Econ 165: International Economics Professor: Doireann FitzgeraldOffice: Room 335, Economics DepartmentOffice Hours: Wednesdays 9 am – 11 amE-­mail: dfitzger at stanford.edu (please put Econ 165 in the subject line) TA: Todd Schoellman, azyndros at stanford.edu Course description:The aim of this class is to give students the tools necessary to read critically and understand discussions ofinternational trade and macroeconomic policy found in popular media such as The Economist magazine, theWall Street Journal and the Financial Times. The course is organized around several questions of currentinterest to policy makers, business leaders and the general public. It covers selected basic models ininternational trade and international macroeconomics relevant to these questions. Recent research on theempirical and practical relevance of these models is also discussed. Prerequisites:Econ 50, 51, 52. Course schedule and location: Monday, Wednesday, 1.15pm – 3.05pm in Econ 140.Final exam: Friday December 15th, 8.30am – 11.30am. If you cannot make this time, donot take this class. Assessment:There will be five problem sets (20%) two midterms (20% each) and a final exam(40%). In marginal cases, class participation will be taken into account. Readings:The main textbook for the class is International Economics: Theory and Policy, 7thedition, by Krugman and Obstfeld (K&O). Additional required readings will be posted onthe class webpage. Some recommended readings will be taken from Pop Internationalismby Paul Krugman, Free Trade Under Fire (2nd edition) by Douglas Irwin andFoundations of International Macroeconomics, by Maurice Obstfeld and Kenneth Rogoff(O&R). These texts are on reserve at the library. Other recommended readings andresources will be made available through links on the class webpage. Discussions:Where noted, the last 15 minutes of class will be devoted to general discussion of a settopic of current interest. If you do no other reading, at least do the readings to preparefor these discussions! I will call on students at random to participate in the discussion(cold calling). What you say in the discussion will not affect your grade. Unexplainedabsences, however, may count against you. Webpage: Available through http://coursework.stanford.eduFrequently asked questionsHow much math is used in this course?

Familiarity with basic calculus is assumed. No accommodation will be made for studentsthat do not have this familiarity.

How much reading should I do?

Required readings have been kept to a minimum. Discussion readings are also required,and should be done before the class for which they are assigned. If you are particularlyinterested in a topic, you are invited to explore the recommended readings. Do I have to go to section?

Section is compulsory. Attendance will be taken. Where indicated, the TA will cover new material. The TAwill also go through the solutions to the previous problem set, and discuss any questions you have onproblem sets, readings or lectures. Can my friends and I work together on the problem sets?

Yes. The problem sets are intended to be learning experiences, so feel free to work in groups. However youmay find it useful to attempt the problems on your own before working with others. Each student mustsubmit their own problem set solutions. Doing the problem sets is the best way to prepare for the exams. Ifyou copy another student’s answers without understanding the material, your exam performance will suffer. How are the problem sets graded?

The problem sets are graded on a scale of check plus, check, check minus and zero (if no problem set ishanded in). Legibility is important. Typewritten problem sets are much appreciated. Where appropriate,graphs (drawn by hand) are very useful. Can I turn a problem set in late?

No. Problem sets turned in after the deadline (12 noon) will not be graded. What if I cannot take one of the midterms?

There will be no make up exams. You should contact me in advance if you cannot make a midterm. What material will be covered on the midterms?

The first midterm will cover the material from the first part of the quarter. The second midterm will coveronly the material from the second part of the quarter. What do I do if a mistake was made in grading my midterm?

After a midterm is returned, you will have one week to contact your TA with problems or concerns.Beyond this deadline, no complaints will be entertained. What material will be covered on the final?

The final will cover material from the entire quarter, weighted towards the final part.

Week 1 Lecture 1: Monday 25th September 2006 Topic: Introduction

1. What is international economics?2. Motivating facts and questions3. Review of budget sets, utility maximization and demand.

Key concepts: Diminishing marginal rate of substitution;; Relative demandRequired reading:

K&O Chapter 2

Class notesPaul Krugman: “What do Undergrads Need to Know about Trade?,” American Economic ReviewPapers and Proceedings, May 1993, p. 23-­26 (also in Pop Internationalism)

Recommended reading:Hal Varian: Intermediate Microeconomics 7th edition, Chapters 2-­6 (or similar material in analternative intermediate micro textbook).Douglas Irwin: Free Trade Under Fire, Chapter 1.

Lecture 2: Wednesday 27th September 2006 Topic: Endowment economies I

1. Aggregation over consumers – some useful results with homothetic preferences2. Free trade vs autarky in a 2-­good small open endowment economy3. A 2-­country 2-­good endowment world

Key concepts: Homothetic preferences;; Terms of trade;; Perfect competition;; Small open economy;; Gainsfrom trade;; Comparative advantageRequired reading:

Class notesRecommended reading:

Hal Varian: Intermediate Microeconomics 7th edition, Chapters 2-­6 and 31 (or similar material in analternative intermediate micro textbook).Alan Deardorff: “Benefits and Costs of Following Comparative Advantage,” 1998.

Section: No section this week

Week 2 Lecture 3: Monday 2nd October 2006 Topic: Endowment economies II

1. Analysis of gains from trade using the Edgeworth Box2. Evidence on trade liberalization and relative prices from Japan and the US3. The redistributive effects of trade4. Introduction to economies with production

Key concepts: Pareto efficiency;; Contract curveRequired reading:

Class notesRecommended reading:

Douglas Irwin (2005), “The Welfare Cost of Autarky: Evidence from the Jeffersonian TradeEmbargo,” Review of International Economics 13 (4) 631-­645.Daniel Bernhofen and John Brown (2004), “A Direct Test of the Theory of ComparativeAdvantage: The Case of Japan,” Journal of Political Economy 112 (1) 48-­67.Hal Varian: Intermediate Microeconomics 7th edition, Chapters 31 and 32 (or similar material in analternative intermediate micro textbook).

Discussion topic: Should trade policy be used as a tool for domestic redistribution?Discussion reading:

White House statement: President announces temporary safeguards for steel industryThe Economist: “Just Say No”

Lecture 4: Wednesday 4th October 2006 – First problem set due Topic: The standard trade model (introducing production)

1. Economies with production2. The effect of terms-­of-­trade changes in the short and long run3. Evidence on trade liberalization, shifts in production and welfare4. What explains changes in the terms-­of-­trade

Key concepts: Production possibility frontier;; Immiserizing growthRequired reading:

K&O Chapter 5Recommended reading:

Hal Varian: Intermediate Microeconomics 7th edition, Chapter 32Douglas Irwin: Free Trade Under Fire, Chapters 2 and 3.

Section: Trade policyReading: Robert Baldwin (1989), “The Political Economy of Trade Policy,” Journal of EconomicPerspectives 3 (4), 119-­135.

Week 3 Lecture 5: Monday 9th October 2006 Topic: Ricardo I

1. Introduction to technology and production2. 2-­good small open Ricardian economy3. 2-­good 2-­country Ricardian world

Key concepts: Factors of production;; Production function;; Marginal rate of transformation;; Constantreturns to scale;; Unit input requirements;; Relative supply;; Absolute advantageRequired reading:

K&O Chapter 3, pages 24-­39Paul Krugman: “Ricardo’s Difficult Idea,”

Discussion topic: Does China’s growth hurt the US?Discussion reading:

Martin Wolf in the Financial Times on the costs and benefits of globalizationPaul Krugman: “Does Third World Growth Hurt First World Prosperity?” Harvard Business Review,July-­August 1994 (in Pop Internationalism)

Lecture 6: Wednesday 11th October 2006 – Second problem set due Topic: Ricardo II

1. Gains from trade in the 2-­good 2-­country model2. Wages in the 2-­good 2-­country model3. Sketch of a more general model4. Evidence on the Ricardian view of the world5. What the Ricardian model cannot explain

Key concepts: Derived demandRequired reading:

K&O Chapter 3, pages 40-­47Recommended reading:

Bela Belassa (1963), “An Empirical Demonstration of Classical Comparative Cost Theory,” Reviewof Economics and Statistics 45 (3), 231-­238.

Section: Review for first midterm

Week 4 Lecture 7: Monday 16th October 2006 Topic: Specific factors model

1. More about production2. Autarky in the specific factors model3. A small open econonomy with specific factors4. Distribution of gains from trade5. Application: the trade and wages debate6. Political economy of trade policy

Key concepts: Marginal product;; Diminishing marginal productRequired reading:

Class notesRecommended reading:

Hal Varian: Intermediate Microeconomics 7th edition, Chapter 18Discussion topic: Are sweatshops good for workers in developing countries?Discussion reading:

Paul Krugman: “In Praise of Cheap Labor,” Slate, March 1997.Nicholas Kristof in the NYT (you can find this through Lexis-­Nexis if you don’t have a New YorkTimes subscription)

Lecture 8: Wednesday 18th October 2006 First midterm exam (1 hour) Topic: Increasing-­returns-­driven specialization I

1. Motivation: Evidence on intra-­industry trade, trade between similar countries2. What are increasing returns/ economies of scale?

Key concepts: Imperfect competition;; Differentiated products;; Increasing returns to scaleRequired reading:

K&O Chapter 6, pages 110-­113Recommended reading:

Hal Varian: Intermediate Microeconomics 7th edition, Chapter 18 Section: Immigration and inequality in the USReading: The Economist: “Myths and Migration”

Week 5 Lecture 9: Monday 23rd October 2006 Topic: Increasing-­returns-­driven specialization II

1. Imperfect competition – monopoly2. Imperfect competition – monopolistic competition

3. Gains from tradeKey concepts: Profit maximization;; Pure monopoly;; Monopolistic competition;; Fixed costs;; Markups;; FreeentryRequired reading:

K&O Chapter 6, pages 110-­130Recommended reading:

Paul Krugman “Talking About a Revolution”Hal Varian: Intermediate Microeconomics 7th edition, Chapter 24

Lecture 10: Wednesday 25th October 2006 Topic: Increasing returns III;; Trade and development

1. Evidence on trade liberalization and variety2. External economies and the agglomeration of economic activity3. Infant industry protection – theory and evidence4. The evidence on trade liberalization, trade and growth

Key concepts: External economies;; Path dependenceRequired reading:

K-­O, Chapter 6, pages 136-­143 and Chapter 10Recommended reading:

Douglas Irwin: Free Trade Under Fire, Chapter 6Pete Klenow and Andres Rodriguez-­Clare “Quantifying Variety Gains from Trade Liberalization”Douglas Irwin (2000), “Did Late Nineteenth-­Century US Tariffs Promote Infant Industries?Evidence from the Tinplate Industry,” Journal of Economic History 60, 335-­360Jeffrey A. Frankel and David Romer, “Does Trade Cause Growth?” American Economic Review,June 1999, pp. 379-­399.Pinelope Goldberg and Nina Pavcnik, “Distributional Effects of Trade Liberalization in PoorCountries”

Discussion: Should developing countries embrace free trade?Discussion reading:

David Dollar and Aart Kraay, “Spreading the Wealth,” Foreign Affairs, Jan-­Feb 2002.· Dani Rodrik, “Globalization for Whom?” Harvard Magazine, Jul-­Aug 2002.· The Economist, “More or Less Equal?”

Section: Review of national income accounting in an open economyReading: Greg Mankiw: Macroeconomics 5th edition, Chapter 5, Sections 1 and 2

Week 6 Lecture 11: Monday 30th October 2006 – Third problem set due Topic: Intertemporal trade I

1. A small 2-­period endowment economy2. The role of government consumption3. Adding investment to the model

Key concepts: Intertemporal preferences;; Discount factor;; Interest rate;; Trade balance;; Current accountRequired reading:

K&O Chapter 12Class notes

Recommended reading:

O&R Chapter 1, Sections 1 and 2Hal Varian: Intermediate Microeconomics 7th edition, Chapter 10

Lecture 12: Wednesday 1st November 2006 Topic: Intertemporal trade II

1. More on the small 2-­period economy with investment2. A 2-­region world economy

Key concepts: Elasticity of intertemporal substitutionRequired reading:

Class notesRecommended reading:

O&R Chapter 1, Sections 2 and 3Economic Report of the President (2006), Chapter 6: The U.S. Capital Account Surplus, pp. 125-­147Maurice Obstfeld “America’s Deficit, the World’s Problem”Dooley, Michael P., David Folkert-­Landau and Peter M. Garber, “Interest Rates, Exchange Rates,and International Adjustment,” National Bureau of Economic Research Working Paper 11771,November 2005

Discussion: Is the US current account deficit sustainable?Discussion reading:

The Economist “Stop Worrying and Love the Deficit” Section: Review of insurance and incentive compatibilityReading: Hal Varian: Intermediate Microeconomics 7th edition, Chapter 12, Chapter 37, section 7

Week 7 Lecture 13: Monday 6th November 2006 – Fourth problem set due Topic: Sovereign debt I

1. A 2-­state model with full commitment2. Absence of commitment3. Lack of commitment and sanctions4. Why do countries repay their debts?5. Investment and sanctions

Required reading:Class notes

Recommended reading:O&R Chapter 6, Sections 1 and 2Hal Varian: Intermediate Microeconomics 7th edition, Chapter 12, Chapter 37, section 7

Lecture 14: Wednesday 8th November 2006 Topic: Sovereign debt II

1. Investment and sanctions – debt overhang2. Debt buybacks

Required reading:Class notes

Recommended reading:O&R Chapter 6, Sections 1 and 2Jeremy Bulow and Kenneth Rogoff (1988), “The Buyback Boondoggle,” Brookings Papers onEconomic Activity 2, 675-­698Jeremy Bulow and Kenneth Rogoff (1990), “Cleaning Up Third World Debt Without Getting Takento the Cleaners,” Journal of Economic Perspectives 4, 31-­42.

Discussion: Should we forgive Third World debt?Discussion reading:

William Easterly “Debt Relief,” Foreign Policy, Nov-­Dec 2001. Section: Review of sovereign debt

Week 8 Lecture 15: Monday 13th November 2006 Second midterm exam (1 hour) Topic: Crises in financial markets I

1. Simplest model of a bank runRequired reading:

Class notesRecommended reading:

Hal Varian: Intermediate Microeconomics 7th edition, Chapter 37, section 4 Lecture 16: Wednesday 15th November 2006 Topic: Crises in financial markets II

1. More on bank runs2. Moral hazard and the lender of last resort3. Case study: the East Asian Crisis

Required reading:Class notesPaul Krugman “Fire-­sale FDI”

Recommended reading:Douglas Diamond and Philip Dybvig (1983), “Bank Runs, Deposit Insurance and Liquidity,”Journal of Political Economy 91 (3), 401-­419.Kenneth Rogoff, "International Institutions for Reducing Global Financial Instability," Journal ofEconomic Perspectives 13, Fall 1999“What caused East Asia’s crisis?” FRBSF Economic Letter 98-­24Paul Krugman (1998), “What happened to Asia?”

Discussion: Do international institutions make international financial crises worse?Discussion reading:

Kenneth Rogoff, “Moral Hazard in IMF Loans: How Big a Concern?” Section: Review of financial crises

Week 9 Lecture 17: Monday 27th November 2006

Topic: Price levels and the exchange rate in the long run1. What is the exchange rate

2. Facts about exchange rates

3. Theory of purchasing power parity

4. Evidence on purchasing power parity

5. The Balassa-­Samuelson effect

Required reading:K&O Chapter 15, pages 369-­372, 379-­388

The Economist: “McCurrencies” (text only from Proquest).

Recommended reading:Kenneth Rogoff, "The Purchasing Power Parity Puzzle," Journal of Economic Literature 34, June1996, 647-­68

Lecture 18: Wednesday 29th November 2006 – Fifth problem set due

Topic: The asset approach to exchange rate determination1. The foreign exchange market

2. Demand for foreign currency assets

3. Market equilibrium

4. Evidence on interest parity conditions

Required reading:K&O Chapter 13, (including pages 335-­337)

Section: Open economy IS-­LM (Mundell-­Fleming)

Reading: Greg Mankiw: Macroeconomics 5th edition, Chapter 5, Section 3

Week 10 Lecture 19: Monday 4

th December 2006

Topic: Monetary and exchange rate policy

1. Review of Mundell-­Fleming

2. Exchange rates and the current account

3. Exchange-­rate based stabilizations

4. Currency crises

Required reading:K&O Chapter 16, 17 and 19

Discussion: Exchange rate policy in developing countries – fix or float?Discussion reading:

Paul Krugman: “Don’t Laugh At Me Argentina”

Lecture 20: Wednesday 6th December 2006

Topic: Optimal currency areas;; Review1. Theory of optimal currency areas

2. The evidence

3. Review

Required reading:K&O Chapter 20

Recommended reading:Andrew Rose (2000), “Does a Currency Union Boost International Trade?” California ManagementReview

Discussion: Did the Euro Experiment Fail?Discussion reading:

The Economist “The Euro and Trade” Section: Review