AMERICAN UNIVERSITY
Department of Economics
Comprehensive Examination in International Economics
June 2014
Instructions: There are two parts to this examination, Part I and Part II. You must
answer both parts. Follow the directions for each part carefully. Answer two (2) questions
from Part I (NO CHOICE). Answer five (5) questions from Part II (SOME CHOICE). Be
sure to define all notation and carefully label all graphs. The time allocations indicate the
expected depth of your answers.
Part I:
Long Answers (No Choice)
Directions: There are two (2) required questions in this section. Allotted time: 60 minutes
per question.
1. Overshooting model with rational expectations (required):
(a) What stylized empirical facts was this model designed to explain? How empirically
successful is the model? (Refer in detail to specific studies, including Frankel (1979).)
(b) Assuming rational expectations, give a graphical and intuitive analysis of the shortrun, intermediate run (dynamic adjustment), and long-run effects of a one-time,
permanent increase in the money supply. (Be sure to fully explain your graphs.)
(c) Assuming rational expectations, give a graphical and intuitive analysis of the shortrun, intermediate run (dynamic adjustment), and long-run effects of a one-time,
permanent fiscal expansion. (Assume a fiscal expansion is effective at raising demand.)
(d) Assuming rational expectations, use the adjoint matrix technique to solve for the
dynamic adjustment path towards the steady state. Carefully distinguish between
predetermined and “jump” variables, both mathematically and economically, and explain how this affects your solution procedure. Can we rule out “explosive” (bubble)
solutions?
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2. Melitz (2003) Model (required):
(a) Discuss the primary assumptions this model of trade.
(b) Assuming there are trade costs, how does trade liberalization change the equilibrium
in the domestic market? In particular, what impact does liberalization have on the
number of firms in the domestic market, and the average productivity level of firms?
How does the productivity level of exporting firms compare to the productivity level
of firms solely serving the domestic market? Make sure you explain why (or through
what channel) these changes occur following trade liberalization. Is this a realistic
explanation of why these changes might occur following trade liberalization? Why
or why not?
(c) Using the basic tenets of the Melitz model, what impact do you think increasing the
number of trade partners available to a country would have on the number of firms
and average productivity in a country.
(d) Have researchers found evidence in support of the predictions of the Melitz model?
Provide a detailed discussion.
Part II:
Shorter Answers (Restricted Choice)
Instructions: Answer the first two (2) questions and three (3) more, for a total of five (5)
questions from this section. Allotted time: 24 minutes per question.
Note: Unless a question specifically asks for math, your answers should focus on detailed
graphical analysis supported by rigorous verbal discussion/explanation. Focus on what the
questions specifically ask for; there is no credit for extraneous material.
1. Neo-classical Models (required):
In the Heckscher-Ohlin model, let λLi and λKi denote the proportion of the labor force
and capital stock, respectively, in a small country used in the production of good i. Define
the production of good i by yi . Using the neo-classical model of trade one can derive the
following expressions:
b =λ y
c2
L
L1 c
1 + λL2 y
c=λ y
c2
K
K1 c
1 + λK2 y
Assuming good 1 is labor intensive, use these expressions to derive the Rybzcynski Theorem, and explain this theorem in words. Should this hypothesis hold true, what impact
do you think foreign direct investment into this country would have on its production
patterns? Illustrate your answer using a well annotated production possibility frontier
graph.
2. Portfolio Balance (required):
Give a detailed graphical analysis of our portfolio balance model, carefully providing full
economic intuition for the model. Assuming rational expectations, analyze the effects of
fiscal and monetary policy shocks in this model.
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3. Multilateral Trade Negotiations:
A number of researchers (Bagwell and Staiger (1999, 2001, 2011), Broda, Limao and
Weinstein (2008)) have hypothesized that countries use multilateral trade negotiations to
escape a terms of trade driven prisoner’s dilemma equilibrium. Should this hypothesis be
correct, what key variables would explain the level of trade liberalization we observe by
a given country during multilateral trade negotiations and why? Have researchers found
evidence to support this theory? Describe at least one other factor outside the terms of
trade hypothesis that might explain the level of trade liberalization that occurs during
multilateral trade negotiations.
4. Outsourcing:
Feenstra (1998) describes a model of outsourcing and uses this model to describe what
impact outsourcing might have on the skilled worker wage premium in a variety of countries. Briefly describe this model and its predictions. Do you think that the results of
research by Hsieh and Woo (2005) in Hong Kong support such a model? Why or why
not?
5. Risk Premium:
Assuming mean-variance optimization, demonstrate mathematically and explain inutively
the determination of the risk premium in the market for foreign exchange. Be sure to
relate your solution to the minimum variance portfolio.
6. Forward Premium Puzzle:
What puzzles were found in the forward exchange rate data by Fama (1984 JFin)? (Give
a full derivation of why the behavior of the forward premium is considered anomalous,
integrating discussion of the empirical results.) What did McCallum (1994 JME) add to
the discussion initiated by Fama? Is there a necessary conflict between rational expectations and the empirical results? (Explain why Fama thought so, and offer a model based
response.)
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