International Economics MCQ

Chapter 2 The Basic Theory Using Demand and Supply

Multiple Choice Questions

1. If a consumer's income doubles and she now purchases more of good X, we can infer that good X is a(n)

__________ good.

a. Luxury

b. Normal

c. Inferior

d. Special

ANSWER: B

2. All of the following can lead to an increase in the demand for ice cream, a normal good, EXCEPT:

a. A decrease in income.

b. An increase in the price of popsicles.

c. A new scientific study that finds eating ice cream does not cause weight gain.

d. A 10% increase in population.

ANSWER: A

3. A decrease in supply will lead to:

a. An increase in price.

b. A increase in quantity.

c. An increase in demand.

d. An increase in sales.

ANSWER: A

4. Generally, with all else held constant, when the price of a good increases, consumers purchase:

a. More of the good.

b. Less of the good.

c. The same amount of the good.

d. None of the good.

ANSWER: B

5. An increase in demand will lead to:

a. An increase in supply.

b. A fall in quantity.

c. An increase in price.

d. A decrease in producer surplus.

ANSWER: C

6. Which of the following events would lead to an increase in demand for air travel?

a. An increase in the number of people who are afraid to fly.

b. A fall in the price of oil.

c. An increase in the price of ground transportation.

d. A decrease in income levels.

ANSWER: C

7. Which of the following will cause a rightward shift of the market supply curve?

a. An increase in the product price.

b. A decrease in input costs.

c. Change in consumers tastes.

d. An increase in income.

ANSWER: B

8. If a 1% increase in the price of DVDs leads to a 3% reduction in the sales of DVDs, we can conclude that:

a. DVDs are normal goods.

b. DVDs are inferior goods.

c. Demand for DVDs is elastic.

d. Demand for DVDs is inelastic.

ANSWER: C

9. An increase in demand will lead to a higher increase in price; the:

a. Greater is the price elasticity of demand.

b. Greater is the population.

c. Flatter is the supply curve.

d. More inelastic is supply.

ANSWER: D

10. Producer surplus is:

a. Found on a graph as the area under the equilibrium price and above the supply curve.

b. The net gain in economic well-being associated with producing and selling the equilibrium quantity of a good.

c. Used to measure the impact of a change in price on the economic well-being of producers.

d. All of the above.

ANSWER: D

Figure 2.1

11. Referring to figure 2.1, at a price of $70, the amount of consumer surplus is:

a. $6,000.

b. $8,000.

c. $15,000.

d. $30,000.

ANSWER: B

12. Referring to figure 2.1, at a price of $70, the amount of producer surplus is:

a. $6,000.

b. $8,000.

c. $15,000.

d. $30,000.

ANSWER: A

13. The opening up of free trade brings gains to:

a. All producers.

b. Producers in export industries.

c. Producers in import-competing industries.

d. Workers in import-competing industries.

ANSWER: B

14. An increase in the imports of clothing into the United States will benefit __________ and hurt __________.

a. U.S. clothing producers; foreign clothing producers

b. foreign clothing consumers; foreign clothing producers

c. U.S. clothing consumers; foreign clothing producers

d. U.S. clothing consumers; U.S. clothing producers

ANSWER: D

15. Which of the following says that any dollar of gain or loss will be equally valued, regardless of who experiences

it?

a. Consumer surplus.

b. Producer surplus.

c. Arbitrage.

d. One-dollar, one-vote metric.

ANSWER: D

16. Consider a typical two-country model. In the exporting country, consumers will be __________ and producers

will be __________ with the opening of international trade.

a. Happy; happy

b. Unhappy; happy

c. Unhappy; unhappy

d. Happy; unhappy

ANSWER: B

Use the following information to answer questions 17 thru 24:

Suppose the domestic supply and demand curves for skateboards in the United States are given by the following

set of equations:

QS = -60 + 3P

QD = 390 2P

17. In the absence of international trade in skateboards, what will the domestic price in the United States be for

skateboards?

a. $66

b. $90

c. $45

d. $150

ANSWER: B

18. In the absence of international trade in skateboards how many skateboards will be sold in the United States?

a. 138

b. 258

c. 210

d. 930

ANSWER: C

19. If the United States could trade skateboards freely with the rest of the world at a price of $75, how many

skateboards would be produced in the United States?

a. 165

b. 240

c. 285

d. It depends on foreign demand for skateboards.

ANSWER: A

20. If the United States could trade skateboards freely with the rest of the world at a price of $75, how many

skateboards would be purchased in the United States?

a. 165

b. 240

c. 285

d. It depends on foreign supplies of skateboards.

ANSWER: B

21. If the United States could trade skateboards freely with the rest of the world at a price of $75, the United

States would import __________ skateboards and export __________ skateboards.

a. 240; 165

b. 0; 165

c. 75; 0

d. 240; 0

ANSWER: C

22. In the absence of trade with the rest of the world, the amount of consumer surplus in the United Statesskateboard

market is __________ and the amount of producer surplus in the United States skateboard market is__________.

a. $7,350; $11,025

b. $31,500; $9,450

c. $20,474; $7,350

d. $11,025; $7,350

ANSWER: D

23. The opening of free trade with an international price for skateboards of $75 will lead to a change in consumer

surplus of:

a. +$2,812.50.

b. -$2,812.50.

c. +$6,300.

d. +$3,375.

ANSWER: D

24. The opening of free trade with an international price for skateboards of $75 will lead to a change in producer

surplus of:

a. +$2,812.50.

b. -$2,812.50.

c. +$3,375.

d. -$3,375.

ANSWER: B


Suppose the domestic supply and demand curves for MP3 players in the United States are given by the following

set of equations:

QS = 25 + 10P

QD = 925 5P

25. In the absence of international trade in MP3 players, what will the domestic price in the United States be for

MP3 players?

a. $60

b. $63.33

c. $90

d. $180

ANSWER: A

26. In the absence of international trade in MP3 players, how many MP3 players will be sold in the United States?

a. 1825

b. 625

c. 608

d. 925

ANSWER: B

27. If the United States could trade MP3 players freely with the rest of the world at a price of $90, how many MP3

players would be produced in the United States?

a. 625

b. 475

c. 925

d. It depends on foreign demand MP3 players.

ANSWER: C

28. If the United States could trade MP3 players freely with the rest of the world at a price of $90, how many MP3

players will be purchased in the United States?

a. 625

b. 475

c. 925

d. It depends on foreign supplies of MP3 players.

ANSWER: B

29. If the United States could trade MP3 players freely with the rest of the world at a price of $90 the United

States would import __________ MP3 players and export __________ MP3 players.

a. 0; 450

b. 450; 0

c. 475; 925

d. 0; 925

ANSWER: A

30. In the absence of trade with the rest of the world, the amount of consumer surplus in the United States MP3

player market is __________ .

a. $22,562.50

b. $30,062.50

c. $39,062.50

d. $19,500.00

ANSWER: C

31. The opening of free trade with an international price for MP3 players of $90 will lead to a __________ to

the United States in the amount of __________.

a. Gain; 2,625 MP3 players

b. Gain: $6,750

c. Loss; 150 MP3 players

d. Loss; $13,500

ANSWER: B

32. During the time span 1960-2006, the Volume of World Trade has been:

a. Growing at a lower rate compared to the World Production.

b. Growing at the same rate as the World Production.

c. Growing at a higher rate compared to the World Production.

d. Declining due to the Cold War.

ANSWER: C

33. Compared to developing countries, industrialized countries:

a. Export more primary products, especially fuels and ores.

b. Export more textiles and clothing.

c. Export more services.

d. None of the above.

ANSWER: C


Suppose the domestic supply and demand curves for bicycles in the United States are given by the following set

of equations:

QS = 2P

QD = 200 2P.

Demand and supply in the Rest of the World is given by the equations:

QS = P

QD =160 P.

Quantities are measured in thousands and price in U.S. dollars.

34. In the absence of international trade, __________ thousand bicycles will be sold in the United States at a price of

__________.

a. 50; $50

b. 100; $100

c. 150; $50

d. 100; $50

ANSWER: D

35. In the absence of international trade, __________ thousand bicycles will be sold in the Rest of the World at a

price of __________.

a. 80; $80

b. 100; $100

c. 50; $100

d. 100; $50

ANSWER: A

36. After the opening of free trade with the Rest of the World, the world price establishes itself at $60.

TheU.S. __________ bicycles.

a. Exports 40,000

b. Exports 60,000

c. Imports 60,000

d. Neither exports nor imports any bicycles

ANSWER: A

37. After the opening of free trade between the U.S. and the Rest of the World:

a. Neither the U.S. nor the Rest of the World gain from trade.

b. Both countries gain from trade, but the U.S. gains more.

c. Both countries gain from trade, but the Rest of the World gains more.

d. One cannot determine who gains more.

ANSWER: C

True/False Questions

38. An increase in demand will lead to a larger increase in price the more elastic is supply.

ANSWER: FALSE

39. A decrease in income will lead to an increase in the quantity demanded of an inferior good.

ANSWER: TRUE

40. A simultaneous increase in supply and decrease in demand will lead to a higher equilibrium price.

ANSWER: FALSE

41. If a 1% increase in price leads to a 5% decrease in quantity demanded, the good is considered to be a normal

good.

ANSWER: FALSE

42. Consumer surplus is the amount of net economic benefit to consumers from being able to purchase in a market.

ANSWER: TRUE

43. Everyone benefits in a country that was closed to world trade when it begins to freely trade with the rest of the

world.

ANSWER: FALSE

44. While international trade will benefit both the importing and exporting country in a two-country world, the gains

from trade in the exporting country will usually be greater than the gains from trade in the importing country.

ANSWER: FALSE

45. The net national gain from trade can be measured by the change in consumer and producer surplus that results

from trade.

ANSWER: TRUE

46. The free-trade price of a good in an importing country is expected to be lower than the price of the good in that

country before trade began.

ANSWER: TRUE

47. When free trade begins, producers in the importing nation gain while producers in the exporting nation lose.

ANSWER: FALSE

48. Free trade is a zero-sum activity. That is, one county always gains and the other always loses from free trade.

ANSWER: FALSE

49. The gains from trade are divided in proportion to the price changes that trade brings to the trading countries.

ANSWER: TRUE

50. If the world price is higher than the no-trade domestic price, then domestic producers gain and domestic

consumers lose as a result of free trade.

ANSWER: TRUE

51. The elasticity of demand measures the responsiveness of consumers to changes in the price of a product.

ANSWER: TRUE

52. Over the past half a century the World Trade Volume increased more than ten times.

ANSWER: TRUE

Essay Questions

53. In a two-country world, the opening of free trade does not make everyone in the two countries better off. What

assumption(s) must be made in order to make the claim that both countries do in fact benefit from the free trade?

POSSIBLE RESPONSE: It is true that free trade does not benefit everyone within a country. However, if we

accept the one-dollar-one-vote metric, and measure the national well-being of a country, we will find that there

are net national gains from trade. That means that the gainers are gaining more than the losers are losing. Among

the gainers are the consumers in the importing country, who enjoy lower prices, and possibly a wider variety of

the product, and the producers in the exporting country, who are expanding their production as they are receiving

a higher price in the international market. Among the losers are the consumers of the export-oriented industry

and the import-competing producers.

54. Assume that there are only two countries in the world, Pacifica and Atlantica. Both countries produce and

consume surfboards. The pre-trade price of surfboards in Atlantica is lower than the pre-trade price of surfboards

in Pacifica. Draw a three-graph diagram to depict the Pacifica, Atlantica, and international markets for surfboards

illustrating the pre-trade price difference. Now assume that free trade opens up between Pacifica and

Atlantica. Depict a plausible world price in the graphs. Using what you have learned about consumer and

producer surplus, describe what happens to consumers and producers in each country as a result of the move to

free trade. What happens to overall economic welfare in the two countries? Be sure to label and refer to the

graphs in your answer.

POSSIBLE RESPONSE:

Pacifica

(demand for imports)

The above graph illustrates a possible international price. The graph to the left represents demand and supply in

Atlantica, the graph in the middle the market in Pacifica, and the graph to the right the World market. The

international price of 60 is between the no-trade prices of 40 and 70. The international price is such a price that

the excess supply in Atlantica matches the excess demand in Pacifica. As a result Atlantica exports 30 units

to Pacifica at a price of 60. Both countries gain from international trade. Atlantica gains area C in the right graph,

and Pacifica gains area P.

55. Carefully explain why nations gain from engaging in international trade. Do nations gain equally from trade? If not,

what determines which country gains more? (In your answer you can assume a two-country world.)

POSSIBLE RESPONSE: Demand and supply differ in the two countries and so prices also differ if there is no

international trade. With the opening of international trade arbitrage opportunities arise: opportunities to make

profit by buying the good cheaper in one country and selling it in another. Due to these opportunities the prices

in the two countries equalize. The gain from trade in the importing country arises because consumers in this

country gain more than producers lose as a result of the reduced price. Conversely, the gain from trade in the

exporting country exists because producers gain more than local consumers lose. In general, nations do not gain

equally from trade. The country which experiences a larger change in its price stands to gain more. More

precisely, the national gain from trade is proportional to the change in the price that occurs due to the shift from

no trade to free trade.

56. What is the logic of producing winter clothing in countries whose residents have very little demand for such

clothing?

POSSIBLE RESPONSE: A country might be interested in the production of winter clothing if this country can

export this good in exchange for other goods that cannot be produced at a low cost domestically in this country. This

might be due to the specificity of the technology in this country; this country might have an abundance of resources

that make the production of winter clothing efficient (low cost), whereas this country might be unable to produce

other goods at such a low cost.

57. China produces shoes at a lower cost than the United States. As a result, most of the shoes purchased in theUnited

States are made in China. Should this be a concern to anyone in the United States? If so, who should be concerned

and why? If not, why not?

POSSIBLE RESPONSE: As a result of the free trade between China and the U.S., the price of shoes in

the U.S. will be equal to the international price. What are the effects of free trade on producers and consumers of

shoes in the United States? As a result of the imports of shoes from China, the price of shoes will be lower

(compared to the situation of no trade). Consumers will gain additional consumer surplus due to the lower price

and the increased purchases of shoes (consumers total surplus is measured by the area below the demand curve

for shoes and above the international price). Facing a lower price (the international price), the domestic

producers of shoes in the United States will react by decreasing their production of shoes. Hence, there is loss of

surplus to producers associated with the opening of trade. Some of the shoe producers might go out of business,

which might create temporary unemployment in this industry which will last until the workers producing shoes

find employment in another sector of the economy. In general, consumers gain more than producers lose, so

there is a net gain for the U.S. of opening to trade.

58. The difference in the prices of a good in two countries creates opportunities for arbitrage: traders buy the good at a

low price in one country and sell it at a higher price in the other. When the difference in the prices vanishes, and the

world price is established in both countries, there is no scope for trade anymore because no trader will be willing to

buy the good in one country and sell it in another. Discuss the validity of this statement.

POSSIBLE RESPONSE: This is not a valid statement. Consider the countries A and B, and assume that without

trade the price of the good is Pa in country A and Pb in country B, where Pa< Pb. With the opening of free trade, the

arbitrage possibilities will eliminate the difference in the prices in the two countries. So, the world price, W, will

establish itself between the two local prices:

Pa

Chapter 3 Why Everybody Trades: Comparative Advantage


1. Based on mercantilist thinking, governments should:

a. Subsidize and encourage imports.

b. Subsidize and encourage exports.

c. Allow for free trade unencumbered by government regulations and restrictions.

d. Both (a) and (b).

ANSWER: B

2. The author of the Wealth of Nations was:

a. David Ricardo.

b. Paul Samuelson.

c. Adam Smith.

d. Karl Marx.

ANSWER: C

3. When Adam Smith presented his theory of absolute advantage, he thought that all value was measured in terms of the

amount of __________ used in the production of the good.

a. Land

b. Labor

c. Capital

d. Money

ANSWER: B

4. Labor productivity is:

a. The number of units of output that a worker can produce in one hour.

b. The total number of units that all workers in a firm produce in one day.

c. The number of hours it takes a worker to produce one unit of output.

d. The total number of hours it takes all the workers in a firm to produce a days output.

ANSWER: A

5. Which of the following is NOT true about mercantilism?

a. Under mercantilism, exports were encouraged and imports were discouraged.

b. Mercantilists believed that one countrys gains from trade came at the expense of another country or countries well

being.

c. Domestic producers were often hurt by mercantilism.

d. Mercantilism focused on the accumulation of gold and silver bullion.

ANSWER: C

6. If Britains labor productivity in the production of umbrellas is greater than the rest of the worlds labor productivity in

umbrellas, we would say that Britain has a(n) __________ in the production of umbrellas.

a. Comparative advantage

b. Absolute advantage

c. Opportunity cost

d. Superiority

ANSWER: B

7. In the two-country, two-good model, which of the following is true?

I. As a result of trade, at least one country is better off and that countrys gain does not reduce the economic welfare of

the other country.

II. Both countries can gain from trade by dividing the benefits of the enhanced global production.

a. I

b. II

c. Both I and II

d. Neither I nor II

ANSWER: C

Table 3.1

In the United Kingdom In the Rest of the World

Productivity

Umbrellas per labor hour 1.00 0.50

Units of corn per labor hour 0.20 0.70

8. Refer to Table 3.1. The number of labor hours to make 1 umbrella in the United Kingdom is:

a. 0.5.

b. 1.

c. 1.43.

d. 2.

ANSWER: B

9. Refer to Table 3.1. The number of labor hours to produce 1 unit of corn in the Rest of the World is:

a. 0.5.

b. 1.

c. 1.43.

d. 2.

ANSWER: C

10. Refer to Table 3.1. Given the productivity information in Table 3.1, the Rest of the World has an absolute advantage in

the production of __________ and the United Kingdom has an absolute advantage in the production of __________.

a. Umbrellas; corn

b. Corn; umbrellas

c. Corn; neither good

d. Neither good; umbrellas

ANSWER: B

11. Refer to Table 3.1. If the United Kingdom shifts 1 hour of labor from the production of corn to the production of

umbrellas and the Rest of the World shifts 1 hour of labor from the production of umbrellas to the production of corn,

total world production of corn will __________ by __________ units and total world production of umbrellas will

__________ by __________.

a. Increase; 1; decrease; 1

b. Increase; 1.43; increase 1

c. Increase; 0.5; increase; 0.5

d. Decrease; 0.5; increase; 0.7

ANSWER: C

12. The theory of comparative advantage was first presented by:

a. Adam Smith.

b. Karl Marx.

c. David Ricardo.

d. Eli Heckscher.

ANSWER: C

13. If a country exports the good that it can produce at a low opportunity cost and imports those goods that it would

otherwise produce at a high opportunity cost, we say that such trade is based upon:

a. Absolute advantage.

b. Arbitrage.

c. Labor productivity differences.

d. Comparative advantage.

ANSWER: D

Table 3.2


Labor hours to make:

1 umbrella 3.00 2.00

1 unit of corn 1.00 0.25

14. Refer to Table 3.2. The United Kingdom has an absolute advantage in the production of __________ and the Rest of

the World has an absolute advantage in the production of __________.

a. Neither good; corn

b. Neither good; both goods

c. Both goods; neither goods

d. Corn; umbrellas

ANSWER: B

15. Refer to Table 3.2. The United Kingdom has a comparative advantage in the production of __________ and the Rest of

the World has a comparative advantage in the production of __________.

a. Neither good; corn


c. Umbrellas; corn

d. Corn; umbrellas

ANSWER: C

16. Refer to Table 3.2. The opportunity cost of producing a unit of corn in the United Kingdom is __________ umbrellas

and the opportunity cost of producing a unit of corn in the Rest of the World is __________ umbrellas.

a. 1/8; 1/3

b. 1/3; 1/8

c. 3; 8

d. 8; 3

ANSWER: B

17. Refer to Table 3.2. The opportunity cost of producing an umbrella in the United Kingdom is __________ units of corn

and the opportunity cost of producing an umbrella in the Rest of the World is __________ units of corn.

a. 1/8; 1/3

b. 1/3; 1/8

c. 3; 8

d. 8; 3

ANSWER: C

18. Refer to Table 3.2. Once trade is opened, we can anticipate that the international price of umbrellas will lie between

__________ and __________.

a. 1/3 of a unit of corn; 3 units of corn

b. 8 units of corn; 3 units of corn

c. 1/8 of a unit of corn; 1/3 of a unit of corn

d. 8 units of corn; 1/8 of a unit of corn

ANSWER: B

19. Refer to Table 3.2. Once trade is open, we can anticipate that the international price of corn will lie between

__________ and __________.

a. 1/3 of an umbrella; 3 umbrellas

b. 8 umbrellas; 3 umbrellas

c. 1/8 of an umbrella; 1/3 of an umbrella

d. 8 umbrellas; 1/8 of an umbrella

ANSWER: C

Table 3.3


Productivity

Umbrellas per labor hour 6 1

Units of corn per labor hour 4 3

20. Refer to Table 3.3. The United Kingdom has an absolute advantage in the production of __________ and the Rest of

the World has an absolute advantage in the production of __________.

a. Both goods; neither good


c. Umbrellas; corn

d. Corn; umbrellas

ANSWER: A

21. Refer to Table 3.3. The United Kingdom has a comparative advantage in the production of __________ and the Rest of

the World has a comparative advantage in the production of __________.



c. Umbrellas; corn

d. Corn; umbrellas

ANSWER: C

22. Refer to Table 3.3. The opportunity cost of producing a unit of corn in the United Kingdom is __________ umbrellas

and the opportunity cost of producing a unit of corn in the Rest of the World is __________ umbrellas.

a. 2/3; 3

b. 3; 2/3

c. 3/2; 1/3

d. 1/3; 3/2

ANSWER: C

23. Refer to Table 3.3. The opportunity cost of producing an umbrella in the United Kingdom is __________ units of corn

and the opportunity cost of producing an umbrella in the Rest of the World is __________ units of corn.

a. 2/3; 3

b. 3; 2/3

c. 3/2; 1/3

d. 1/3; 3/2

ANSWER: A

24. Refer to Table 3.3. Once trade is opened, we can anticipate that the international price of umbrellas will lie between

__________ and __________.

a. 2/3 of a unit of corn; 3 units of corn

b. 3/2 units of corn; 2/3 of a unit of corn

c. 3/2 of a unit of corn; 1/3 of a unit of corn

d. 3 units of corn; 1/3 of a unit of corn

ANSWER: A

25. Refer to Table 3.3. Once trade is open, we can anticipate that the international price of corn will lie between

__________ and __________.

a. 2/3 of an umbrella; 3 umbrellas

b. 3/2 umbrellas; 2/3 of an umbrella

c. 3/2 umbrellas; 1/3 of an umbrella

d. 3 umbrellas; 3/2 umbrellas

ANSWER: C

Table 3.4

In the United States In France

Labor hours to make:

1 gallon of Wine 4.00 1.00

1 pound of Cheese 1.00 2.00

26. Refer to Table 3.4 and assume the United States and France trade only with each other. The United States has an

absolute advantage in the production of __________ and France has an absolute advantage in the production of

__________.

a. Neither good; wine

b. Cheese; neither good

c. Wine; cheese

d. Cheese; wine

ANSWER: D

27. Refer to Table 3.4. What is the relative price of cheese (the price of cheese in terms of wine) in France if it does not

engage in trade?

a. 2 gallons of wine per pound.

b. 1 gallon of wine per pound.

c. 0.5 gallons of wine per pound.

d. 0.25 gallons of wine per pound.

ANSWER: A

28. Refer to table 3.4. The opportunity cost of cheese in France is __________ and the opportunity cost of cheese in

the United States is __________.

a. 1 gallon of wine; 0.5 gallons of wine

b. 2 gallons of wine; 1 gallon of wine

c. 2 gallons of wine; 0.25 gallons of wine

d. 0.5 gallons of wine; 4 gallons of wine

ANSWER: C

29. Refer to Table 3.4 and assume the United States and France trade only with each other. The United States has a

comparative advantage in the production of __________ and France has a comparative advantage in the production of

__________.


b. Cheese; wine

c. Wine; cheese

d. Neither good; both goods

ANSWER: B

30. Refer to Table 3.4. Once trade between the United States and France opens, we can anticipate that the international

price of wine will be between __________ and __________.

a. 1 pound of cheese; 4 pounds of cheese

b. 0.5 pounds of cheese; 4 pounds of cheese

c. 1 pound of cheese; 2 pounds of cheese

d. 0.5 pounds of cheese; 2 pounds of cheese

ANSWER: B

31. Refer to Table 3.4. Once trade between the United States and France opens, we can anticipate that the international

price of cheese will be between __________ and __________.

a. 1 gallon of wine; 0.5 gallons of wine

b. 2 gallons of wine; 4 gallons of wine

c. 2 gallons of wine; 0.25 gallons of wine

d. 1 gallon of wine; 4 gallons of wine

ANSWER: C

32. Which of the following is NOT true about a nations production-possibility curve?

a. The production-possibility curve shows all the amounts of different products that an economy can produce when its

resources are fully employed.

b. Points inside the production-possibility curve are feasible, but may represent unemployment of some of the economys

resources.

c. Points outside the production-possibility curve are not feasible production points given the resources in the economy.

d. The production-possibility curve shows how the country gains from trade.

ANSWER: D

33. Which of the following is NOT true about a constant cost production possibilities curve?

a. A constant cost production possibilities curve is drawn as a straight line.

b. Along a constant cost production possibilities curve opportunity cost is constant.

c. The opening up of free trade causes a constant cost production possibilities curve to shift to the right.

d. Constant cost production possibilities curves can lead to complete specialization when free trade opens.

ANSWER: C

Figure 3.1

34. Refer to Figure 3.1. The opportunity cost of one unit of corn production in Canada is __________ liters of maple syrup

and in the Rest of the World is __________ liters of maple syrup.

a. 9/7; 2

b. 7/9; 2

c. 9/7; 1/2

d. 7/9; 1/2

ANSWER: C

35. Refer to Figure 3.1. The opportunity cost of one liter of maple syrup production in Canada is __________ units of corn

and in the Rest of the World is __________ units of corn.

a. 9/7; 2

b. 7/9; 2

c. 9/7; 1/2

d. 7/9; 1/2

ANSWER: B

36. Refer to Figure 3.1. After the opening of free trade between Canada and the Rest of the World at the world price of 1

corn per unit of maple syrup, Canada will produce __________ units of corn and __________ liters of maple syrup.

The Rest of the World will produce __________ units of corn and __________ liters of maple syrup.

a. 35; 45; 35; 32.5

b. 70; 90; 100; 50

c. 0; 90; 100; 0

d. 70; 0; 0; 50

ANSWER: C

37. Refer to Figure 3.1. Which of the following terms of trade is a plausible terms of trade for the two-country, two-good

model depicted in the figure?

a. 3/2 units of corn trades for 1 liter of maple syrup.

b. 1 unit of corn trades for 1/4 liter of maple syrup.

c. 3 units of corn trades for 1 liter of maple syrup.

d. 10 liters of maple syrup trades for 2 units of corn.

ANSWER: A

38. Products produced by high-wage workers in developed countries can compete with those produced by low-wage

workers in less-developed countries because:

a. High-wage workers tend to be less productive than low-wage workers.

b. High-wage workers tend to be more productive than low-wage workers.

c. High-wage workers tend to put more time into the production of their goods.

d. Products produced by high-wage workers in developed countries can not compete with those produced by low-wage

workers in less-developed countries.

ANSWER: B

39. A bottle of wine can be produced in France with 2 labor hours, and in the United States with 4 labor hours. A pound of

beef can be produced in France with 1 labor hour, and in the United States with labor hour.

a. France has a comparative advantage in the production of beef.

b. France has an absolute advantage in the production of beef.

c. The United States has an absolute, but not a comparative advantage in the production of beef.

d. The United States has both a comparative and an absolute advantage in the production of beef.

ANSWER: D

Use the following information to answer the questions 40 and 41. Vintland and Moonited Republic produce wine

and cheese. The opportunity cost for the production of a bottle of wine in Vintland is 2 pounds of cheese, and in

theMoonited Republic is 2.5 pounds of cheese.

40. Based on the above information it can be concluded that:

a. Trade between the two countries based on comparative advantage is not possible.

b. Vintland has a comparative advantage in the production of wine and Moonited has a comparative advantage in the

production of cheese.

c. Vintland has a comparative advantage in the production of cheese and Moonited has a comparative advantage in the

production of wine.

d. Vintland has an absolute disadvantage in the production of both goods.

ANSWER: B

41. Based on the above information, the international equilibrium price ratio can be:

a. 2/5 bottles of wine for a pound of cheese.

b. 3/5 bottles of wine for a pound of cheese.

c. 4/5 bottle of wine for a pound of cheese.

d. 1 bottle of wine for a pound of cheese.

ANSWER: A

42. In the two-country-two-good model, if a country has a comparative advantage in the production of a certain good, that

means that this country:

a. Also has an absolute advantage in the production of this good.

b. Will start importing this good.

c. Can produce this good at a lower opportunity cost.

d. Can produce this good at the same opportunity cost.

ANSWER: C

43. In the two-country, two-good model, if a country has an absolute advantage in the production of a certain good, that

means that:

a. It is not possible that this country will start importing this good from the other country.

b. This country also has a comparative advantage in the production of this good.

c. Trade based on comparative advantage will not be possible.

d. This country has a higher labor productivity in the production of this good.

ANSWER: D


44. David Ricardo is the author of the Wealth of Nations.

ANSWER: FALSE

45. Adam Smiths theory of absolute advantage relied on the labor theory of value.

ANSWER: TRUE

46. Mercantilists believe that when one country benefited from international trade it was at the expense of another country

or countries.

ANSWER: TRUE

47. If Country X has a higher level of labor productivity than the rest of the world in the production of a good, then

Country X has a comparative advantage in the production of the good.

ANSWER: FALSE

48. In order for trade to occur, both countries must be made better off as a result of trade.

ANSWER: FALSE

49. If a country does not have an absolute advantage in the production of a least one good, then trade will not take place.

ANSWER: FALSE

50. In Country X, the opportunity cost of producing an additional unit of Good A is the amount of Good B given up.

ANSWER: TRUE

51. In the Wealth of Nations, Adam Smith presented his theory of comparative advantage.

ANSWER: FALSE

52. If Country A is more productive than Country B in the production of both Good X and Good Y, then economists expect

that Country A will produce everything and export both Good X and Good Y to Country B.

ANSWER: FALSE

53. In the two-country, two-good model, both countries can gain from trade as long as their relative advantages and

disadvantages in producing different goods are different.

ANSWER: TRUE

54. According to the theory of comparative advantage, countries will export those goods for which they have a lower

opportunity cost and import those goods for which they have a higher opportunity cost than the rest of the world.

ANSWER: TRUE

55. The act of buying at a low price in one place and selling at a high price in another place is called relative pricing.

ANSWER: FALSE

56. Arbitrage is the act of buying at one place and selling at another place in order to profit from the price differences that

exist between the two places.

ANSWER: TRUE

57. In the two-country, two-good model, international trade will cause the two national prices that existed in autarky to

move towards a new worldwide equilibrium price.

ANSWER: TRUE

58. A nations production-possibility curve shows the amounts of different products that an economy can produce if all of

its resources are fully employed.

ANSWER: TRUE

59. Straight-line production-possibility curves reflect that the opportunity cost of producing additional units of each good is

constant.

ANSWER: TRUE

60. The production-possibility curve shows various bundles of consumption quantities that lead to the same level of well

being.

ANSWER: FALSE

61. Free trade with constant-cost production-possibility curves usually leads to partial production specialization.

ANSWER: FALSE

62. In the two-country, two-good model, the relative price that will exist in the international markets for a good following

the emergence of free trade will necessarily lie in the range bracketed by the autarky relative prices for the good in the

two countries.

ANSWER: TRUE

63. According to the theory of comparative advantage, trade will not occur if one country is less efficient in the production

of all products.

ANSWER: FALSE

64. A country has a comparative advantage in the production of a good if it can produce more of the good than another

country.

ANSWER: FALSE

65. In Ricardos model, if labor productivity is constant, the production possibilities curve will look like a straight line.

ANSWER: TRUE

66. Ricardos theory of comparative advantage tells us that, if opportunity costs differ and labor productivities are constant,

free trade will lead at least one country to a complete production specialization.

ANSWER: TRUE

67. The opportunity cost measures the amount of labor necessary for the production of one unit of a good.

ANSWER: FALSE

Essay Questions 68. Explain how a country can have an absolute advantage in the production of both goods in the two-country, two-good

model and one country can have the comparative advantage in the production of one good and the other country will

have a comparative advantage in the production of the other good.

POSSIBLE RESPONSE: Let us begin with Adam Smiths theory of absolute advantage. Imagine that two countries, A

and B, use only labor to produce wheat and cloth. We say that one country, say A, has an absolute advantage in the

production of one of the goods, say wheat, if this country can produce more units of wheat per labor hour. If Country A

can also produce more units of cloth per labor hour than Country B, then Country A will also have an absolute

advantage in the production of cloth. So what kind of advantage can Country B then have? It seems that this country is

less efficient in the production of both goods. To answer this question, we look at the opportunity cost of production.

Now we present David Ricardos theory of comparative advantage. We ask the question, how many units of wheat

must Country B forego in order to produce one more unit of cloth? If Country B must forego fewer units of wheat in

order to produce one more unit of cloth compared to Country A, we say that Country B has a lower opportunity cost in

the production of cloth. That implies that Country B has a comparative advantage in the production of cloth; production

of cloth requires a lower sacrifice of production of wheat in Country B.

69. Using graphs, illustrate a two-country, two-good model in which one country has an absolute advantage in the

production of both goods, but a comparative advantage in the production of only one good.

POSSIBLE RESPONSE:

Assume Countries A and B have the same endowment of labor, and let labor be the sole factor of production. Country

B has an absolute advantage in the production of wheat as with the same resources Country B can produce 60 units.

Country A can produce only 40 units. Country B has also an absolute advantage in the production of Cloth (80>40).

The opportunity cost in Country A for the production of one unit of wheat is 40/40=1C/W. The opportunity cost in

Country B is 80/60=(4/3) C/W. Country A has a lower opportunity cost in the production of wheat, hence Country A

has a comparative advantage in the production of wheat.

70. Suppose labor productivity in France is such that one hour of labor is required to produce one gallon of wine while two

hours of labor are required to produce one pound of cheese. Assuming the availability of 1 million labor hours, draw a

constant cost production possibilities curve for France with cheese on the vertical axis and wine on the horizontal axis.

If France has a comparative advantage in the production of wine, show where, with free trade, France will produce on

its production possibilities curve. If the free trade price of wine is two pounds of cheese per gallon, draw a trade line

and use it to illustrate how France can gain from trade.

POSSIBLE RESPONSE:

Wine

(millions gallons)

If France produces only cheese, with 1 million labor hours France will be able to produce half a million pounds of

cheese. If France produces only wine, France will be able produce 1 million gallons of wine. The production

possibilities curve for France is a straight line as is shown in the graph. The opportunity cost of one gallon of wine

in France is half a pound cheese. The international price of a gallon of wine is two pounds of cheese, which is higher

than the opportunity cost of wine production in France. That means it will be beneficial for France to produce only wine

and trade it for cheese instead of producing cheese itself. With free trade France can consume any combination of

quantities of wine and cheese lying on the trade line shown in the graph. France gains from trade because these

combinations are clearly outside of Frances production possibilities curve, so that is they are unattainable without

trade.

71. Explain how products produced by high-wage workers in the United States can compete in countries whose workers

earn much lower wages.

POSSIBLE RESPONSE:

To answer this question let us focus on the basis for trade between the United States and the other countries: the

comparative advantage of the United States in the production of some products and the comparative advantage of the

other countries in the production of another set of products. To determine whether theUnited States has a comparative

advantage in a particular product we need to compare the worker productivity and wages in the United States to the

productivity and wages in the other countries.

Although worker wages in the United States are higher, the United States will have a comparative advantage if

the U.S. workers are sufficiently productive. If the productivity advantage is large enough, the cost of manufacturing

the product in the U.S. will be lower despite the high wages. The U.S. will be able to successfully export this product

and import the products for which it does not have a comparative advantage.

72. According to Ricardos theory, countries will specialize in the production of the good in which they have a comparative

advantage, and the specialization will be complete if free-trade relative prices differ from no-trade relative prices. Yet,

the real world fails to show total specialization. Explain the reasons for this discrepancy.

POSSIBLE RESPONSE: Ricardos theory is based on the assumption of constant labor productivity for each good.

This assumption means that the labor input necessary for the production of each additional unit of the good does not

depend on how much is produced. Because of this assumption, the opportunity costthe amount of the other product

foregone in order to produce one more unit of the goodis constant. A country will produce only the good with a

lower opportunity cost, and will find it beneficial to trade it for the other at a relative price higher than this opportunity

cost. The specialization will be full. In reality, goods are produced with several other factors besides labor, and the

productivity of these production factors is not constant. As a result, in reality the production possibilities curve will be

bowed out, and complete specialization will not be an optimal choice for the country, even if free-trade prices differ

from no-trade prices.

Chapter 4: Trade: Factor Availability and Factor Proportions are Key

Multiple Choice Questions 1. Constant cost production possibility curves lead to __________ specialization. Increasing cost production

possibility curves lead to __________ specialization.

a. no; partial

b. complete; no

c. complete; partial

d. partial; complete

ANSWER: C

2. Which of the following statements is true about production possibility curves?

I. Constant cost production possibility curves are straight lines and lead to complete specialization.

II. Bowed-out production possibility curves are associated with partial specialization, but the opportunity cost

of producing each good is constant along the curve.

a. I

b. II

c. I and II


ANSWER: A

3. Which of the following are reasons why increasing marginal costs of production arise?

I. Different products use inputs to production in different proportions.

II. Different inputs are better utilized in the production of different products.

III. Different countries have different endowments of the different factors of production.

a. III

b. II and III

c. I and II and III

d. I and II

ANSWER: D

4. Assume that Country X produces two goodssugar and shoesand that the countrys production possibility curve is bowed-out. As the

country produces more sugar:

a. The opportunity cost of sugar in terms of shoes foregone will increase.

b. The opportunity cost of sugar in terms of shoes foregone will decrease.

c. The opportunity cost of shoes in terms of sugar foregone will increase.

d. The opportunity cost of sugar in terms of shoes foregone will be the same.

ANSWER: A

5. In the two-country, two-good model with an increasing-cost production-possibility curve, the amount of both

goods that are produced in the economy in autarky is determined by:

a. Relative prices.

b. Factor endowments.

c. Community indifference curves.

d. Labor productivity.

ANSWER: A

6. Refer to Figure 4.1. In autarky Canada will produce at point __________ and consume at point __________.

a. S1; C1

b. S0; C0

c. S1; C0

d. S0; C1

ANSWER: B

7. Refer to Figure 4.1. After the opening up of international trade, Canada will produce at point __________ and

consume at point __________.

a. S1; C1

b. S0; C0

c. S1; C0

d. S0; C1

ANSWER: A

8. Refer to Figure 4.1. Canada has a comparative advantage in which good?

a. Wheat.

b. Cloth.

c. Both wheat and cloth.

d. Neither wheat nor cloth.

ANSWER: A

9. Refer to Figure 4.1. After the opening up of international trade, Canada will export __________ units of wheat and

import __________ units of cloth.

a. 0; 0

b. 20; 80

c. 20; 5

d. 60; 15

ANSWER: B

10. Refer to Figure 4.1. After the opening up of international trade, Canada will import __________ units of wheat and

export __________ units of cloth.

a. 0; 0

b. 25; 25

c. 30; 65

d. 65; 65

ANSWER: A

11. Refer to Figure 4.1. Before the opening up of international trade, 1 unit of wheat will trade for __________ units of

cloth. After the opening up of international trade 1 unit of wheat will trade for __________ units of cloth.

a. 1; 0.25

b. 4; 1.

c. 1; 4.

d. 0; 2.5.

ANSWER: C

12. Refer to Figure 4.2. Before trade opens, the Rest of the World produces __________ yards of cloth and __________

units of wheat; while consuming __________ yards of cloth and __________ units of wheat.

a. 10; 8; 8; 10

b. 4; 16; 8; 10

c. 8; 10; 12; 8

d. 8; 10; 8; 10

ANSWER: D

13. Refer to Figure 4.2. After trade, Canada produces __________ yards of cloth and __________ units of wheat and

consumes __________ yards of cloth and __________ units of wheat.

a. 20; 3; 12; 11

b. 12; 11; 12; 11

c. 20; 3; 20; 3

d. 16; 6; 12; 11

ANSWER: A

14. Refer to Figure 4.2. In autarky, the Rest of the World produces and consumes __________ yards of cloth and

__________ units of wheat. In autarky Canada produces and consumes __________ yards of cloth and __________

units of wheat.

a. 8; 10; 20; 3

b. 8; 10; 16; 6

c. 4; 16; 20; 3

d. 12; 8; 12; 11

ANSWER: B

Figure 4.2

15. Refer to Figure 4.2. Before trade, the total amount of cloth produced in the world was __________ yards and the

total amount of wheat produced in the world was __________.

a. 24; 19

b. 24; 16

c. 19; 24

d. 16; 24

ANSWER: B

16. Refer to Figure 4.2. As a result of specialization and trade, cloth production in the world is increased by __________ yards and wheat

production is increased by __________ units.

a. 0; 3

b. 0; 0

c. 24; 19

d. 3; 0

ANSWER: A

17. Which of the following can explain why product prices in two countries will differ in a world with no trade?

I. Production conditions in the two countries are different and therefore the production-possibility curves

in the two countries are different.

II. Consumption conditions are different in the two countries and therefore the community indifference

curves in the two countries are different.

III. Trade would not be possible because the international price ratio would be the same in the two

countries.

a. I and III

b. II

c. I and II

d. I and II and III

ANSWER: C

18. A country whose ratio of capital to other factors of production is greater than the rest of the worlds ratio of capital

to other factors of production is:

a. Relatively capital-intensive.

b. Relatively capital-abundant.

c. Running a trade deficit.

d. Operating at a point inside its production possibilities curve.

ANSWER: B

19. The United States is relatively capital-abundant because:

a. Capital costs more in the United States than in the rest of the world.

b. The United States has more capital than the rest of the world.

c. The United States produces more high-tech goods than the rest of the world.

d. The ratio of capital to other factors of production is greater in the United States than the rest of the

worlds ratio of capital to other factors of production.

ANSWER: D

20. Which of the following theories predicts that a country will export those goods that use the countrys abundant

factor(s) intensively in production and import those goods that use the countrys scarce factor(s) intensively in

production?

a. Absolute advantage.

b. Comparative advantage.

c. Heckscher-Ohlin theory.

d. The production differentiation model.

ANSWER: C

21. If Country A is labor-abundant and capital-scarce, Country B is labor-scarce and capital-abundant, Good X is

produced in a labor-intensive process, and Good Y is produced in a capital-intensive process, we would expect that:

a. Country A would export Good X.

b. Country B would import Good Y.

c. Country A would import Good X.

d. Country B would import both Good X and Good Y.

ANSWER: A

22. China has 20% of the worlds population but only 10% of the worlds farmable land. The Heckscher-Ohlin theory of

trade would predict which of the following for China following the opening of trade?

a. China will export land-intensive goods like wheat and import labor-intensive goods like clothing.

b. China will shift resources into the production of agricultural goods and away from manufactured goods.

c. China will shift resources out of the production of agricultural goods and into the production of labor-

intensive goods.

d. China will export capital-intensive goods like automobiles and import labor-intensive goods like clothing.

ANSWER: C

23. A product is relatively __________ if labor costs are a greater proportion of the products value than they are the

value of other products.

a. Capital-abundant

b. Labor-abundant

c. Capital-intensive

d. Labor-intensive

ANSWER: D

24. If Country A has a relatively higher ratio of labor to the other factors of production than does Country B, then:

a. Country A is labor-abundant.

b. Country A is labor-scarce.

c. Country A is labor-intensive.

d. Country B is labor-intensive.

ANSWER: A

25. Given the following relationship:

(U.K. land supply) < (Rest of the worlds land supply)

(U.K. labor supply) > (Rest of the worlds labor supply)

One can conclude that:

a. The U.K is labor abundant.

b. The U.K. is labor intensive.

c. The Rest of the World is labor abundant.

d. The Rest of the World is land intensive.

ANSWER: A

26. Which of the following economists proposed an international trade model that explains international trade

patterns using factor proportions?

a. Adam Smith

b. David Ricardo

c. Eli Heckscher and Bertil Ohlin

d. Joseph Stiglitz

ANSWER: C

27. Assume a two-country, two-good, two-factor of production world with the countries being the United States and

the Rest of the World, the two goods being steel and wheat, and the two factors of production being capital and

land. If the United States was capital-abundant and steel production was capital-intensive, the Heckscher-Ohlin

model would predict that the United States would export __________ and import __________.

a. Steel; wheat

b. Wheat; steel

c. Steel; steel

d. Wheat; wheat

ANSWER: A



land. If the United States was capital-abundant and steel production was capital-intensive, the Heckscher-Ohlin

model would predict that the Rest of the World would export __________ and import __________.

a. Steel; wheat

b. Wheat; steel

c. Steel; steel

d. Wheat; wheat

ANSWER: B

Use the following information to answer questions 29 thru 35.

Assume a two-country, two-good, two-factor of production world where the following relationships hold:

(K/L)US > (K/L)ROW

(K/L)automobiles > (K/L)shoes

Where (K/L)US is the capital-labor ratio in the United States, (K/L)ROW is the capital-labor ratio in the Rest of the World,

(K/L)automobilesis the capital-labor ratio in the production of automobiles, and (K/L)shoes is the capital-labor ratio in the

production of shoes. Assume further that technology and tastes are the same in the United States and the Rest of the

World.

29. The relationships shown above indicate that the United States is:

a. A capital-intensive country.

b. Scarce in land.

c. A labor-abundant country.

d. A capital-abundant country.

ANSWER: D

30. The relationships shown above indicate that the production of shoes is:

a. Capital-intensive.

b. Labor-intensive.

c. Labor-abundant.

d. Capital-abundant.

ANSWER: B

31. The relationships shown above indicate that in the United States the price of automobiles relative to shoes is:

a. Higher than in the Rest of the World.

b. Lower than in the Rest of the World.

c. The same as in the Rest of the World.

d. It is impossible to compare the prices with the information provided.

ANSWER: B

32. The relationships shown above indicate that the United States has a comparative advantage in the production of

__________ while the Rest of the World has a comparative advantage in the production of __________.


b. Shoes; automobiles

c. Automobiles; shoes


ANSWER: C

33. According to the Heckscher-Ohlin model, the opening of trade between the United States and the Rest of the

World should cause theUnited States to export __________ and import __________.





ANSWER: C

34. According to the Heckscher-Ohlin model, the opening of trade between the United States and the Rest of the

World should cause the Rest of the World to export __________ and import __________.





ANSWER: B

35. Trade between the United States and the Rest of the World would lead to:

a. An improvement in economic well-being in the United States but deterioration in economic well-being in

the Rest of the World.

b. No change in economic well-being in the United States but an improvement in economic well-being in the

Rest of the World.

c. An improvement in economic well-being in both the United States and in the Rest of the World.

d. Deterioration in economic well-being in the United States but an improvement in economic well-being in

the Rest of the World.

ANSWER: C

Use the information below to answer questions 36 thru 38.

The following cost data is for the mythical land of Painduvin where they produce nothing but bread and wine using

only land and labor as inputs.

1 unit of Bread 1 unit of Cheese

Labor Input 5 dollars 20 dollars

Land Input 4 dollars 10 dollars

36. In Painduvin, bread is __________ and cheese is __________.

a. Labor-intensive; land-intensive

b. Land-intensive; labor-intensive

c. Labor-abundant; land-abundant

d. Land-abundant; labor-abundant

ANSWER: B

37. If Painduvin were land-abundant, the opening up of free trade would cause the price of bread relative to cheese to:

a. Rise.

b. Fall.

c. Stay the same.

d. Unable to answer with the information provided.

ANSWER: A

38. If Painduvin were land-abundant, the opening up of free trade would cause the production of bread to __________

and the production of cheese to __________.

a. Rise; rise

b. Rise; fall

c. Fall; fall

d. Fall; rise

ANSWER: B

Use the following information to answer questions 39 and 40.

Puglia has 15 thousand acres of land and 45 thousand laborers, whereas the Rest of the World has 100 thousand acres

of land 200 thousand laborers. These countries produce the labor intensive good A, and the land intensive good B.

39. Based on the above information, Pugelovia is relatively:

a. Labor-abundant.

b. Labor-intensive.

c. Land-abundant.

d. Land-intensive.

ANSWER: A

40. Based on the above information, Pugelovia will:

a. Not trade with the Rest of the World.

b. Export good B, and import good A.

c. Export good A, and import good B.

d. Import both good A and good B.

ANSWER: C

International Price = 1

C/W

41. Figure 4.2 illustrates the production possibilities curve of Pugelovia. This country can produce only wine and

cheese, and trade these products with the rest of the world. Pugelovias production possibilities curve indicates

that this country has __________ marginal costs of production.

a. Constant

b. Increasing

c. Decreasing

d. Progressive

ANSWER: B

42. Refer to Figure 4.2. Pugelovia imports:

a. 20 units of wine.

b. 20 units of cheese.

c. 50 units of wine.

d. 80 units of cheese.

ANSWER: B

43. Refer to Figure 4.2. Pugelovia exports:

a. 50 units of wine.

b. 50 units of cheese.

c. 30 units of wine.

d. 80 units of cheese.

ANSWER: B


44. Increasing-cost production-possibility curves are bowed out from the origin.

ANSWER: TRUE

45. Increasing-cost production-possibility curves lead to partial specialization.

ANSWER: TRUE

46. In the two-country, two-good model, the opening of trade will necessarily lead to complete specialization in the

production of one good by one country and complete specialization in the production of the other good by the

other country.

ANSWER: FALSE

47. Increasing marginal costs of production arise as a result of the fact that different inputs to production are used in

different proportions in the production of different goods.

ANSWER: TRUE

48. As a country moves up along its bowed-out production possibility curve, the opportunity cost of producing more

of the good on the y-axis decreases.

ANSWER: FALSE

49. The production-possibility curve does not provide enough information to determine the amount of each good

produced by the economy.

ANSWER: TRUE

50. The comparison of the production-possibility curves of the two countries in the two-country, two-good model with

constant-cost production-possibility curves is sufficient to determine the specialization point, but insufficient to

determine the specialization point with increasing-cost production-possibility curves.

ANSWER: TRUE

51. Indifference curves show the various bundles of consumption quantities that lead to the same level of well-being.

ANSWER: TRUE

52. Heckscher-Ohlin theory relies upon the factor proportions used in the production of different goods and

differences in the endowments of different factors in different countries to explain international trade patterns.

ANSWER: TRUE

53. If the proportion of labor to capital in a country is greater than the proportion of labor to capital in the rest of the

world, we can conclude that the country is labor abundant and will have a comparative advantage in the

production of goods that use capital intensively.

ANSWER: FALSE

54. If Country A is relatively abundant in labor and Country B is relatively abundant in capital, Heckscher-Ohlins theory

predicts that Country A will export relatively labor-intensive goods and Country B will export relatively capital-

intensive goods.

ANSWER: TRUE

55. If Country A is relatively land-abundant and Country B is relatively labor-abundant, Heckscher-Ohlin theory predicts

that Country A will export textiles (a relatively labor-intensive good) and Country B will export corn (a relatively

land-intensive good).

ANSWER: FALSE

56. The Heckscher-Ohlin theory of trade differs from the Ricardian model by assuming that there are only two goods.

ANSWER: FALSE

57. In contrast to the Ricardian model, the Heckscher-Ohlin model assumes that production has increasing marginal

costs.

ANSWER: TRUE

58. The community indifference curves illustrate the technological capabilities of a country.

ANSWER: FALSE

59. The production possibilities curve illustrates the consumption preferences of a countrys population, and explains

why all people prefer to be employed rather than unemployed.

ANSWER: FALSE

60. According to the Heckscher-Ohlin model, countries will engage in trade only if they have different production

technologies.

ANSWER: FALSE

Essay Questions

61. Explain the differences between the two-country two-good model with constant costs of production and the model

with increasing costs of production. Adequately describe the production possibilities curves for each country in

each case. Describe production, consumption, and the degree of specialization in each country under both cost

situations.

POSSIBLE RESPONSE: If the cost of production of each good is constant, the opportunity cost of production of one

good (in terms of production foregone of the other good) is also constant. In an economy with constant cost of

production, the production possibilities curve (ppc) is a straight line. In such a situation it is beneficial for a country

to fully specialize in the production of one good, and export this good in exchange for imports of the other good.

The good that will be produced is the good with an opportunity cost that is lower than the relative international

price of this good (the price of the good expressed in units of the other good). Conversely, the good with an

opportunity cost higher than the international price will be imported. The result is complete specialization.

This reasoning is behind Ricardos idea of comparative advantage and complete specialization. Ricardo assumed

that all goods are produced with one factor of production labor, and in order to double the production of a

product, a producer just needs to double the amount of the input factor the labor hours. Realistically, however,

production requires a variety of factor inputs: land, skilled labor, unskilled labor, capital, etc., and different

products use factor inputs in different proportions. The basic variation of these inputs leads to an increasing cost of

production. That means the production possibilities curve is bowed out. In other words, the opportunity cost of

production of one good is not constant but rather increasing with the increased production of this good. When a

country is opened to trade only a partial specialization will be observed.

62. Explain why constant costs of production result in complete specialization and why increasing costs of production

result in partial specialization.

POSSIBLE RESPONSE: Constant cost of production implies constant opportunity cost, which is the amount of the

other good that must be foregone to increase the production of a certain good with one unit. If a good has a higher

opportunity cost compared to the relative international price of this good, then it is beneficial for a country to

produce the other good and export it in exchange for imports of this good. Because the opportunity cost does not

change with the increased production of the other good, it will be beneficial for the country to completely

specialize in the good with opportunity cost lower than the international price, and import the other good.

With increasing cost of production, the opportunity cost of a good is increasing with the increased production.

Optimally, the country will produce the two goods in such a proportion, that the opportunity cost is equal to the

international price ratio. With increasing opportunity cost this implies a partial specialization.

63. Is the following statement true or false and why? In the two-good, two-country model with increasing costs, the

degree of specialization is determined only by considering societys preferences as illustrated with indifference

curves. However, in the same model, it is possible to determine the post-trade consumption point in each country

without indifference curves.

POSSIBLE RESPONSE: The community indifference curves reflect the preferences of the countrys consumers for

consumption of both goods. With or without trade, the production decision of a country will depend on the

technology and the available factors of production (production possibilities curve), on the one hand, and the

preferences of the consumers toward the consumption of the two goods (indifference curves) on the other hand.

Without a free trade the consumption point coincides with the production. When international trade is allowed,

the consumption point does not coincide with the production point anymore, but reflects both production and

trade. It is not possible to determine post-trade consumption in each country without indifference curves as we

will not know which consumption point is preferred by the consumers in the country.



land. Further assume that the United States is capital-abundant and steel production is capital-intensive. Suppose

that in autarky the United States operates at a point on its production possibilities curve where it produces 20 units

of wheat and 20 units of steel. Once international trade opens, the international price of one unit of steel is two

units of wheat. In response to the opening of trade the United States moves along its production possibilities curve

to a new point where it produces 30 units of steel and 10 units of wheat. Is the United States better-off following

the opening of trade? Provide a logical proof of your answer.

POSSIBLE RESPONSE: The opening of trade allows the United States to (partially) specialize in the production of

steel because steel is capital intensive and the United States is capital abundant. We need to compare the well-

being of the United States in the case of autarky to the case of free trade. In autarky the United States would

consume 20 units of steel and 20 units of wheat.

When free trade is allowed, the United States can extend the production of steel to 30 units, that is, by 10 units.

The foregone wheat is also 10 units; the production of wheat goes down from 20 to 10 units. But the United

States can exchange steel for wheat in the proportion 1 unit of steel for 2 units of wheat. If the United States would

sell the 10 more units of steel produced for 20 units of wheat, the United States would end up in a situation in

which it consumes 30 units of wheat and 20 units of steel. This is better than the autarky situation of only 20 units

of wheat and 20 units of steel. The country is thus better off in the case of free trade.

65. As a result of the North American Free Trade Agreement (NAFTA), trade restrictions between Canada, the United

States, and Mexicowere eased and cross-border trade increased. What predictions would the Heckscher-Ohlin

model make concerning the changes in labor-intensive industries such as textiles in both Mexico and the United

States and in capital-intensive-industries such as steel production in both Mexico and the United States as a result

of NAFTA?

POSSIBLE RESPONSE: The Heckscher-Ohlin model predicts that free trade will allow countries to specialize in the

production of goods that intensively use their relatively abundant factors of production. Applied to NAFTA, the

Heckscher-Ohlin model implies thatMexico will extend its production in industries such as textiles as they require

the intensive use of labor. The United States, on the other hand, will expand its production of steel, which is a

capital-intensive industry.

66. Explain how tastes or preferences can reverse the predictions made by the Heckscher-Ohlin trade model so that,

for example, labor-abundant countries import labor-intensive goods.

POSSIBLE RESPONSE: The production decision of a country depends not only on the available factors of production,

but also on the technology of the country, and the preferences of the consumers within the country. The

preferences of consumers of this country as well as other countries define the international demand for a product.

Conversely, factor availability, and technology define the international supply of a product. If consumers within a

country value labor-intensive goods so much that the marginal satisfaction of this product is higher than the

opportunity cost of production, then it possible that this country consumes more than their own production of

labor-intensive goods, which means the country is importing these goods from other countries.

67. Using the concepts of community indifference curves and production possibilities frontier, explain how the

international price of a good is determined in the Heckscher-Ohlin two goods model. What is the unit of

measurement for the price of a good in this model?

POSSIBLE RESPONSE: The production possibilities curve (ppc) illustrates the maximal quantities of two goods that a

country can produce with full employment of its resources. What combination of quantities along the ppc

producers will eventually decide to produce depends on the relative price of the good (the price is expressed in

units of the other good). A community indifference curve indicates all combinations of quantities of the two goods,

which provide the same satisfaction to the community. The ppc can be used to derive the marginal cost of a

product (expressed in units of the other product to be given up), which defines the supply of this product. The

system of indifference curves can be used to derive the demand of the product. The international price of a good in

the Hecksher-Olin model is determined in such a way, that the excess supply in one of the countries is matched by

the shortage (excess demand) in the other country. The first country exports the good in exchange for importing

the other good.

68. Explain why the Heckscher-Olin model predicts only partial specialization in the production of two goods, while

Ricardos comparative advantage model predicts full specialization.

POSSIBLE RESPONSE: Ricardo considered only labor as a production resource and believed that production has

constant costs. That is, to double production, the producer just needs to employ twice as much labor. The

opportunity cost in Ricardos model is constant, which implies that the production possibilities curve is a straight

line. Assume that a country faces a relative international price of a product that is, lets say, lower than the

opportunity cost of production of that product. That means, it is cheaper to buy that product at international

market in exchange for the other product rather than use their own labor for producing it. Their own labor will be

more efficiently employed in the production of the other product. Because the marginal cost is the same no matter

how much of both products is produced, the country specializes fully in the production of the product that has a

lower opportunity cost compared to the international price, and exchanges it for the other at the international

market.

This is the major difference to the Heckscher-Ohlin model. In this model, opportunity cost is increasing, so there

will be a certain quantity combination of the two goods along the production possibilities curve, for which

opportunity cost matches the relative (international) price. This is the optimal combination of production

quantities for the country.

Chapter 5 Who Gains and Who Loses from Trade?


1. Which of the following is NOT true about trade?

a. Trade will cause expansion in the export-oriented sector.

b. Trade will cause contraction in the import-competing sector.

c. Trade occurs because of similarities in the availability of factor inputs across countries

and differences in the proportions of those factors that are used in producing different

products.


ANSWER: C

2. According to the Stolper-Samuelson theorem, in the short-run, following the opening of trade:

a. Workers can change jobs but will receive the same wage.

b. Workers will suffer from lower wages but land owners will benefit from higher rents.

c. All groups tied to declining sectors of the economy will suffer from lower returns.

d. Output remains constant.

ANSWER: C

3. According to the Heckscher-Ohlin theorem, in the short-run, following the opening of trade:

a. Inputs are mobile across sectors, but input returns remain constant.

b. Capital and labor will move to better-paying sectors.

c. Land owners will benefit from higher rents.

d. Workers will experience lower wages due to cheap imports.

ANSWER: B

4. The theory that predicts that trade occurs because of differences in the availability of factor

inputs across countries and the differences in the proportions in which the factor inputs are

used in producing different products is called:

a. The Stolper-Samuelson theory.

b. The Heckscher-Ohlin theory.

c. Comparative advantage.

d. Absolute advantage.

ANSWER: B

5. Trade occurs because of __________ in the availability of factor inputs across countries and

the differences in the proportions of those factors that are used in producing different goods.

Trade causes __________ in the export-oriented sector and __________ in the import-

competing sector.

a. differences; expansion; contraction

b. similarities; expansion; contraction

c. similarities; contraction; expansion

d. differences; contraction; expansion

ANSWER: A

6. In the long-run, following the opening of trade, a labor-abundant country will:

a. Employ less labor than it did pre-trade.

b. Produce goods using a higher land to labor ratio than it did pre-trade.

c. Produce goods using a lower land to labor ratio than it did pre-trade.

d. Experience higher rents and wages.

ANSWER: C

7. The opening of trade between a land-abundant country and a labor-abundant country should

lead to:

a. Higher rents and wages in both countries.

b. Lower rents and wages in both countries.

c. Higher rents in the labor-abundant country and higher wages in the land-abundant

country.

d. Lower rents in the labor-abundant country and lower wages in the land-abundant

country.

ANSWER: D

8. Given the assumptions of the Heckscher-Ohlin model, the opening of trade in a land-abundant

country will cause the domestic price of wheat to:

a. Fall.

b. Rise.

c. Be unaffected.

d. At first rise but then fall back to its original level.

ANSWER: B

9. The Stolper-Samuelson theorem states that given certain assumptions and conditions:

a. The real return to the factor used intensively in the import-competing industry will rise

in the long-run.

b. The real return to the factor used intensively in the export industry will fall in the long-

run.

c. The real return to the factor used in the rising price industry will rise in the long-run.

d. The real return to the factor used intensively in the export industry will rise in the long-

run.

ANSWER: D

10. If the domestic country is labor abundant, which of the following groups will gain in the short-

run, but lose in the long-run?

a. Domestic landowners in the farming sector.

b. Domestic landowners in the cloth-making sector.

c. Foreign landowners in the farming sector.

d. Foreign workers in the cloth-making sector.

ANSWER: B

11. The Stolper-Samuelson theorem would predict that trade between the United States, a capital-

abundant country, and Mexico, a labor-abundant country, should lead to:

a. Higher wages in both countries.

b. Lower wages in both countries.

c. Higher wages in Mexico.

d. Lower wages in Mexico.

ANSWER: C

12. According to the factor-price-equalization theorem, free trade equalizes:

a. Product prices as well as the prices of individual factors of production between two

countries.

b. Product prices between two countries but not the prices of individual factors of

production.

c. Product prices between two countries and factor prices within each country but not

between countries.

d. Product prices and factor prices within each country but not between countries.

ANSWER: A

13. The factor-price-equalization theorem tells us that free trade between two countries should

lead to:

a. All workers in the two countries earning the same wage rate.

b. All workers in the two countries having the same skill level.

c. All workers of the same skill level earning the same wage rate in the two countries.

d. All factors of production earning the same amount within each country.

ANSWER: C

14. According to the Stolper-Samuelsom theorem, an increase in the price of a countrys imports

would:

a. Lower the returns to all factors of production within the country.

b. Raise the returns to all factors of production within the country.

c. Lower the returns to the factor of production used relatively intensively in the import-

competing industry.

d. Raise the returns to the factor of production used relatively intensively in the import-

competing industry.

ANSWER: D

15. According to the Stolper-Samuelsom theorem, a decrease in the price of a countrys exports

would:

e. Lower the returns to all factors of production with

Documents

International Economics MCQ