International Economics

国际经济学
Chapter 1
1. Interdependence among today's economies reflects the historical evolution of
the world's economic and political order. Since World War II, Europe and Japan
have reindustrialized. What is more, the formation of the European Community
and the Organization of Petroleum Exporting Countries, as well as the rise of
multinational corporations, has contributed to closer economic and political
linkages.

2. Proponents of an open trading system maintain that free trade leads to lower
prices, the development of more efficient production methods, and a greater
range of consumption choices. Free trade permits resources to move from their
lowest productivity to their highest productivity. Critics of an open trading
system maintain that import competition may displace domestic firms and
workers. It is also argued that during periods of national emergency, it is in the
best interests of a nation to protect strategic industries.

3. For the United States, growing economic interdependence has resulted in

exports and imports increasing as a share of national output. Profits of domestic
firms and wages of domestic workers are increasingly being affected by foreign
competition. Political and economic events play important roles for the
operation of some sectors of the American economy, such as energy and
agriculture.

4. The volume of international trade is governed by factors including the level of

domestic economic activity (e.g., prosperity versus recession) and restrictions
imposed by countries on their imports.

5. The chapter describes three fallacies of international trade:

a. Trade is a zero sum activity
b. Imports reduce employment and act as a drag on the economy
c. Tariffs and quotas will save jobs and promote a higher level of employment

6. International competitiveness refers to the extent to which the goods of a firm or

industry can compete in the marketplace; this competitiveness depends on the
relative prices and qualities of products. No nation can be competitive in, and
thus be a net exporter of everything. Because a nation’s stock of resources is
limited, the ideal is for these resources to be used in their most productive
manner. Nations will benefit from specialization and trade by exporting
products having a comparative advantage.

7. Researchers at the McKinsey Global Institute have found that global

competitiveness is a bit like sports. You get better by playing against folks who
are better than you. This means companies are exposed to intense global

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competition tend to be more productive than those who aren’t.

8. International trade benefits most workers, especially those in exporting

industries. In addition to providing them jobs and income, it allows them to
shop for consumption goods that are cheapest and of the highest quality.
However, workers in import-competing industries often feel threatened from
competition of cheap foreign labor.

9. Among the challenges confronting the international trading system are

maintaining fair standards for labor and promoting environmental quality.

10. The threat of international terrorism tends to slow the degree of globalization
and also make it become costlier. With terrorism, companies must pay more to
insure and provide security for overseas staff and property. Heightened border
inspections could slow shipments of cargo, forcing companies to stock more
inventory. Tighter immigration policies could reduce the liberal inflows of
skilled and blue-collar laborers that permitted companies to expand while
keeping wages in check. Moreover, a greater preoccupation with political risk
has companies greatly narrowing their horizons when making new investments.

Chapter 2
1. Modern trade theory addresses the following questions: (1) What constitutes
the basis for trade? (2) At what terms of trade do nations export and import
certain products? (3) What are the gains from trade in terms of production and
consumption?

2. The mercantilists maintained that government should stimulate exports and

restrict imports so as to increase a nation's holdings of gold. A nation could
only gain at the expense of other nations because not all nations could
simultaneously have a trade surplus. Smith maintained that with free trade,
international specialization of resources in production leads to an increase in
world output which can be shared by both trading partners. All nations
simultaneously can enjoy gains from trade in terms of production and
consumption.

3. Assume that by devoting all of its resources to the production of steel, France
can produce 40 tons. By devoting all of its resources to televisions, France can
produce 60 televisions. Comparable figures for Japan are 20 tons of steel and
10 televisions. In this example, France has an absolute advantage in the
production of steel and televisions. France has a comparative advantage in
televisions.

4. Ignoring the role of demand's impact on market prices, Smith and Ricardo
maintained that a country's competitive position is underlaid by cost conditions.

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Smith's trade theory is based on absolute costs, while comparative costs

underlie Ricardo's trade theory.

5. The principle of comparative advantage can be explained in opportunity cost,

which indicates the amount of one product that must be sacrificed in order to
release enough resources to be able to produce one more unit of another
product. The slope of the production possibilities curve (i.e., the marginal rate
of transformation) indicates this rate of sacrifice. A nation facing a straight-line
production possibilities curve produces under conditions of constant costs,
while production under increasing costs refers to a bowed-out (i.e., concave)
production possibilities curve.

6. Constant opportunity costs refer to a situation where the cost of each additional
unit of one product in terms of another product remains the same. Constant
costs occur when resources are completely adaptable to alternative uses. Under
increasing cost conditions, a nation must sacrifice more and more of one
product to produce each additional unit of another product. Increasing costs
occur when resources are not completely adaptable to alternative uses.

7. Where a nation produces along its production possibilities curve in autarky

affects the nation's comparative costs under increasing cost conditions. This is
because the slope of a bowed-out production possibilities curve, which indicates
the marginal rate of transformation, varies at each point along the curve. Under
conditions of constant costs, the production possibilities curve is a straight line.
The marginal rate of transformation does not change in response to movements
along the production possibilities curve.

8. Under constant opportunity cost conditions, specialization is complete. A

country can devote all of its resources to the production of a good without
losing its comparative advantage. Under increasing cost conditions,
specialization tends to be partial. As production costs rise with expanded
production, the home country eventually loses its comparative advantage.

9. Production gains from trade refer to the increased output of goods and services
made possible by the international division of labor and specialization.
Consumption gains from trade refer to the increased amount of goods made
available to consumers as the result of international trade.

10. The trade triangle includes a nation's exports, its imports, and international
terms of trade.

11. The free trade argument maintains that international trade permits international
division of labor and specialization and results in resources being transferred to
their highest productivity. World output thus rises above autarky levels.

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12. a. Canada's MRT of steel into aluminum equals 1/3 ton of steel per ton of
aluminum while France's MRT of steel into aluminum equals 1 ½ tons
of steel per ton of aluminum. Canada specializes in the production of
aluminum while France specializes in the production of steel.
Complete specialization occurs in each country. The production gains
from trade for the two countries total 500 tons of aluminum and 300
tons of steel.

b. Lower limit, 1 ton of aluminum = 1/3 ton of steel; upper limit, 1 ton of
aluminum = 1 ½ tons of steel. The consumption gains from trade for
Canada consist of 400 tons of aluminum and 200 tons of steel; the
consumption gains from trade for France consist of 100 tons of
aluminum and 100 tons of steel.

c. Canada's trade triangle is bounded by 500 tons of aluminum (export),

500 tons of steel (import), and a term of trade equal to 1 ton of
aluminum per ton of steel. France's trade triangle is bounded by 500
tons of steel (export), 500 tons of aluminum (import), and a term of
trade equal to 1 ton of steel per ton of aluminum.

13. a. Concave production possibilities schedules are explained by increasing

opportunity costs.

b. Japan's MRT of steel into autos equals 1/6 ton of steel per auto; South
Korea's MRT of steel into autos equals 6 tons of steel per auto.

c. Japan specializes in the production of autos while South Korea

specializes in steel.

d. With partial specialization, Japan produces 200 tons of steel and 1300
autos while South Korea produces 900 tons of steel and 400 autos.
The production gains for the two countries combined total 400 tons of
steel and 300 autos.

e. Japan's consumption gains from trade consist of 200 tons of steel and
200 autos; South Korea's consumption gains consist of 200 tons of
steel and 100 autos.

Chapter 3
1. The introduction of community indifference curves into the trade model permits
two questions to be answered: (1) At what point on its production possibilities
curve will a country choose to locate in the absence of trade? (2) At what point
along the terms-of-trade line will a country choose in a trading situation?

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2. The marginal rate of transformation indicates the amount of a commodity that a

nation must sacrifice in order to produce one more unit of a second commodity.
The marginal rate of substitution indicates the amount of a commodity that a
nation is willing to sacrifice in order to consume one additional unit of another
commodity and realize the same level of total satisfaction.

3. Under increasing cost conditions, the slope of a country's production

possibilities curve, which indicates the relative cost of one product in terms of
another product, varies at each point along the curve. In autarky, a nation is in
equilibrium when its community indifference curve is tangent to its production
possibilities curve. Two nations having identical production possibilities
curves, but different community indifference curves, would have different
equilibrium points and therefore different price (cost) ratios for the two goods.

4. The gains a country enjoys from free trade depend on the equilibrium terms of
trade, which is determined by world supply and demand conditions. By
recognizing only the role of supply, Ricardo was unable to determine the
equilibrium terms of trade.

5. The law of reciprocal demand suggests that if we know the domestic demands
expressed by both trading partners for both products, the equilibrium terms of
trade can be defined.

6. Like domestic market prices, the international terms of trade are influenced by
changes in world demand and supply conditions. Changes in factors such as
tastes and income on the demand side and productivity on the supply side can
induce changes in a country's terms of trade.

7. If a nation is to enjoy gains from trade, it must be able to sell its export product
overseas at a higher price than could be obtained domestically.

8. The commodity terms of trade considers the direction of the gains from trade by
measuring the relationship between the prices a country gets for its exports and
the prices it pays for its imports, over a given time period.

9. The commodity terms of trade faces several limitations: (1) the problem of
allowing for new commodities and changes in commodity quality, (2) the
methods of valuing exports and imports, (3) the methods used to weigh the
commodities in the index, and (4) making allowance for changes in
productivity.

10. Japan's terms of trade equal 107 and show improvement. Canada's terms of
trade equal 100 and does not change. Ireland's terms of trade equal 88 and

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shows deterioration.

11. For a large country, export biased growth leads to two opposing welfare effects:
(1) worsening terms of trade, (2) rising national output. If the negative terms of
trade effect more than outweighs the positive effect of increased output, national
welfare decreases, and vice versa.

12. Referring to question 11, immiserizing growth would occur if the negative
terms of trade effect more than offset the positive effect of increased output.
Export biased growth thus contributes to a reduction in domestic welfare.

Chapter 4
1. Transportation costs affect the location of industry since firms recognize that
transportation costs in addition to production costs affect profitability. A firm
achieves its best location when it can minimize its total operating costs,
including production and transportation costs. When adding transportation
costs to the prices of traded goods, a nation's volume of trade decreases.

2. The factor endowment theory suggests that a capital-abundant nation enjoys

relatively cheap capital. It thus specializes in and exports a capital-intensive
good. This leads to increased demand for capital, which forces up the price of
capital and thus the price of the capital-intensive good. The opposite occurs in
the capital-scarce country. The basis for further specialization and trade ceases
when the capital prices and product prices in each nation equate.

3. The Heckscher-Ohlin theory emphasizes factor endowments as the basis for

trade, while Ricardian theory stresses the role of labor productivity.

4. The Heckscher-Ohlin theory reasons that exports of products embodying large

amounts of relatively cheap, abundant factors makes those factors less abundant
domestically. This leads to higher prices and thus an increased share of national
income for these factors.

5. The Leontief paradox questioned the applicability of the factor-endowment

theory by concluding that the United States exported labor-intensive goods.
This was the opposite conclusion that would be expected when applying the
factor endowment theory to the United States.

6. Linder maintains that the factor-endowment theory is valid for trade in primary
products, but that the theory of overlapping demands best applies to trade in
manufactured goods.

7. There appears to be some empirical support for the product life cycle theory in
the area of manufactured goods.

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8. Adam Smith recognized that the division of labor is limited by the size of the
market; world trade can permit longer production runs for domestic
manufacturers, which leads to increasing efficiency and increasing
competitiveness.

9. Interindustry trade refers to the exchange between nations of products of

different industries. Intraindustry trade refers to two-way trade in a similar
product. Among the determinants of intraindustry trade are: (a) overlapping
demand segments in trading countries, (b) the extent to which domestic
producers ignore "minority" consumer tastes, and (c) economies of scale
associated with differentiated goods.

10. Industrial policy refers to a governmental strategy intended to revitalize,

improve, and/or develop an industry. Governmental policies intended to foster
an industry's development include loan guarantees, research and development
subsidies, low interest rate loans, trade protection, and the like. Creating
comparative advantage requires the government to identify industries with the
highest growth prospects. Problems of industrial policy include: (a) identifying
growth oriented industries; (b) government policy makers may be unduly
influenced by their voting constituents.

11. Environmental regulations imposed on domestic producers lead to higher

production costs and a decrease in competitiveness. Such regulation is a
negative determinant on trade performance. Nations that impose more stringent
and costly environmental regulations on their producers, relative to those
abroad, tend to lessen their international competitiveness.

12. Trade in business services is governed by factors such as: (a) employee skills
and compensation levels, (b) a firm's ability to organize its employees in a
productive manner, (c) availability of capital equipment, and (d) potential for
economies of scale made possible by a market's size.

13. a. Sweden—P = $15, Q = 600; Norway—P = $30, Q = 600. Sweden has

the comparative advantage in calculators.

b. P = $22.50 and 600 calculators are traded at that price. Sweden—Qs =

900, Qd = 300; Norway—Qs = 300, Qd = 900.
c. Sweden—P = $20; Norway—P = $25. Sweden—Qs = 800, Qd = 400,
Exports = 400; Norway—Qs = 400, Qd = 800, Imports = 400.
d. Prices do not equalize. Less specialization occurs. A smaller trade
volume occurs.

Chapter 5

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1. A specific tariff is expressed as a fixed amount of money per unit of the

imported product. An ad valorem tariff is a fixed percentage of the value of the
imported product as it enters the country. A compound tariff combines a
specific tariff and an ad valorem tariff.

2. Two commonly used valuation concepts used by customs appraisers are the
free-on-board technique and the cost-insurance-freight technique.

3. When material inputs or intermediate products enter a country at a low duty

while the final imported product is protected by a high duty, the nominal tariff
rate on the final product overstates the effective rate of protection. The opposite
also applies.

4. Developing countries have argued that industrial countries allow raw materials
to be imported at low nominal tariff rates while maintaining high nominal tariff
rates on finished products.

5. Consumer surplus (producer surplus) refers to the difference between the

amount actually paid by the buyer (received by the producer) and the maximum
(minimum) that the buyer (producer) would have been willing to pay (receive)
for the product. By influencing market prices, trade restrictions influence
consumer and producer surplus.

6. A tariff detracts from the nation's welfare via its consumption effect and
protective effect.

7. In general, the size of the welfare responses to tariffs is determined by the

impact of the tariffs on domestic prices and the response of domestic producers
and consumers to these price changes.

8. Given a large-country model, a country which imposes a tariff on imports finds

its terms of trade improving. Should the favorable terms-of-trade effect more
than offset the deadweight losses resulting from the tariff, national welfare
improves.

9. Economists generally contend that most arguments for trade restrictions cannot
withstand searching analysis. The infant industry and national security
arguments may have some validity, but they must be highly qualified.

10. By increasing the price of trade goods, tariffs lower the volume of trade. For
the world as a whole, there is no favorable terms-of-trade effect to offset the
trade volume effect.

11. Terms of trade improve, while trade volume declines.

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12. Effective tariff rate equals 21 percent.

13. Our trade model predicts that by forcing up the price of oil in the United States,
domestic production would be encouraged, while domestic consumption would
be discouraged.

14. A bonded warehouse is a storage facility for imported goods; it allows imported
goods to be put into storage without the payment of duties. Goods may be later
sold overseas duty free or withdrawn for domestic sale upon payment of import
duties. A foreign trade zone is a site where foreign merchandise can be
imported with no import duty; merchandise in the zone can be stored or used in
the manufacturing of final products.

15. a. P = $250; Q = 25. Consumer surplus = $3125; producer surplus =

$3125.
b. Qs = 10, Qd = 40, Imports = 30. Consumer surplus = $8000; producer
surplus = $500.
c. P = $200, Qs = 20, Qd = 30, Imports = 10. $3500. Consumption
effect = $500, protective effect = $500, redistribution effect = $1500,
revenue effect = $1000. Deadweight welfare loss = $1000.

16. a. $400, 12 tons, 2 tons, 10 tons.

b-1. SUS+F shifts upward by the amount of the tariff, $250.
b-2. $600, 10 tons, 4 tons, 6 tons.
b-3. $2200, $200, $200, $600, $1200, $400.
b-4. $350, improve, increase, $300.
b-5. The United States suffers a welfare loss of $100 since the welfare
reduction of the consumption and protective effects ($400) exceeds the
welfare gain of the terms-of-trade effect ($300).

Chapter 6
1. Nontariff trade barriers include import quotas, voluntary export agreements,
subsidies, buy-national policies, product and safety standards, and content
requirements.

2. The revenue effect of a tariff is captured by the government, while a quota's

revenue tends to be captured by domestic or foreign firms.

3. Subsidies include domestic subsidies and export subsidies. Methods used to

subsidize producers include tax concessions, low interest rate loans, and loan
guarantees.

4. Voluntary export restraints are market-sharing agreements negotiated by

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producing and consuming countries. Because voluntary export quotas are

typically administered from the supply side of the market, the foreign exporter
tends to capture the largest share of the quota revenue.

5. While antidumping laws are typically defined in terms of full cost, it may be
rational for a firm to sell its product overseas at losses, provided that prices are
sufficiently high to cover marginal cost.

6. Since import quotas directly limit the number of goods that can enter the home
nation, they tend to be more restrictive than import tariffs which may be
circumvented by foreign producers absorbing the tariff as a lower selling price.
During periods of rising domestic demand, quotas hold down imports more
effectively than tariffs.

7. Sporadic dumping--firms with temporary inventories sell their products

overseas at lower prices than at home. Predatory dumping--firms cut prices
overseas to eliminate competitors. Persistent dumping--in an effort to maximize
profits, firms continuously sell abroad at lower prices than at home.

8. Domestic subsidies avoid the deadweight losses due to the consumption effect.

9. Subsidies are not free goods since they are financed by taxpayer dollars. In
return for granting subsidies, governments often pressure management and
labor to adopt measures to lower costs of production so as to become more
competitive.

10. The import quota tends to permit domestic firms and workers to enjoy higher
sales, profits, and employment levels. Consumers tend to face higher prices and
expenditure levels. The economy as a whole faces deadweight losses in
production and consumption.

11. The sugar import quota was viewed as a method of increasing the domestic
price of sugar, so as to offset the adverse effects of falling prices for U.S. sugar
producers.

12. Under an import quota, the distribution of the revenue effect is indeterminate,
depending on the relative bargaining power of foreign producers and domestic
buyers. Because voluntary export quotas are typically administered from the
supply side of the market, the largest share of the revenue effect tends to be
captured by foreign exporters.

13. Same general answer as Question 12. The distribution of the revenue effect
tends to accrue to foreign auto-makers.

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14. By contributing to a scarcity of steel in the domestic market, quotas lead to

higher steel prices and production costs for domestic steel-using firms. Such
cost increases detract from their international competitiveness.

15. According to the priced-based definition, dumping occurs whenever a foreign

firm sells a product in the importing country’s market at a price below that for
which the product is sold in the firm's home market. According to the cost-
based definition, dumping occurs when foreign merchandise is sold in the
domestic market at "less than fair value" (i.e., price is less than average total
cost).

16. a. Qs = 100, Qd = 800, Imports = 700. Consumer surplus = $160,000,

producer surplus = $2500.
b. Price rises by $100 and consumer surplus falls by $70,000.
Redistribution effect = $20,000, consumption effect = $10,000,
protective effect = $10,000, revenue effect = $30,000. Overall welfare
loss = $50,000.
c. Price remains at the free trade level. Qs = 300, Qd = 800, imports =
500. Total cost of subsidy = $30,000 of which $20,000 is absorbed by
producer surplus and $10,000 is absorbed by higher domestic
production costs. Overall welfare loss = $10,000.

17. a. Ecuador imports 80 computers from Hong Kong.

b. Price rises by $400 and consumer surplus falls by $30,000.
Redistribution effect = $6000, protective effect = $4000, consumption
effect = $4000, revenue effect = $16,000. Overall welfare loss =
$24,000.
c. Overall welfare loss = $14,000; of this amount, the revenue effect =
$12,000, consumption effect = $1000, protection effect = $1000.
d. Smaller by $10,000.

18. a. Output = 9, price = $5, profit = $18. Profits on U.K. sales = $14 while
profits on Canadian sales = $4.
b. Price = $7 and profits = $20. Price = $4 and profit = $4. With
dumping, total profits rise by $6.

19. A tariff-rate quota attempts to minimize the consumer costs of protectionism by

applying a modest within-quota tariff rate; it also shields home producers from
severe import competition with a stiffer over-quota tariff rate. Of a tariff quota's
revenue effect, a portion accrues to the domestic government while the
remainder is captured by domestic importers or foreign exporters as windfall
profits.

Chapter 7

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1. Traditional protectionist arguments (e.g., protective argument and infant

industry) have influenced much of U.S. trade legislation. During the 1970s and
1980s, the issue of jobs has underlaid many protectionist proposals.

2. Protectionism in the United States culminated with the passage of the Smoot-
Hawley Tariff Act of 1930.

3. Under the normal-trade-relations (most-favored-nation) principle, reductions of

trade restrictions agreed to by two nations are extended to all other nations with
which the bargaining nations have normal-trade-relation agreements. The
United States maintains normal trade relations with most nations of the world.

4. The World Trade Organization provides a mechanism whereby trade disputes

among member countries can be settled, so as to reduce the possibility of an
international trade war.

5. The Tokyo Round of multilateral trade negotiations emphasized the role of

nontariff trade barriers that gained in importance during the 1960s and 1970s.
Codes of conduct were agreed to concerning nontariff trade barriers. Minor
reductions in tariff barriers also occurred.

6. These laws attempt to redress hardships for U.S. producers resulting from
policies of foreign firms and governments, thus resulting in a fair trading
environment. They consist of the escape clause, countervailing duties,
antidumping duties, and Section 301 of the 1974 Trade Act that deals with
unfair trading practices by foreign nations.

7. Intellectual property refers to inventions, ideas and processes that are registered
with the government and which awards the inventor (author) exclusive rights to
use the invention for a given period of time.

8. Under the adjustment assistance program, workers, firms and communities who
are injured by foreign competition may obtain financial and technical assistance
from the government.

9. Industrial policies of the United States have been less formal than those of
Europe and Japan. The U.S. government encourages exports via its Export-
Import Bank and Commodity Credit Corporation. Firms are also allowed to
form export trading companies and export trade associations.

10. The U.S. as a whole gains from the foreign subsidy since the resulting increases
in consumer surplus more than offset the reduction in producer surplus.

11. Strategic trade policy refers to governmental assistance provided to support key

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industries that are considered important to future domestic economic growth

and provide widespread benefits to society.

12. Economic sanctions refer to trade and financial restrictions levied against a
foreign country. Such restrictions are designed to impose economic hardship on
the people of the foreign nation which will lead to their pressuring the
government to modify its political behavior. A country facing economic
sanctions may initiate offsetting sanctions such as stockpiling crucial imports or
purchasing goods from countries that do not participate in the sanctions.

13. a. 4 tons, 8 tons, 4 tons, $800, $3200.

b-1. $200, 2 tons, 10 tons, 8 tons.
b-2. Hurts, falls by $600, rises by $1800, benefits by $1200.

Chapter 8
1. Developing nations often contend that the existing pattern of trade and
specialization has made them excessively dependent on primary products,
which has led to unstable export markets and secularly declining terms of trade.

2. To promote stability in commodity markets, international commodity

agreements have relied on production and export controls, buffer stocks, and
multilateral contracts.

3. International commodity agreements have been applied to commodities such as

tin, cocoa, coffee, sugar, and wheat. Deciding on acceptable ranges for price
and output fluctuations has been difficult. Convincing countries to accept
production and export quotas has also been difficult, especially during periods
of falling market demand.

4. Many developing countries find that their economies are greatly tied to the
export of one commodity, such as tin. Since the price elasticities of supply and
demand of most commodities are low, modest changes in supply or demand can
exert large swings in commodity prices and export earnings.

5. During the 1960s oil was relatively abundant at the world level, which limited
OPEC's ability to raise oil prices. By the 1970s oil was perceived as being in
short supply. Following the Yom Kippur War in 1973, OPEC realized that
market conditions would support substantial increases in the price of oil.
Among the factors that contributed to the downfall of OPEC during the 1980s
were worldwide recession, oil conservation efforts of importing countries, and
increased oil supply by non-OPEC nations.

6. The purpose of a cartel is to restrict market output, thus driving up price and
profits; output restriction requires cartel members to sell no more than their

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quotas. An individual cartel member has the economic incentive to sell more
than its quota, thus becoming a cheater. But if all cartel members sell more than
their quotas, the cartel price will fall and profits will vanish.

7. Under the GSP program, industrial countries reduce tariffs on imports from
developing countries below the levels applied to imports from other industrial
countries.

8. Developing countries use import substitution policies to restrict the import of

manufacturers so that domestic producers can take over established markets.
Export promotion policies attempt to replace commodity exports with exports
of processed primary products, semi-manufacturers, and manufacturers.

9. East Asia’s growth strategy has emphasized high rates of investment combined
with high and increasing endowments of human capital due to universal primary
and secondary education. East Asia’s economies have followed a flying geese
pattern of growth in which countries gradually move up in technological
development by following in the pattern of countries ahead of them in the
development process. Moreover, industrial policies have attempted to support
selected sectors of East Asia’s economies. Economic growth for East Asia has
been export oriented.

10. Since the 1970s, China has abolished much of its centrally-planned economy
and allowed free enterprise to replace it. This move toward capitalism has
dramatically improved the productivity and export performance of the Chinese.
In the United States, there has existed pressure to use China’s normal-trade-
relation status as a lever to force China to improve in areas such as human
rights, trade, and weapons proliferation. Although China has moved away from
central planning, government intervention in its economy still remains strong.

Chapter 9
1. The General Agreements on Tariffs and Trade represent trade liberalization on a
nondiscriminatory basis. Participating nations acknowledge that tariff
reductions agreed to by any two nations will be extended to all other members.
Trade liberalization on a discriminatory basis occurs when nations form
preferential trading arrangements in which tariff reductions are limited to
member nations.

2. Economic integration refers to the process of eliminating restrictions on

international trade, payments, and factor mobility. The stages of economic
integration include free trade area, customs union, common market, economic
union, and monetary union.

3. The formation of a customs union results in static, or once-and-for-all, welfare

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effects. Included is a welfare-increasing trade creation effect and a welfare-

reducing trade diversion effect. A country's decision to participate in the
customs union depends on which of these effects is the most significant. Over
the long run, the formation of a customs union affects national welfare via
economies of scale, investment incentives, and the level of competition.

4. One major problem confronting the CAP is that agricultural efficiencies differ
among members of the European Community. This has led to internal disputes
over the level of support provided to member farmers. The export subsidies of
the CAP have also been criticized by nonmember countries.

5. Empirical studies suggest that the static welfare effects of the EU's formation
have generally been favorable for member countries. The benefits associated
with trade creation appear to offset the losses associated with trade diversion.

6. a. Germany exports gloves to Portugal. For Portugal, Qs = 4, Qd = 14,

Imports = 10.
b. Germany exports gloves to Portugal. For Portugal, Qs = 8, Qd = 10,
Imports = 2.
c. Trade creation effect = $2, trade diversion effect = $2. The overall
welfare of Portugal does not change.
d. Trade creating customs union. The welfare of Portugal rises by an
amount equal to the trade creation effect ($8); there is no trade
diversion effect since the customs union includes the world's lowest
cost producer.

Chapter 10
1. Vertical integration generally results in the establishment of foreign subsidiaries
that supply inputs going into the finished good. Horizontal integration occurs
when the parent firm sets up a subsidiary to produce an identical product
overseas. Conglomerate integration results in a firm's diversification into
nonrelated markets.

2. The manufacturing sector has dominated in both cases.

3. That rates of return on investments in developing countries exceed those on

investments in industrial countries in part reflects political risks and fears of
expropriation often associated with the developing countries.

4. Demand and cost factors tend to underlie a firm's decision to undergo direct
foreign investment.

5. There is no exact definition of a multinational enterprise. However, it is

generally recognized that multinational firms operate in more than one country,

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conduct research and development activities in addition to manufacturing, and

have stock ownership and management which is multinational in character.

6. The decision to undergo direct foreign investment or licensing is based on

several criteria: (1) import tariff structures; (2) the size of the foreign market in
relation to the firm's most efficient plant size; (3) comparative labor
productivities and wage levels; and (4) the amount of capital used in the
production process.

7. As a source of conflict, multinational enterprises involve issues pertaining to

employment, national sovereignty, the balance of payments, and taxation.

8. The traditional trade model involves the movement of finished products among
nations, while multinational enterprise analysis stresses movements of factor
inputs. Both models are based on the principle of comparative advantage.

9. A joint venture leads to welfare gains when the newly established firm adds to
productive capacity and fosters competition, enters markets that the parent firms
could not enter, and yields cost reductions unavailable to the parent firms.
Welfare losses occur if the formation of a joint venture results in greater
amounts of market power so that output is restricted and price is raised.

10. In response to higher U.S. wage rates, labor migration from Mexico to the
United States results in a reduction in the Mexican labor supply and an increase
in the U.S. labor supply. Wage rates tend to rise in Mexico and fall in the
United States until they equalize. The labor migration hurts native U.S.
workers, but helps U.S. owners of capital; the opposite occurs in Mexico. Since
migrant workers flow from uses of lower productivity to higher productivity, the
world's output potential expands.

11. a. P = $4, Q = 5, consumer surplus = $12.50, profit = $0.

b. Q = 3, P = $6, profit = $6, deadweight loss of consumer surplus = $2.
c. Welfare gain of $4. Welfare loss of $2. Welfare gain of $4.

12. a. Wage = $6, payments to native American workers = $12, payments to

U.S. capital owners = $2.
b. Wages = $4, payments to native American workers = $8, payments to
U.S. capital owners = $8.
c. U.S. capital owners gain from the labor immigration. Native U.S.
workers resist labor immigration.

Chapter 11
1. The balance of payments is a record of the monetary transactions between
residents of one country and the rest of the world that occur over the course of a

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one-year period.

2. The receipt of dollars from foreigners results from the following transactions:
(1) merchandise exports, (2) transportation-travel receipts, (3) income received
from foreign investments abroad, (4) gifts received from foreign residents, (5)
aid received from foreign governments, and (6) investments in the U.S. by
overseas residents. The payment of dollars to foreigners would suggest the
opposite for the above transactions.

3. Because the balance-of-payments statement utilizes a double-entry booking

system, in which each credit entry is balanced by a debit entry, the overall
balance of payments must numerically balance.

4. Balance-of-payments transactions are grouped into two categories: (1) the

current account which refers to the monetary value of international flows
associated with flows in goods, services, income, and unilateral transfers; and
(2) the capital account which includes all international purchases and sales of
assets.

5. Official reserve assets consist of gold, Special Drawing Rights, reserve

positions in the International Monetary Fund, and convertible currencies.

6. A merchandise trade surplus suggests that the home country is a net exporter of
merchandise. A goods and services surplus suggests that the home country
transfers more real resources (goods and services) to other countries than it
receives from them. A current account surplus means an excess of exports over
imports of goods, services, income, and unilateral transfers.

7. If the surplus balance on the service account exceeds the deficit balance on the
merchandise (goods) account, the goods and services balance will be in surplus.

8. The balance of international indebtedness indicates the international investment

position of a country at one moment in time. The balance of payments indicates
all of the international monetary transactions of a country over a one-year
period.

9. a-debit; b-credit; c-credit; d-debit; e-debit; f-debit; g-credit; h-debit; i-debit.

10. a. Merchandise trade balance, $75 billion deficit. Services

balance, $60 billion surplus. Goods and services balance, $15 billion
deficit. Investment income balance, $5 billion surplus. Unilateral
transfers balance, $20 billion deficit. Current account balance, $30
billion deficit.
b. Current account. The current account deficit implies that the United

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States is a net-demander of funds from the rest of the world.

11. Net debtor nation of the amount $25 billion.

Chapter 12
1. The foreign exchange market refers to the organizational setting within which
individuals, firms, and banks buy and sell foreign currencies. The two largest
foreign exchange markets are located in New York and London.

2. The spot market permits the buying and selling of foreign exchange for
immediate delivery. Future contracts are made by those who will make or
receive foreign exchange payments in the weeks or months ahead.

3. The supply and demand for foreign exchange is derived from the credit (debit)
items on the balance of payments, such as exports or investment flows.

4. Exchange-rate quotations throughout the world are brought into harmony via
exchange arbitrage.

5. Traders and investors often participate in the forward market to protect their
expected profits from the risk of exchange rate fluctuations. Speculators also
participate in the forward market.

6. The relation between the spot rate and the forward rate is maintained via the
process of covered interest arbitrage.

7. Exchange market speculators deliberately assume foreign exchange risk with

the hope of profiting from exchange rate fluctuations over time. Most
speculation is conducted in the forward market.

8. Stabilizing speculation refers to the purchase of a foreign currency with the

domestic currency when there occurs a fall in the foreign exchange rate. The
anticipation is that the exchange rate will soon rise and thus generate a profit.
Stabilizing speculation moderates a fall (rise) in the exchange rate.
Destabilizing speculation reinforces fluctuations in exchange rates.

9. The dollar appreciates against the pound; the pound depreciates against the
dollar. The dollar depreciates against the pound; the pound appreciates against
the dollar.

10. Arbitragers will buy pounds in New York, at $1.69 per pound, and sell pounds
in London, at $1.71 per pound, thus making a profit of 2 cents on each pound.
As pounds are bought in New York, their prices rises; as pounds are sold in
London, their price falls. When the dollar price of the pound equalizes in the

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financial centers, the profitability of arbitrage ceases and the practice stops.

11. a. $1.50 per pound. 30 pounds are purchased at a cost of $45.

b. Excess supply, 20 pounds. Dollar price of the pound decreases, decrease,
increase.
c. Excess demand, 20 pounds. Dollar price of the pound increases,
increase, decrease.

12. a. The U.S. importer can cover her foreign exchange risk by purchasing
20,000 pounds for three-month delivery at today's three-month forward
rate of $1.75 per pound. The importer is willing to pay 5 cents more
per pound (or $1000 more for the 20,000 pounds) than today's spot rate
to guard against the possibility that the spot rate in three months will
exceed $1.70 per pound. In three months, when her payments are due,
the importer will pay $35,000 and get the 20,000 pounds needed for
payment, irrespective of what the pound's spot rate is at that time.
b. If the spot rate of the pound in three months is $1.80 per pound, and
the U.S. importer does not obtain forward cover, she must pay $36,000
for the 20,000 pounds; this amount exceeds by $1000 the cost of the
pounds she incurs by hedging.

13. a. The U.S. investor would purchase pounds on the spot market at $2 per
pound, and use the pounds to buy U.K. treasury bills in London; he
would earn 4 percent per annum (1 percent per three months) more
than he would if he had purchased U.S. treasury bills in New York.
b. Yes, by 0.5 percent.

14. a. 1.7090, 1.7105, 1.7084, 1.7099, 1.7081, 1.7096, 1.7090, 1.7103.

b. $0.5851 per franc, $1.7090 francs per dollar.
c. Depreciated, appreciated.
d. $58.51, 170.9 francs.
e. The 30-day forward franc was at a premium of $.0002 which equals
0.4 percent on an annual basis. The 90-day forward franc was at a
premium of $.0003 which equals 0.2 percent on an annual basis.

15. a. The U.S. speculator should sell francs today for delivery in 6 months at
today's forward rate of the franc, which equals $0.50.
b. After 6 months, if the franc's spot rate is $0.40, the speculator can
purchase francs at the price of $0.40 each and deliver them for the
previously contracted rate of $0.50 per franc; the speculator realizes a
profit of $0.10 on each franc which the forward contract specifies. If
the franc's spot rate after 6 months is $0.60, the speculator must
purchase francs at a price of $0.60 per franc and resell them at a price
of $0.50 per franc; the speculator would suffer losses of $0.10 on each

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franc specified in the forward contract. If the franc's spot rate after 6
months is $0.50, the speculator realizes neither a profit nor a loss on
the transaction.

16. An arbitrager could purchase 3 francs for $1, purchase 6 schilling with 3 francs,
and sell 6 schilling for $1.50. Ignoring transaction costs, the arbitrager realizes
a $0.50 profit on the transactions.

Chapter 13
1. Market fundamentals and market expectations. Long run exchange rates are
best explained by factors including real income differentials, inflation rate
differentials, productivity changes, and the like. In the short run, exchange rates
respond to real interest rate differentials, news about market fundamentals, and
speculative opinion about future exchange rates.

2. The nominal interest rate refers to the interest rate, unadjusted for inflation. The
real interest rate equals the nominal interest rate minus the inflation rate.
International investors are especially concerned about the real interest rate.

3. The purchasing-power-parity theory predicts that a country's currency will

depreciate by an amount equal to the excess of domestic inflation over foreign
inflation. The theory also predicts that a country's exchange rate will appreciate
by an amount equal to the excess of foreign inflation over domestic inflation.
The theory does not consider the impact of international capital movements, and
it suffers from the choice of an appropriate price index used in price
calculations.

4. An overvalued currency tends to lead to a balance-of-payments deficit for the

home country, while an undervalued currency leads to a balance-of-payments
surplus.

5. The monetary approach to exchange-rate determination views exchange rates as

determined by changes in the supplies and demands of national currencies. The
monetary approach suggests that an increase in the domestic money supply
causes the home currency's exchange rate to depreciate, and vice versa. It also
maintains that an increase in the domestic demand for money leads to an
appreciation in the home country's exchange rate.

6. The asset-markets approach contends that stock adjustments among financial

assets are a key determinant of exchange-rate movements. This approach is
thus a broader or more comprehensive approach than the monetary approach,
which emphasizes national currencies.

7. The dollar's exchange rate will:

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a. Depreciate
b. Appreciate
c. Appreciate, depreciate
d. Appreciate
e. Depreciate
f. Depreciate
g. Appreciate

8. An exchange rate is said to overshoot when its short-run response

(depreciation/appreciation) to a change in market fundamentals is greater than
its long-run response. Exchange rate overshooting occurs because exchange
rates tend to be more flexible than other prices; exchange rates often
depreciate/appreciate more in the short run than in the long run so as to
compensate for other prices that are slower to adjust to their long-run
equilibrium levels.

9. Currency forecasters generally use one of three methods to predict future

exchange rates: (1) judgmental analysis, (2) technical analysis, or (c)
fundamental analysis.

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10. Supply of Demand for Exchange rate

Pounds Pounds ($ Per Pound)

a. -------- decrease decrease

b. decrease increase increase
c. increase decrease decrease
d. -------- decrease decrease
e. -------- increase increase
f. increase decrease decrease
g. -------- decrease decrease
h. -------- increase increase
i. increase decrease decrease
j. increase -------- decrease
k. -------- -------- --------

11. a. False
b. True
c. True
d. True

12. More expensive, less expensive, increased, decreased

13. a. Dollar depreciates by 10 percent, to approximately $0.55 per franc.

b. Dollar appreciates by 10 percent, to approximately $0.45 per franc.
c. Dollar appreciates by 15 percent, to approximately $0.43 per franc.
d. Dollar depreciates by 5 percent, to approximately $0.53 per franc.

14. a. -2 percent in the U.S., 2 percent in the U.K.

b. Investment would flow from the U.S. to the U.K.
c. The dollar would depreciate against the pound.

Chapter 14
1. Balance-of-payments adjustment concerns the return to payments equilibrium
after the initial equilibrium has been disrupted. Deficit countries face
adjustment incentives due to limited quantities of international reserves and
limited willingness of trading partners to lend to the deficit country. Once a
surplus country believes its stocks of international reserves or overseas
investments to be adequate, it generally is reluctant to run prolonged surpluses.

2. Automatic balance-of-payments adjustments consist of changes in domestic

prices, interest rates, and income. The impact of money on the balance of
payments is also considered an automatic adjustment mechanism.

3. The quantity theory of money is a theory based on the equation of exchange that

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hypothesizes that a change in the money supply will cause a proportional

change in the price level. Under the classical gold standard, a nation with a
payments surplus would experience gold inflows and an increase in its money
supply. This leads to an increase in domestic prices, a worsening of the
country's competitive position, a decline in exports, and a rise in imports. The
opposite sequence of events applies to a deficit country.

4. Changes in interest rates promote balance-of-payments adjustments via their

impact on short-term capital movements.

5. The so-called rules of the game resulted in central bankers agreeing to reinforce
and speed up the automatic balance-of-payments adjustment mechanism that
existed under the gold standard. In practice, they were not closely adhered to
during the gold standard era.

6. The income adjustment mechanism suggests that a nation with a payments

surplus would face rising income levels and increased imports, thus tending to
eliminate the payments surplus. The opposite applies to a deficit nation.

7. The foreign repercussion effect suggests that in a two-country world, a change

in the level of trade of Country 1 affects the level of income of Country 2. This
in turn affects the level of trade and income of Country 1.

8. A main problem of the automatic adjustment mechanisms is that a country must

be willing to accept domestic inflation or recession when balance-of-payments
adjustment requires it.

9. The monetary approach suggests that economic policy affects the balance of
payments through its impact on the domestic demand for, and supply of, money.
A policy that increases the supply (demand) of money relative to the demand
(supply) for money will lead to a payments deficit (surplus).

10. The monetary approach suggests that a nation's central bank can influence the
balance of payments through changes in the money supply. However,
nonmonetary policies (such as tariffs) are unnecessary since balance-of-
payments disequilibrium is self correcting.

Chapter 15
1. Currency devaluation affects a country's trade balance via its impact on relative
prices (elasticity approach), spending behavior (absorption approach), and the
purchasing power of money balances (monetary approach).

2. See Question 1.

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3. The Marshall-Lerner condition refers to the elasticities approach to devaluation.

It suggests that devaluation works best at improving a country's trade balance
when demand elasticities are high (i.e., the sum of the domestic demand
elasticity for imports plus the foreign demand elasticity for exports exceeds
one). Empirical studies suggest that demand elasticity for most countries are
quite high.

4. The J-curve effect implies that due to time lags between the response of goods
traded to relative price changes (e.g., recognition lags), currency devaluation
will have a more pronounced effect on a country's trade balance over the longer
run.

5. The extent to which changing currency values lead to changes in import and
export prices is known as the pass-through relationship. Pass-through is
important since buyers have incentives to alter their purchases of foreign goods
only to the extent that the prices of these goods change in terms of their
domestic currency following a change in the exchange rate.

6. The absorption approach concludes that currency devaluation best improves the
trade balance when the country faces a trade deficit along with domestic
unemployment.

7. The monetary approach suggests currency devaluation affects the domestic

price level and the purchasing power of money balances, which lead to changes
in domestic expenditures and the level of imports.

8. The 50 percent dollar appreciation results in a 50 percent increase in the firm's

production cost in terms of the peso.

9. The 50 percent dollar appreciation results in a less-than 50 percent increase in

the firm's production cost in terms of the peso.

10. a. Export quantity 1000, 1300, 1030

Import quantity 150, 120, 147
Export price $3000, $3000, $3000
Export receipts $3 million, $3.9 million, and $3.09 million
Import price $20,000, $22,000, $22,000
Import payments $3 million, $2.64 million, $3.234 million
Trade balance $0, $1.26 million, -$144,000

b. The dollar depreciation improves (worsens) the U.S. trade balance

when the sum of the export-demand elasticity and the import-demand
elasticity are greater (less) than 1.0.

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c. Because the sum of the export-demand elasticity and the import-

demand elasticity are less than 1.0, the U.S. trade balance will worsen.

Chapter 16
1. The choice of floating exchange rates versus pegged exchange rates relates to
the economic and political characteristics of nations. For example, small
nations, who’s financial and trade relationships are mainly with a single trading
partner, often choose to adopt pegged rates. Large countries with large and
diversified economies often prefer floating rates.

2. Managed floating exchange rates utilize the philosophy of "leaning against the
wind," in which exchange market intervention is conducted so as to reduce
short-term fluctuations in exchange rates without attempting to adhere to any
particular rate over the long run.

3. Currency boards and dollarization are seen as methods of stabilizing exchange

rates of developing countries. With a currency board, a monetary authority
issues notes and coins convertible into a foreign currency at a fixed exchange
rate. With dollarization, a monetary authority use the dollar alongside or instead
of their own currency.

4. The adjustable-pegged exchange rate system attempted to provide essentially

fixed exchange rates for international transactions. When the balance of
payments moved away from its long-run equilibrium position, a country could
devalue or revalue its currency so as to restore payments balance.

5. Nations sometimes use crawling pegged exchange rates so as to make small but
frequent exchange rate adjustments promoting payments balance.

6. Exchange controls, including the rationing of foreign exchange among domestic

importers, are sometimes used to help a nation gain control over its balance-of-
payments position.

7. Dual exchange rates apply pegged exchange rates to commercial transactions

and floating rates to financial transactions.

8. Small countries with several major trading partners often peg their exchange
rates to a basket of currencies of these trading partners so as to reduce the
impact of exchange fluctuations on the domestic economy.

9. The SDR is a currency basket composed of the currencies of the five IMF
countries having the largest shares of world exports. The basket valuation
technique allows the SDR's value to be more stable than the value of any single
national currency. Small nations desiring exchange rate stability often peg their

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currency to the SDR.

10. Proponents of floating exchange rates emphasize the following points: (a)
simplicity, (b) continuous adjustment, (c) independent economic policies, (d)
increased effectiveness of monetary policy, (e) reduction in the need for
international reserves. Critics of floating exchange rates emphasize the
following points: (a) world demand elasticities for traded goods, (b) disorderly
exchange markets, (c) reckless financial policies.

11. Central bankers attempt to stabilize exchange rates via the purchase/sales of
currencies and via monetary policy.

12. To bring about currency depreciation and an improvement in a country's trade

balance.

Chapter 17
1. Internal balance consists of full employment with price stability. External
balance consists of balance-of-payments equilibrium. Overall balance consists
of internal balance plus external balance.

2. International economic policy makes use of expenditure-switching instruments

(e.g., import tariffs) and expenditure-changing instruments (e.g., monetary
policy).

3. An expenditure-changing policy refers to a government’s attempt to induce

changes in aggregate demand, via fiscal policy (e.g., taxes, government
expenditures) or monetary policy (e.g., open market operations, reserve
requirements). An expenditure-switching policy attempts to divert expenditures
away from foreign goods to domestic goods. Currency devaluation and import
barriers are examples of expenditure-switching policies.

4. International economic policy formation faces political constraints such as

society’s willingness to bear inflation or unemployment as part of the balance-
of-payments adjustment process.

5. Currency devaluation (depreciation). Currency revaluation (appreciation).

6. Under a fixed exchange rate system, fiscal policy is successful in promoting

internal balance while monetary policy is unsuccessful.

7. Under a floating exchange rate system, monetary policy is successful in

promoting internal balance while fiscal policy is unsuccessful.

8. An expansionary monetary policy leads to a worsening in the home-country’s

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trade account and capital account, and thus deterioration in the overall balance-
of-payments position. A concretionary monetary policy leads to an
improvement in the home-country’s trade account and capital account, and thus
an improvement in the overall balance-of-payments position.

9. An expansionary fiscal policy improves the nation’s balance-of-payments

position if the resulting net-capital inflows more than offset the resulting trade-
account deficit; if the trade-account deficit more than offsets the net-capital
inflows, the overall balance-of-payments position deteriorates.

10. Policy agreement occurs when a given policy can improve two (or more)
economic objectives at the same time. Policy conflict occurs when a given
policy improves one objective while detracting from another objective; a
dilemma thus exists concerning which objective to pursue.

11. Unemployment-with-BOP-surplus, policy agreement. Inflation-with-BOP-

deficit, policy agreement. Unemployment-with-BOP-deficit, policy conflict.
Inflation-with-BOP-surplus, policy conflict.

12. Examples of obstacles to successful international economic policy coordination

include: (1) different national economic objectives, (2) different national
institutions, (3) different national political climates, (4) different phases in the
business cycle, and (5) lack of guarantee that governments can design and
implement policies that are capable of achieving the intended results.

Chapter 18
1. Similar to a householder’s desire for cash balances, nations require international
reserves to bridge the gap between monetary receipts and payments. Deficit
nations require international reserves to finance their payments disequilibrium.

2. A country’s demand for international reserves depends on the monetary value of

international transactions as well as the size and duration of payments
disequilibrium.

3. Owned reserves include monetary gold stocks, foreign currencies, and special
drawing rights. Borrowed reserves include IMF drawings, swap arrangements,
compensatory export financing, oil facility, and buffer stock facility.
4. Foreign currencies constitute the most important component of the world’s
international reserves while special drawing rights constitute the least important
component.

5. A reserve currency, such as the U.S. dollar or British pound, is a currency that
trading nations are willing to hold along with other international reserve assets,
such as gold.

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6. Since 1975 gold has been demonetized. Today, gold is considered a commodity
by the International Monetary Fund.

7. One drawback of a pure gold standard is that gold stocks might not grow as
rapidly as international trade. A gold-exchange standard attempts to economize
on gold as an international reserve by including key currencies (i.e., the U.S.
dollar) as an international reserve.

8. Special drawing rights are unconditional rights to draw currencies of other

countries. They were created by the IMF to supplement the other forms of
international reserve assets. The SDR’s value is determined by the basket
valuation technique.

9. See Question 3.

10. The international debt problem of the 1980s referred to the inability of some
developing countries to pay back loans to Western commercial banks. The debt
problem was intensified by factors including world recession, high interest
rates, and the appreciation of the U.S. dollar.

11. A Eurocurrency is a deposit, denominated and payable in dollars and other

foreign currencies, in banks outside the United States. Dollar deposits located
in banks outside the United States are known as Eurodollars.

12. When making international loans, bankers face the following risks: (a) credit
risk, (b) country risk, and (c) currency risk.

13. A country’s debt-to-export ratio is the ratio of external debt to exports of goods
and services. Changes in this ratio indicate whether a country’s debt burden is
rising or falling relative to its ability to pay. The debt service ratio refers to the
scheduled interest and principal payments as a percent of export earnings.

14. A country facing debt servicing problems has several options: (a) cease
repayment on its debt, (b) service the debt at all cost, or (c) reschedule the debt.

15. Banks can reduce their exposure to developing country debt via several
methods: (a) outright loan sales, (b) debt buybacks, (c) debt-for-debt swaps, or
(d) debt/equity swaps.

16. Debt equity swaps involve commercial banks selling their foreign loans to the
foreign government for foreign currency which is then used to finance an equity
investment in the foreign country. The equity investment is assumed to be a
safer investment than the original loans made to the foreign borrower.

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