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Page 1 of 3 AMERICAN UNIVERSITY Department of Economics Comprehensive Examination International Economics June 2012 Instructions: You must answer both parts of this examination, Parts I and II. 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: 75 minutes per question. 1. Give a detailed graphical and algebraic presentation of a simple, dynamic portfolio balance model with rational expectations. a. What stylized empirical facts was this model designed to explain? b. Give a graphical and intuitive analysis of the short-run, intermediate run (dynamic adjustment), and long-run effects of a one-time, permanent increase in the money supply. c. Give a graphical and intuitive analysis of the short-run, intermediate run (dynamic adjustment), and long-run effects of a one-time, permanent fiscal expansion. (For the analysis, assume it is effective at raising demand, but explain why it might not be.) d. Illustrate the use of the adjoint matrix technique to solve for the dynamic adjustment path towards the steady state. How is the initial value of foreign assets determined? How is the initial value of the exchange rate determined? On what basis can we rule out “explosive” solutions? 2. Please discuss the primary assumptions of Krugman’s (1979) monopolistic competition model of trade, and explain how the equilibrium level of the number of firms and value of consumption of each variety is determined in autarky. Then answer the following questions. a. What are the principal lessons from the model? Please discuss what impact trade liberalization is expected to have on the direction of trade, the number and size of firms in each country, and the aggregate welfare effects? b. Why is an increase in the number of varieties of goods considered a gain from trade? Can you think of economic disadvantages associated with greater product variety? c. Have researchers found evidence in support of the predictions of monopolistic competition models? Please explain your answer. d. Melitz (2003) expands upon such monopolistic competition models to address the impact of trade liberalization on individual firms. What is the primary addition Meltiz makes to this model, and what are the implications of the Meltiz extension on the impact of trade liberalization on aggregate industry productivity? Part II: Shorter Answers (Restricted Choice) Instructions: Answer the first two questions and three more, for a total of five (5) questions from this section. 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! Allotted time: 30 minutes per question. 1. Give a detailed graphical analysis of the Dornbusch overshooting model, carefully providing full “intuition” for the model. How supportive has empirical work been of the basic overshooting model? (Refer in detail to specific studies, including Frankel (1979).) 2. In the Heckscher-Ohlin model, let λL1 denote the proportion of the labor force in the small country used in the production of good 1, and λK1 denote the proportion of the capital stock used in the production of good 1. Let denote the proportional changes in the wage rate, rental rate of capital, and the prices of goods 1 and 2 respectively. One set of key relationships implied by the H-O model if the following: In words, what do these expressions mean? What is the interpretation of θ? Use these expressions to derive the Stolper-Samuelson theorem, and explain the Stolper-Samuelson theorem in words. 3. A basic tenant of international trade theory is that there is an equivalence between tariffs and quotas. a. Show why this is true, using either a graphical or mathematical approach. b. The equivalence between tariffs and quotas depends on the details of how the quota is implemented. Discuss some alternative assumptions on how the quota is implemented and discuss the implications for the welfare of home-country consumers and producers. c. Discuss why the equivalence between tariffs and quotas may not hold in the longrun, and why quotas may have different implications for the unit import prices than tariffs. 4. What type of trade is missing, according to Trefler’s “Case of the Missing Trade” paper? Write down the basic equations that Trefler uses, and describe the model upon these equations are based. Discuss the assumptions Trefler employs and the data he uses. What evidence does he present that trade is “missing”? What does Trefler argue is necessary to reconcile theory with his data? 5. Grossman and Helpman’s (1994) “Protection for Sale” paper postulates that industryspecific tariff levels are determined in part by political factors. Discuss the main assumptions of the Grossman and Helpman paper, along with what variables the model predicts should impact the tariff level. Have researchers found empirical evidence that the Protection for Sale model can explain tariff levels? 6. Provide sufficient conditions for purchasing power parity to hold? (Give a detailed algebraic analysis, including a discussion of the monotonicity and homogeneity of price indexes.) Empirically, is purchasing power parity a good characterization of the relationship between exchange rates and relative price levels in the short run? In the long run? (Cite specific studies to support your answer.) Algebraically show how the BalassaSamuelson critique can produce measured deviations from purchasing-power parity. 7. 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.)