.6.

  • 3.6.6 Types of Fixed Exchange Rates: Reserve Currency and Gold Standard Systems  

    Note: This topic is covered by the resources assigned below subunit 3.6.

  • 3.6.7 Zero Interest Rates, Deflation, and Liquidity Traps  

    Note: This topic is covered by the resources assigned below subunit 3.6.

  • Unit 4: International Macroeconomic Policy  

    In the previous unit, we saw how a country can use monetary, fiscal, and exchange rate policy to change the levels of employment and production within its borders. The inherent independence of open national economies has sometimes made it more difficult for governments to achieve such policy goals as low unemployment and stable prices. The channels of independence depend, in turn, on the monetary and exchange rate arrangements that are adopted by countries and are collectively known as the international monetary system. 

    In this unit, we will examine how the international monetary system influences macroeconomic policy-making and performance.  We will also apply models of fixed and floating exchange rates to examine the recent performance of floating rates and to compare the macroeconomic policy problems of different exchange rate regimes.  Then, we will study the role that international trade plays in both developing countries and economies transitioning from a central planning system to a market-based one.

    Time Advisory   show close
    Learning Outcomes   show close
  • 4.1 The International Monetary System, 1870-1973  

    Note: In this subunit, we will learn how the goals of internal and external balance motivate economic policy makers in open economies.  We will also discuss the structure of the international gold standard that linked countries' exchange rates and policies prior to World War I, and the role of the Great Depression of the 1930s in ending efforts to restore the pre-1914 world monetary order.  Then, we will discuss how the post-World War II Bretton Woods system of globally fixed exchange rates was designed to combine exchange rate stability with limited autonomy of national macroeconomic policies, list and assess the policy options available for attaining internal and external balance under the Bretton Woods arrangements, and explain the factors that led to the final collapse of the Bretton Woods system in 1973 (and the subsequent shift to the current system of floating exchange rates).

  • 4.1.1 Goals of Macroeconomic Policies  

    Note: This topic is covered by the resources assigned below subunit 4.1.

  • 4.1.2 Gold Standard  

    Note: This topic is covered by the resources assigned below subunit 4.1.

  • 4.1.3 Interwar Years  

    Note: This topic is covered by the resources assigned below subunit 4.1.

  • 4.1.4 Bretton Woods System  

    Note: This topic is covered by the resources assigned below subunit 4.1.

  • 4.1.5 Collapse of the Bretton Woods System  

    Note: This topic is covered by the resources assigned below subunit 4.1.

  • 4.1.6 International Effects of US Macroeconomic Policies  

    Note: This topic is covered by the resources assigned below subunit 4.1.

  • 4.2 Macroeconomic Policy and Coordination under Floating Exchange Rates  

    Note: In this subunit, we will examine the reasons why many economists favor an international financial system based on floating dollar exchange rates and the counterarguments they face.  We will also discuss how commodity-price and policy disturbances raised inflation and unemployment in the early years of floating exchange rates (1973-1980), summarize how the monetary and fiscal policies of a large country such as the United States are transmitted abroad, and describe the effects of the disinflationary and fiscal policies followed by the United States in the 1980s and the role of international policy coordination.  Then, we will discuss how the world economy has performed in recent years and consider the lessons the post-1973 experience holds in terms of reforming the international monetary system.

  • 4.2.1 Arguments for Flexible Exchange Rates  

    Note: This topic is covered by the resources assigned below subunit 4.2.

  • 4.2.2 Arguments against Flexible Exchange Rates  

    Note: This topic is covered by the resources assigned below subunit 4.2.

  • 4.2.3 Foreign Exchange Markets since 1973  

    Note: This topic is covered by the resources assigned below subunit 4.2.

  • 4.2.4 Interdependence of Large Countries  

    Note: This topic is covered by the resources assigned below subunit 4.2.

  • 4.2.5 The Chaing Mai Initiative for East Asian Countries  

    Note: This topic is covered by the resources assigned below subunit 4.2.

  • 4.3 Optimum Currency Areas and the European Experience  

    Note: In this subunit, we will discuss why Europeans have long sought to stabilize their mutual exchange rates while floating against the U.S. dollar.  We will also learn how the European Union, through the Maastricht Treaty of 1991, placed itself on the road to having a single currency (the euro) issued and managed by a European System of Central Banks (ESCB).  We will then detail the structure of the ESCB and the European Union's restrictions on member states' fiscal policies, articulate the main lessons of the theory of optimum currency areas, and recount how the 17* countries using the euro have fared so far in their currency union.

    *This number reflects the number of Eurozone countries as of Oct. 17, 2011.

  • 4.3.1 The European Union  

    Note: This topic is covered by the resources assigned below subunit 4.3.

  • 4.3.2 The European Monetary System  

    Note: This topic is covered by the resources assigned below subunit 4.3.

  • 4.3.3 Policies of the EU and the EMS  

    Note: This topic is covered by the resources assigned below subunit 4.3.

  • 4.3.4 Theory of Optimal Currency Areas  

    Note: This topic is covered by the resources assigned below subunit 4.3.

  • 4.3.5 Is the EU an Optimal Currency Area?  

    Note: This topic is covered by the resources assigned below subunit 4.3.

  • 4.3.6 Other Considerations of an Economic and Monetary Union  

    Note: This topic is covered by the resources assigned below subunit 4.3.

  • 4.4 The Global Capital Market: Performance and Policy Problems  

    Note: In this subunit, we will discuss the economic function of international portfolio diversification, explain factors leading to the explosive recent growth of international financial markets, and analyze problems in the regulation and supervision of international banks and nonbank financial institutions.  We will also describe some different methods that have been used to measure the degree of international financial integration and evaluate the performance of the international capital market in linking the economies of the industrial countries.

  • 4.4.1 Gains from Trade  

    Note: This topic is covered by the resources assigned below subunit 4.4.

  • 4.4.2 Portfolio Diversification  

    Note: This topic is covered by the resources assigned below subunit 4.4

  • 4.4.3 Players in the International Capital Markets  

    Note: This topic is covered by the resources assigned below subunit 4.4

  • 4.4.4 Attainable Policies with International Capital Markets  

    Note: This topic is covered by the resources assigned below subunit 4.4

  • 4.4.5 Offshore Banking and Offshore Currency Trading  

    Note: This topic is covered by the resources assigned below subunit 4.4

  • 4.4.6 Regulation of International Banking  

    Note: This topic is covered by the resources assigned below subunit 4.4

  • 4.4.7 Apparent Autocorrelation  

    Note: This topic is covered by the resources assigned below subunit 4.4

  • 4.4.8 Tests of How Well International Capital Markets Allow Portfolio Diversification, Allow Intertemporal Trade and Transmit Information  

    Note: This topic is covered by the resources assigned below subunit 4.4

  • 4.5 Developing Countries: Growth, Crisis, and Reform  

    Note: In this subunit, we will describe the persistently unequal world distribution of income and evidence that has been gathered in order to define its causes.  We will also summarize the major economic features of developing countries and explain the position of developing countries in the world capital market before examining the problem of default by developing borrowers. Then, we will recount the recent history of developing country currency and financial crises and discuss measures that have been proposed in order to enhance poorer countries' gains from participation in the world capital market.

  • 4.5.1 Snapshots of Rich and Poor Countries  

    Note: This topic is covered by the resources assigned below subunit 4.5.

  • 4.5.2 Characteristics of Poor Countries  

    Note: This topic is covered by the resources assigned below subunit 4.5.

  • 4.5.3 The Problem of “Original Sin”  

    Note: This topic is covered by the resources assigned below subunit 4.5.

  • 4.5.4 Types of Financial Assets  

    Note: This topic is covered by the resources assigned below subunit 4.5.

  • 4.5.5 Latin American, East Asian, and Russian Crises  

    Note: This topic is covered by the resources assigned below subunit 4.5.

  • 4.5.6 Currency Boards and Dollarization  

    Note: This topic is covered by the resources assigned below subunit 4.5.

  • 4.5.7 Lessons from Crises and Potential Reforms  

    Note: This topic is covered by the resources assigned below subunit 4.5.

  • 4.5.8 Geography’s and Human Capital’s Role in Poverty  

    Note: This topic is covered by the resources assigned below subunit 4.5.

  • Final Exam  

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