ECO 358 Section 1Professor Malamud

International EconomicsAugust 5, 2004

Classroom Exam # 2

You can rewrite one question at home after the exam is returned to you. If you choose to rewrite a question, you must rewrite ALL of the question, even parts that you got a perfect score on in class. Rewrites are graded to a higher standard than answers written in class! The exact same answer may earn fewer points on the rewrite than on the exam taken in class. Your score for the exam is the average of your classroom score and your rewrite score. Rewrites are due on August 11. You must submit your classroom exam together with your rewrite so your scores can be averaged.

Question I (60 points)

In this question, you are asked to contrast import substitution industrialization and export-led growth strategies for economic development. (60 points, 5 points each part)

  1. Countries that adopted an ISI strategy often did so to escape the “primary goods trap.”
  2. What short-run problem does a country that exports primary goods face? Explain why.
  3. What possible long-run problem does a country that exports primary goods face? Explain why.
  4. What is tariff escalation and how does it reinforce the primary good trap?
  5. Apart from tariff escalation, what other US and EU policies negatively impact the economies of less developed agricultural economies? Describe the impacts of these policies.
  6. Consider ISI as championed by the United Nations in the 1950s and 1960s.
  7. In what part of the world was ISI most prominent?
  8. What advantages did countries hope to gain from ISI?
  9. Why was ISI ultimately a disappointment?
  10. Many of the disadvantages of ISI were apparent by the 1970s. Why did ISI policies survive through the 1970s and what forced their abandonment in the 1980s?
  11. How can membership in a regional trading bloc like the European Economic Community (EEC) or MERCOSUR (the Common Market of Southern Cone nations – Argentina, Brazil, Paraguay, and Uruguay) promote economic efficiency and development? What is trade diversion? is it a benefit or drawback of regional trading blocs?
  12. Now consider export-led growth as championed by the Washington Consensus.
  13. In what part of the world has export-led growth been most prominent and successful?
  14. What is the flying geese pattern of economic development and what does successful pursuit of this strategy depend on?
  15. The Washington Consensus champions trade liberalization and export-led growth. What else does the Washington Consensus prescribe for developing countries?

Question II (40 points, 5 points each part)

  1. In this question, you are asked to consider advantages and disadvantages of a currency union.
  2. What advantages does a country realize when it joins a currency union?
  3. What are the disadvantages of being a member of a currency union?
  4. Why are interest rates in Italy essentially the same as interest rates everywhere else in the EMU? (Refer to interest rate parity in your answer).
  5. The following parts of Question II deal with the evolution of the US current account balance since the end of World War II.
  6. Describe the evolution of the US merchandise trade balance since the end of WWII. Explain the major changes.
  7. The US balance on services has consistently been positive. What is included in the service balance?
  8. Describe the evolution of net US income on investments abroad since the end of WWII. Explain the major changes.
  9. A large and persistent current account deficit is not a sign of US economic weakness; it is even a sign of US economic strength. Explain why.
  10. A large and persistent current account deficit poses grave threats to the US and world economies. Explain why.

Question III

  1. This Monday, the euro’s spot price was $1.2050/Є while its 6-month forward price was $1.2034/Є. Why would a bank be willing to sell you euros at a lower price six months from now than you would have to pay on the spot market today? (10 points)
  2. Suppose that you have $1 million. Just suppose. One-year interest rates on British government bonds are 5%; one-year interest rates on comparable US government bonds are 4%. You expect the dollar to depreciate by 4% against the pound over the next year. What should you do with your money? Explain. How much do you expect to earn (show your calculation and express your answer as a percent of the number of dollars you start with)? (10 points)
  3. Suppose an automobile air conditioner, an intermediate input into auto production, sells for 6,000 pesos in Mexico while an identical air conditioner sells for $600 in the United States. If the exchange rate between the peso and the dollar is 12 pesos per dollar, does the law of one price hold? (Show your calculation). If not, what adjustments would you expect in the peso and dollar prices of auto air conditioners? How would these adjustments come about? How would your answer differ if the item in question were the price of having a car washed, say 6 pesos vs. $6, rather than the price of an air conditioner? (10 points)
  4. Explain how the following factors affect the dollar’s exchange rate under a system of floating exchange rates. Indicate whether the dollar will appreciate or depreciate and explain why. (5 points each part)
  5. a rise in the foreign price level, with the US price level held constant.
  6. tariffs placed on US goods by foreign countries
  7. increased demands by foreigners for US financial and consulting services
  8. fear of terrorist strikes against US banks.