CHAPTER 2FOUNDATIONS OF MODERN TRADE THEORY: COMPARATIVE

ADVANTAGE
MULTIPLE CHOICE
1. The mercantilists would have objected to:
a
.
Export promotion policies initiated by the government
b
.
The use of tariffs or quotas to restrict imports
c
.
Trade policies designed to accumulate gold and other precious metals
d
.
International trade based on open marets
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&. 'nlie the mercantilists( !dam #mith maintained that:
a
.
Trade benefits one nation only at the expense of another nation
b
.
)overnment control of trade leads to maximum economic welfare
c
.
!ll nations can gain from free international trade
d
.
The world*s output of goods must remain constant over time
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,. The trading principle formulated by !dam #mith maintained that:
a
.
International prices are determined from the demand side of the maret
b
.
$ifferences in resource endowments determine comparative advantage
c
.
$ifferences in income levels govern world trade patterns
d
.
!bsolute cost differences determine the immediate basis for trade
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-. 'nlie !dam #mith( $avid .icardo*s trading principle emphasi/es the:
a
.
$emand side of the maret
b
.
#upply side of the maret
c
.
.ole of comparative costs
d .ole of absolute costs
.
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0. 1hen a nation requires fewer resources than another nation to produce a product( the nation is said to
have a:
a
.
!bsolute advantage in the production of the product
b
.
+omparative advantage in the production of the product
c
.
2ower marginal rate of transformation for the product
d
.
2ower opportunity cost of producing the product
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3. !ccording to the principle of comparative advantage( speciali/ation and trade increase a nation*s total
output since:
a
.
.esources are directed to their highest productivity
b
.
The output of the nation*s trading partner declines
c
.
The nation can produce outside of its production possibilities curve
d
.
The problem of unemployment is eliminated
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4. In a two5product( two5country world( international trade can lead to increases in:
a
.
+onsumer welfare only if output of both products is increased
b
.
6utput of both products and consumer welfare in both countries
c
.
Total production of both products( but not consumer welfare in both countries
d
.
+onsumer welfare in both countries( but not total production of both products
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8. !s a result of international trade( speciali/ation in production tends to be:
a
.
+omplete with constant costs55complete with increasing costs
b
.
+omplete with constant costs55incomplete with increasing costs
c Incomplete with constant costs55complete with increasing costs
.
d
.
Incomplete with constant costs55incomplete with increasing costs
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9. ! nation that gains from trade will find its consumption point being located:
a
.
Inside its production possibilities curve
b
.
!long its production possibilities curve
c
.
6utside its production possibilities curve
d
.
"one of the above
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Table 2.1. Outut P!""#b#l#t#e" !$ t%e U.S. a&' t%e U.(.
6utput per 1orer per day
+ountry Tons of #teel Televisions
'nited #tates 10 -0
'nited :ingdom 1; &;
1;. .eferring to Table &.1( the 'nited #tates has the absolute advantage in the production of:
a
.
#teel
b
.
Televisions
c
.
7oth steel and televisions
d
.
"either steel nor televisions
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11. .eferring to Table &.1( the 'nited :ingdom has a comparative advantage in the production of:
a
.
#teel
b
.
Televisions
c
.
7oth steel and televisions
d
.
"either steel nor televisions
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1&. .efer to Table &.1. If trade opens up between the 'nited #tates and the 'nited :ingdom( !merican
firms should speciali/e in producing:
a
.
#teel
b
.
Televisions
c
.
7oth steel and televisions
d
.
"either steel nor televisions
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1,. .eferring to Table &.1( the opportunity cost of producing one ton of steel in the 'nited #tates is:
a
.
, televisions
b
.
1; televisions
c
.
&; televisions
d
.
-0 televisions
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1-. .efer to Table &.1. <utually advantageous trade will occur between the 'nited #tates and the 'nited
:ingdom so long as one ton of steel trades for:
a
.
!t least 1 television( but no more than & televisions
b
.
!t least & televisions( but no more than , televisions
c
.
!t least , televisions( but no more than - televisions
d
.
!t least - televisions( but no more than 0 televisions
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10. .eferring to Table &.1( the 'nited :ingdom gains most from trade if:
a
.
1 ton of steel trades for & televisions
b
.
1 ton of steel trades for , televisions
c
.
& tons of steel trade for - televisions
d
.
& tons of steel trade for 0 televisions
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13. +oncerning international trade restrictions( which of the following is false= Trade restrictions:
a
.
2imit speciali/ation and the division of labor
b
.
.educe the volume of trade and the gains from trade
c
.
+ause nations to produce inside their production possibilities curves
d
.
<ay result in a country producing some of the product of its comparative disadvantage
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14. If a production possibilities curve is bowed out >i.e.( concave? in appearance( production occurs under
conditions of:
a
.
+onstant opportunity costs
b
.
Increasing opportunity costs
c
.
$ecreasing opportunity costs
d
.
@ero opportunity costs
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18. Increasing opportunity costs suggest that:
a
.
.esources are not perfectly shiftable between the production of two goods
b
.
.esources are fully shiftable between the production of two goods
c
.
! country*s production possibilities curve appears as a straight line
d
.
! country*s production possibilities curve is bowed inward >i.e.( convex? in appearance
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19. The trading5triangle concept is used to indicate a nation*s:
a
.
Exports( marginal rate of transformation( terms of trade
b
.
Imports( terms of trade( marginal rate of transformation
c
.
<arginal rate of transformation( imports( exports
d
.
Terms of trade( exports( imports
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&;. !ssuming increasing cost conditions( trade between two countries would not be liely if they have:
a
.
Identical demand conditions but different supply conditions
b
.
Identical supply conditions but different demand conditions
c
.
$ifferent supply conditions and different demand conditions
d
.
Identical demand conditions and identical supply conditions
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Table 2.2. Outut !""#b#l#t#e" $!) S!ut% (!)ea a&' *aa&
6utput per worer per day
+ountry Tons of steel A+.s
#outh :orea 8; -;
Bapan &; &;
&1. .eferring to Table &.&( the opportunity cost of one A+. in Bapan is:
a
.
1 ton of steel
b
.
& tons of steel
c
.
, tons of steel
d
.
- tons of steel
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&&. .eferring to Table &.&( the opportunity cost of one A+. in #outh :orea is:
a
.
1C& ton of steel
b
.
1 ton of steel
c
.
1 1C& tons of steel
d
.
& tons of steel
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&,. .efer to Table &.&. !ccording to the principle of absolute advantage( Bapan should:
a
.
Export steel
b
.
Export A+.s
c
.
Export steel and A+.s
d
.
"one of the aboveD there is no basis for gainful trade
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&-. .efer to Table &.&. !ccording to the principle of comparative advantage:
a
.
#outh :orea should export steel
b
.
#outh :orea should export steel and A+.s
c
.
Bapan should export steel
d
.
Bapan should export steel and A+.s
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&0. .efer to Table &.&. 1ith international trade( what would be the maximum amount of steel that #outh
:orea would be willing to export to Bapan in exchange for each A+.=
a
.
1C& ton of steel
b
.
1 ton of steel
c
.
151C& tons of steel
d
.
& tons of steel
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&3. .efer to Table &.&. 1ith international trade( what would be the maximum number of A+.s that Bapan
would be willing to export to #outh :orea in exchange for each ton of steel=
a
.
1 A+.
b
.
& A+.s
c
.
, A+.s
d
.
- A+.s
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&4. The earliest statement of the principle of comparative advantage is associated with:
a
.
!dam #mith
b
.
$avid .icardo
c
.
Eli Eecscher
d
.
7ertil 6hlin
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&8. If Eong :ong and Taiwan had identical labor costs but were subject to increasing costs of production:
a
.
Trade would depend on differences in demand conditions
b
.
Trade would depend on economies of large5scale production
c
.
Trade would depend on the use of different currencies
d
.
There would be no basis for gainful trade
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&9. If the international terms of trade settle at a level that is between each country*s opportunity cost:
a
.
There is no basis for gainful trade for either country
b
.
7oth countries gain from trade
c
.
6nly one country gains from trade
d
.
6ne country gains and the other country loses from trade
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,;. International trade is based on the notion that:
a
.
$ifferent currencies are an obstacle to international trade
b
.
)oods are more mobile internationally than are resources
c
.
.esources are more mobile internationally than are goods
d
.
! country*s exports should always exceed its imports
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F#+u)e 2.1. P)!'u,t#!& P!""#b#l#t#e" S,%e'ule
,1. .eferring to Figure &.1( the relative cost of steel in terms of aluminum is:
a
.
-.; tons
b
.
&.; tons
c
.
;.0 tons
d
.
;.&0 tons
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,&. .eferring to Figure &.1( the relative cost of aluminum in terms of steel is:
a
.
-.; tons
b
.
&.; tons
c
.
;.0 tons
d
.
;.&0 tons
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,,. .efer to Figure &.1. If the relative cost of steel were to rise( then the production possibilities schedule
would:
a
.
7ecome steeper
b
.
7ecome flatter
c #hift inward in a parallel manner
.
d
.
#hift outward in a parallel manner
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,-. .efer to Figure &.1. If the relative cost of aluminum were to rise( then the production possibilities
schedule would:
a
.
7ecome steeper
b
.
7ecome flatter
c
.
#hift inward in a parallel manner
d
.
#hift outward in a parallel manner
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,0. 1hen a nation achieves autary equilibrium:
a
.
Input price equals final product price
b
.
2abor productivity equals the wage rate
c
.
Imports equal exports
d
.
%roduction equals consumption
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,3. 1hen a nation is in autary and maximi/es its living standard( its consumption and production points
are:
a
.
!long the production possibilities schedule
b
.
!bove the production possibilities schedule
c
.
7eneath the production possibilities schedule
d
.
!ny of the above
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,4. If +anada experiences increasing opportunity costs( its supply schedule of steel will be:
a
.
$ownward5sloping
b 'pward5sloping
.
c
.
Eori/ontal
d
.
Aertical
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,8. If +anada experiences constant opportunity costs( its supply schedule of steel will be:
a
.
$ownward5sloping
b
.
'pward5sloping
c
.
Eori/ontal
d
.
Aertical
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,9. The gains from international trade increase as:
a
.
! nation consumes inside of its production possibilities schedule
b
.
! nation consumes along its production possibilities schedule
c
.
The international terms of trade rises above the nation*s autary price
d
.
The international terms of trade approaches the nation*s autary price
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-;. In a two5country( two5product world( the statement GBapan enjoys a comparative advantage over
France in steel relative to bicyclesG is equivalent to:
a
.
France having a comparative advantage over Bapan in bicycles relative to steel
b
.
France having a comparative disadvantage against Bapan in bicycles and steel
c
.
Bapan having a comparative advantage over France in steel and bicycles
d
.
Bapan having a comparative disadvantage against Bapan in bicycles and steel
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-1. .icardo*s theory of comparative advantage was of limited real5world validity because it was founded
on the:
a 2abor theory of value
.
b
.
+apital theory of value
c
.
2and theory of value
d
.
Entrepreneur theory of value
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-&. !ssume that labor is the only factor of production and that wages in the 'nited #tates equal H&; per
hour while wages in the 'nited :ingdom equal H1; per hour. %roduction costs would be lower in the
'nited #tates than the 'nited :ingdom if:
a
.
'.#. labor productivity equaled -; units per hour while '.:. labor productivity equaled
10 units per hour
b
.
'.#. labor productivity equaled ,; units per hour while '.:. labor productivity equaled
&; units per hour
c
.
'.#. labor productivity equaled &; units per hour while '.:. labor productivity equaled
,; units per hour
d
.
'.#. labor productivity equaled 10 units per hour while '.:. labor productivity equaled
&0 units per hour
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-,. !ccording to .icardo( a country will have a comparative advantage in the product in which its:
a
.
2abor productivity is relatively low
b
.
2abor productivity is relatively high
c
.
2abor mobility is relatively low
d
.
2abor mobility is relatively high
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--. The .icardian model of comparative advantage is based on all of the following assumptions except:
a
.
6nly two nations and two products
b
.
%roduct quality varies among nations
c
.
2abor is the only factor of production
d
.
2abor can move freely within a nation
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-0. The writings of ). <ac$ougall emphasi/ed which of the following as an explanation of a country*s
competitive position=
a
.
"ational income levels
b
.
.elative endowments of natural resources
c
.
$omestic tastes and preferences
d
.
2abor compensation and productivity levels
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-3. The introduction of community indifference curves into our trading example focuses attention on the
nation*s:
a
.
Income level
b
.
.esource prices
c
.
Tastes and preferences
d
.
%roductivity level
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-4. Introducing indifference curves into our trade model permits us to determine:
a
.
1here a nation chooses to locate along its production possibilities curve in autary
b
.
The precise location of a nation*s production possibilities curve
c
.
1hether absolute cost or comparative cost conditions exist
d
.
The currency price of one product in terms of another product
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-8. In the absence of trade( a nation is in equilibrium where a community indifference curve:
a
.
2ies above its production possibilities curve
b
.
Is tangent to its production possibilities curve
c
.
Intersects its production possibilities curve
d
.
2ies below its production possibilities curve
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-9. The use of indifference curves helps us determine the point:
a
.
!long the terms5of5trade line a country will choose
b
.
1here a country maximi/es its resource productivity
c
.
!t which a country ceases to become competitive
d
.
1here the marginal rate of transformation approaches /ero
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0;. 1ith trade( a country will maximi/e its satisfaction when it:
a
.
<oves to the highest possible indifference curve
b
.
Forces the marginal rate of substitution to its lowest possible value
c
.
+onsumes more of both goods than it does in autary
d
.
Finds its marginal rate of substitution exceeding its marginal rate of transformation
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01. Trade between two nations would not be possible if they have:
a
.
Identical community indifference curves but different production possibilities curves
b
.
Identical production possibilities curves but different community indifference curves
c
.
$ifferent production possibilities curves and different community indifference curves
d
.
Identical production possibilities curves and identical community indifference curves
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0&. )iven a two5country and two5product world( the 'nited #tates would enjoy all the attainable gains
from free trade with +anada if it:
a
.
Trades at the '.#. rate of transformation
b
.
Trades at the +anadian rate of transformation
c
.
#peciali/es completely in the production of both goods
d
.
#peciali/es partially in the production of both goods
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0,. Bohn #tuart <ill*s theory of reciprocal demand best applies when trading partners:
a
.
!re of equal si/e and importance in the maret
b
.
%roduce under increasing cost conditions
c
.
%artially speciali/e in the production of commodities
d
.
Eave similar taste and preference levels
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0-. The equilibrium prices and quantities established after trade are fully determinate if we now:
a
.
The location of all countries* indifference curves
b
.
The shape of each country*s production possibilities curve
c
.
The comparative costs of each trading partner
d
.
The strength of world supply and demand for each good
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00. GThe equilibrium relative commodity price at which trade taes place is determined by the conditions
of demand and supply for each commodity in both nations. 6ther things being equal( the nation with
the more intense demand for the other nation*s exported good will gain less from trade than the nation
with the less intense demand.G This statement was first proposed by:
a
.
!lfred <arshall with offer curve analysis
b
.
Bohn #tuart <ill with the theory of reciprocal demand
c
.
!dam #mith with the theory of absolute advantage
d
.
$avid .icardo with the theory of comparative advantage
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03. 1hich of the following terms5of5trade concepts is calculated by dividing the change in a country*s
export price index by the change in its import price index between two points in time( multiplied by
1;; to express the terms of trade in percentages=
a
.
+ommodity terms of trade
b
.
<arginal rate of transformation
c
.
<arginal rate of substitution
d
.
!utary price ratio
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04. The best explanation of the gains from trade that $avid .icardo could provide was to describe only the
outer limits within which the equilibrium terms of trade would fall. This is because .icardo*s theory
did not recogni/e how maret prices are influenced by:
a
.
$emand conditions
b
.
#upply conditions
c
.
7usiness expectations
d
.
%rofit patterns
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08. 'nder free trade( #weden enjoys all of the gains from trade with Eolland if #weden:
a
.
Trades at Eolland*s rate of transformation
b
.
Trades at #weden*s rate of transformation
c
.
#peciali/es completely in the production of its export good
d
.
#peciali/es partially in the production of its export good
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09. 7ecause the .icardian trade theory recogni/ed only how supply conditions influence international
prices( it could determine:
a
.
The equilibrium terms of trade
b
.
The outer limits for the terms of trade
c
.
1here a country chooses to locate along its production possibilities curve
d
.
1here a country chooses to locate along its trade triangle
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3;. The terms of trade is given by the prices:
a
.
%aid for all goods imported by the home country
b .eceived for all goods exported by the home country
.
c
.
.eceived for exports and paid for imports
d
.
6f primary products as opposed to manufactured products
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Table 2.-. Te)." !$ T)a'e
Export %rice Index Import %rice Index
+ountry 199; &;;- 199; &;;-
<exico 1;; &&; 1;; &;;
#weden 1;; 13; 1;; 10;
#pain 1;; 100 1;; 100
France 1;; 14; 1;; &,;
$enmar 1;; 1&; 1;; 1&0
31. .eferring to Table &.,( which countries* terms of trade improved between 199; and &;;-=
a
.
<exico and $enmar
b
.
#weden and $enmar
c
.
#weden and #pain
d
.
<exico and #weden
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3&. .eferring to Table &.,( which countries* terms of trade worsened between 199; and &;;-=
a
.
#pain and <exico
b
.
<exico and France
c
.
France and $enmar
d
.
$enmar and #weden
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3,. .eferring to Table &.,( which country*s terms of trade did not change between 199; and &;;-=
a
.
#pain
b
.
#weden
c France
.
d
.
$enmar
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3-. )iven free trade( small nations tend to benefit the most from trade since they:
a
.
!re more productive than their large trading partners
b
.
!re less productive than their large trading partners
c
.
Eave demand preferences and income levels lower than their large trading partners
d
.
Enjoy terms of trade lying near the opportunity costs of their large trading partners
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30. ! terms5of5trade index that equals 10; indicates that compared to the base year:
a
.
It requires a greater output of domestic goods to obtain the same amount of foreign
goods
b
.
It requires a lesser amount of domestic goods to obtain the same amount of foreign goods
c
.
The price of exports has risen from H1;; to H10;
d
.
The price of imports has risen from H1;; to H10;
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33. ! term5of5trade index that equals 9; indicates that compared to the base year:
a
.
It requires a greater output of domestic goods to obtain the same amount of foreign
goods
b
.
It requires a lesser amount of domestic goods to obtain the same amount of foreign goods
c
.
The price of exports has fallen from H1;; to H9;
d
.
The price of imports has fallen from H1;; to H9;
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34. The theory of reciprocal demand does not well apply when one country:
a
.
%roduces under constant cost conditions
b
.
%roduces along its production possibilities curve
c Is of minor economic importance in the world maretplace
.
d
.
%artially speciali/es the production of its export good
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38. The terms of trade is given by:
a
.
>%rice of exportsCprice of imports? 1;;
b
.
>%rice of exportsCprice of imports? I 1;;
c
.
>%rice of exportsCprice of imports? 1;;
d
.
>%rice of exportsCprice of imports? 1;;
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39. If Bapan and France have identical production possibilities curves and identical community
indifference curves:
a
.
Bapan will enjoy all the gains from trade
b
.
France will enjoy all the gains from trade
c
.
Bapan and France share equally in the gains from trade
d
.
)ainful speciali/ation and trade are not possible
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4;. ! rise in the price of imports or a fall in the price of exports will:
a
.
Improve the terms of trade
b
.
1orsen the terms of trade
c
.
Expand the production possibilities curve
d
.
+ontract the production possibilities curve
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41. ! fall in the price of imports or a rise in the price of exports will:
a
.
Improve the terms of trade
b
.
1orsen the terms of trade
c
.
Expand the production possibilities curve
d
.
+ontract the production possibilities curve
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4&. 'nder free trade( +anada would not enjoy any gains from trade with #weden if +anada:
a
.
Trades at the +anadian rate of transformation
b
.
Trades at #weden*s rate of transformation
c
.
#peciali/es completely in the production of its export good
d
.
#peciali/es partially in the production of its export good
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Figure 2.2 illustrates trade data for Canada. The figure assumes that Canada attains international
trade equilibrium at point C.
F#+u)e 2.2. Ca&a'#a& T)a'e P!""#b#l#t#e"
4,. +onsider Figure &.&. In the absence of trade( +anada would produce and consume:
a
.
8 televisions and 13 refrigerators
b
.
1& televisions and 13 refrigerators
c
.
8 televisions and 1& refrigerators
d
.
1& televisions and 8 refrigerators
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4-. .eferring to Figure &.&( +anada has a comparative advantage in:
a
.
Televisions
b
.
.efrigerators
c
.
Televisions and refrigerators
d
.
"either televisions nor refrigerators
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40. +onsider Figure &.&. 1ith speciali/ation( +anada produces:
a
.
13 televisions
b
.
1& televisions and 8 refrigerators
c
.
8 televisions and 13 refrigerators
d
.
&- refrigerators
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43. +onsider Figure &.&. 1ith trade( +anada consumes:
a
.
1& televisions and 8 refrigerators
b
.
1& televisions and 13 refrigerators
c
.
8 televisions and 13 refrigerators
d
.
&- refrigerators
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44. !ccording to Figure &.&( exports for +anada total:
a
.
13 refrigerators
b
.
8 refrigerators
c
.
1& refrigerators
d
.
13 refrigerators
!"#: 7 %T#: 1
48. !ccording to Figure &.&( imports for +anada total:
a
.
3 televisions
b
.
8 televisions
c
.
1& televisions
d
.
13 televisions
!"#: + %T#: 1
49. +oncerning possible determinants of international trade( which are sources of comparative advantage=
$ifferences in:
a
.
<ethods of production
b
.
Tastes and preferences
c
.
Technological now5how
d
.
!ll of the above
!"#: $ %T#: 1
8;. .icardo*s model of comparative advantage assumed all of the following except:
a
.
In each nation( labor is the only input
b
.
+osts do not vary with the level of production
c
.
%erfect competition prevails in all marets
d
.
Transportation costs rise as distance increases between countries
!"#: $ %T#: 1
81. .icardo*s model of comparative advantage assumed all of the following except:
a
.
Trade is balanced( thus ruling out flows of money between nations
b
.
Firms mae production decisions in an attempt to maximi/e profits
c
.
Free trade occurs between nations
d 2abor is immobile within a country( but is incapable of moving between countries
.
!"#: $ %T#: 1
8&. The dynamic gains from trade include all of the following except:
a
.
Economies of large5scale production resulting in decreasing unit cost
b
.
Increased saving and investment resulting in economic growth
c
.
Increased competition resulting in lower prices and wider range of output
d
.
Increasing comparative advantage leading to speciali/ation
!"#: $ %T#: 1
8,. !ll of the following may be exit barriers except
a
.
Employee health benefit costs
b
.
Treatment( storage and disposal costs
c
.
%enalties for terminating contracts with raw material suppliers
d
.
Increasing opportunity cost of production
!"#: $ %T#: 1
8-. Incomplete speciali/ation may be caused by
a
.
Increasing opportunity cost
b
.
'nrestricted trade
c
.
+onstant opportunity cost
d
.
$ecreasing opportunity cost
!"#: ! %T#: 1
80. Improvements in productivity may lead to decreasing comparative costs if
a
.
The assumption of fixed technologies under constant costs is relaxed
b
.
Technologies available to each nation is allowed to differ
c
.
.esource endowments are allowed to vary
d !ll of the above
.
!"#: $ %T#: 1
83. !dam #mith
a
.
1as a leading advocate of free trade
b
.
$eveloped the concept of absolute advantage
c
.
<aintained that labor costs represent the major determinant of production cost
d
.
!ll of the above
!"#: $ %T#: 1
84. <odern trade theory contends that the pattern of world trade is governed by
a
.
$ifferences in supply conditions and demand conditions
b
.
#upply conditions only
c
.
$emand conditions only
d
.
"one of the above
!"#: ! %T#: 1
88. 1hen nations are of similar si/e( and have similar taste patterns( the gains from trade
a
.
!re shared equally between them
b
.
!re impossible to determine
c
.
!re too small( so that trading is not beneficial
d
.
!re determined by the nation that has comparative advantage in the more essential
product
!"#: ! %T#: 1
89. The commodity terms of trade measures
a
.
The rate at which exports exchange for imports
b
.
The influence trade has on productivity levels
c
.
The effect on income of the trading nation
d The improvement in a nation*s welfare
.
!"#: ! %T#: 1
TRUE/FALSE
1. !ccording to the mercantilists( a nation*s welfare would improve if it maintained a surplus of exports
over imports.
!"#: T %T#: 1
&. The mercantilists maintained that a free5trade policy best enhances a nation*s welfare.
!"#: F %T#: 1
,. The mercantilists contended that because one nation*s gains from trade come the expense of its trading
partners( not all nations could simultaneously reali/e gains from trade.
!"#: T %T#: 1
-. !ccording to the price5specie5flow5doctrine( a trade5surplus nation would experience gold outflows( a
decrease in its money supply( and a fall in its price level.
!"#: F %T#: 1
0. The trade theories of !dam #mith and $avid .icardo viewed the determination of competitiveness
from the demand side of the maret.
!"#: F %T#: 1
3. !ccording to the principle of absolute advantage( international trade is beneficial to the world if one
nation has an absolute cost advantage in the production of one good while the other nation has an
absolute cost advantage in the other good.
!"#: T %T#: 1
4. The principle of absolute advantage asserts that mutually beneficial trade can occur even if one nation
is absolutely more efficient in the production of all goods.
!"#: F %T#: 1
8. The basis for trade is explained by the principle of absolute advantage according to $avid .icardo and
the principle of comparative advantage according to !dam #mith.
!"#: F %T#: 1
9. The principle of comparative advantage contends that a nation should speciali/e in and export the good
in which its absolute advantage is smallest or its absolute disadvantage is greatest.
!"#: F %T#: 1
1;. The .icardian theory of comparative advantage assumes only two nations and two products( labor can
move freely within a nation( and perfect competition exists in all marets.
!"#: T %T#: 1
11. !ssume that the 'nited #tates is more efficient than the 'nited :ingdom in the production of all
goods. <utually beneficial trade is possible according to the principle of absolute advantage( but is
impossible according to the principle of comparative advantage.
!"#: F %T#: 1
1&. It is possible for a nation not to have an absolute advantage in anythingD but it is not possible for one
nation to have a comparative advantage in everything and the other nation to have a comparative
advantage in nothing.
!"#: F %T#: 1
1,. .icardo*s theory of comparative advantage was of limited relevance to the real world since it assumed
that labor was only one of several factors of production.
!"#: F %T#: 1
1-. +ompared to .icardian trade theory( modern trade theory provides a more general view of comparative
advantage since it is based on all factors of production rather than just labor.
!"#: T %T#: 1
10. +onstant opportunity costs suggest that the relative cost of producing one product in terms of the other
will remain the same no matter where a nation chooses to locate on its production5possibilities
schedule.
!"#: T %T#: 1
13. There are two explanations of constant opportunity costs: >1? factors of production are imperfect
substitutes for each otherD >&? all units of a given factor have different qualities.
!"#: F %T#: 1
14. 1ith increasing opportunity costs( a nation totally speciali/es in the production of the commodity of its
comparative advantageD with constant opportunity costs( a nation partially speciali/es in the production
of the commodity of its comparative advantage.
!"#: F %T#: 1
18. ! nation*s trade triangle denotes its exports( imports( and terms of trade.
!"#: T %T#: 1
19. International trade leads to increased welfare if a nation can achieve a post5trade consumption point
lying inside of its production5possibilities schedule.
!"#: F %T#: 1
&;. If the '.#. post5trade consumption point lies along its production possibilities schedule( the 'nited
#tates achieves a higher level of welfare with trade than without trade.
!"#: F %T#: 1
&1. If productivity in the )erman computer industry grows faster than it does in the Bapanese computer
industry( the opportunity cost of each computer produced in Bapan increases relative to the opportunity
cost of a computer produced in )ermany.
!"#: T %T#: 1
&&. If Bapan loses competitiveness in computers( Bapanese computer worers lose jobs to foreign computer
worers and the wages of Bapanese computer worers tend to fall relative to the wages of foreign
computer worers.
!"#: T %T#: 1
&,. 1ith constant opportunity costs( a nation will achieve the greatest possible gains from trade if it
partially speciali/es in the production of the commodity of its comparative disadvantage.
!"#: F %T#: 1
&-. 7y reducing the overall volume of trade( import restrictions tend to reduce a nation*s gains from trade.
!"#: T %T#: 1
&0. 1ith increasing opportunity costs( comparative advantage depends on a nation*s supply conditions and
demand conditionsD with constant opportunity costs( comparative advantage depends only on demand
conditions.
!"#: F %T#: 1
&3. !ccording to the principle of comparative advantage( an open trading system results in resources being
channeled from uses of low productivity to those of high productivity.
!"#: T %T#: 1
&4. The existence of exit barriers tends to delay the closing of inefficient firms that face international
competitive disadvantages.
!"#: T %T#: 1
&8. <ac$ougall*s empirical study of comparative advantage was based on the notion that a product*s labor
cost is underlaid by labor productivity and the wage rate.
!"#: T %T#: 1
&9. The <ac$ougall study of comparative advantage hypothesi/ed that in those industries in which '.#.
labor productivity was relatively high( '.#. exports to the world should be lower than '.:. exports to
the world( after adjusting for wage differentials.
!"#: F %T#: 1
,;. The basic idea of mercantilism was that wealth consisted of the goods and services produced by a
nation.
!"#: F %T#: 1
,1. !ccording to !dam #mith( international trade was a Gwin5winG situation since all nations could enjoy
gains from trade.
!"#: T %T#: 1
,&. The price5specie5flow mechanism illustrated why one nation*s gains from trade were accompanied by
another country*s losses.
!"#: F %T#: 1
,,. +omplete speciali/ation usually occurs under the assumption of increasing opportunity costs.
!"#: F %T#: 1
,-. !dam #mith contended that gold( silver( and other precious metals constituted the wealth of a nation.
!"#: F %T#: 1
,0. The price5specie5flow mechanism illustrated why nations could not maintain trade surpluses or trade
deficits over the long run.
!"#: T %T#: 1
,3. The marginal rate of transformation equals the absolute slope of a country*s production possibilities
schedule.
!"#: T %T#: 1
,4. !ssume that )ermany has higher labor productivity and higher wage levels than France. )ermany can
produce a commodity more cheaply than France if its productivity differential more than offsets its
wage differential.
!"#: T %T#: 1
,8. .icardo*s theory of comparative advantage does not tae into account demand conditions when
determining relative commodity prices.
!"#: T %T#: 1
,9. If +anada has a higher wage level and higher labor productivity than <exico( +anada will necessarily
produce a good at a higher labor cost than <exico.
!"#: F %T#: 1
-;. If !rgentina has a comparative advantage over 7ra/il in beef relative to coffee( !rgentina will
speciali/e in beef production.
!"#: T %T#: 1
-1. <odern trade theory recogni/es that the pattern of world trade is governed by both demand conditions
and supply conditions.
!"#: T %T#: 1
-&. ! nation achieves autary equilibrium at the point where its community indifference curve is tangent
to its production possibilities schedule.
!"#: T %T#: 1
-,. In autary equilibrium( a nation reali/es the lowest possible level of satisfaction given the constraint of
its production possibilities schedule.
!"#: F %T#: 1
--. ! nation benefits from international trade if it can achieve a higher indifference curve than it can in
autary.
!"#: T %T#: 1
-0. ! nation reali/es maximum gains from trade at the point where the international terms5of5trade line is
tangent to its community indifference curve.
!"#: T %T#: 1
-3. The .icardian theory of comparative advantage could fully explain the distribution of the gains from
trade among trading partners.
!"#: F %T#: 1
-4. 7ecause the .icardian theory of comparative advantage was based only on a nation*s demand
conditions( it could not fully explain the distribution of the gains from trade among trading partners.
!"#: F %T#: 1
-8. 7ecause the .icardian theory of comparative advantage was based only on a nation*s supply
conditions( it could only determine the outer limits within which the equilibrium terms of trade would
lie.
!"#: T %T#: 1
-9. The domestic cost ratios of nations set the outer limits to the equilibrium terms of trade.
!"#: T %T#: 1
0;. <utually beneficial trade for two countries occurs if the equilibrium terms of trade lies between the
two countries* domestic cost ratios.
!"#: T %T#: 1
01. !ssume that the 'nited #tates and +anada engage in trade. If the international terms of trade coincides
with the '.#. cost ratio( the 'nited #tates reali/es all of the gains from trade with +anada.
!"#: F %T#: 1
0&. !ssume that the 'nited #tates and +anada engage in trade. If the international terms of trade coincides
with the +anadian cost ratio( the 'nited #tates reali/es all of the gains from trade with +anada.
!"#: T %T#: 1
0,. If the international terms of trade lies beneath >inside? the <exican cost ratio( <exico is worse off with
trade than without trade.
!"#: T %T#: 1
0-. !lthough B. #. <ill recogni/ed that the region of mutually beneficial trade is bounded by the cost
ratios of two countries( it was not until $avid .icardo developed the theory of reciprocal demand that
the equilibrium terms of trade could be determined.
!"#: F %T#: 1
00. !ccording to B. #. <ill( if we now the domestic demand expressed by both trading partners for both
products( the equilibrium terms of trade can be defined.
!"#: T %T#: 1
03. The theory of reciprocal demand asserts that as the '.#. demand for +anadian wheat rises( the
equilibrium terms of trade improve for the 'nited #tates.
!"#: F %T#: 1
04. !ssume that +anada has a comparative advantage in wheat and a comparative disadvantage in autos.
!s the +anadian demand for wheat increases( +anada*s equilibrium terms of trade improves.
!"#: F %T#: 1
08. The theory of reciprocal demand best applies when two countries are of equal economic si/e( so that
the demand conditions of each nation have a noticeable impact on maret prices.
!"#: T %T#: 1
09. The theory of reciprocal demand best applies when one country has a GlargeG economy and the other
country has a GsmallG economy.
!"#: F %T#: 1
3;. If two nations of approximately the same si/e and with similar taste patterns participate in international
trade( the gains from trade tend to be shared about equally between them.
!"#: T %T#: 1
31. The expression Gimportance of being unimportantG suggests that if one nation is much larger than the
other( the larger nation reali/es most of the gains from trade while the smaller nation reali/es fewer
gains from trade.
!"#: F %T#: 1
3&. !n improvement in a nation*s terms of trade occurs if the prices of its exports rise relative to the prices
of its imports over a given time period.
!"#: T %T#: 1
3,. If a country*s terms of trade worsen( it must exchange fewer exports for a given amount of imports.
!"#: F %T#: 1
3-. If a country*s terms of trade improve( it must exchange more exports for a given amount of imports.
!"#: F %T#: 1
30. The terms of trade represents the rate of exchange between a country*s exports and imports.
!"#: T %T#: 1
33. !ssume 199; to be the base year. If by the end of &;;- a country*s export price index rose from 1;; to
1,; while its import price index rose from 1;; to 110( its terms of trade would equal 11,.
!"#: T %T#: 1
34. !ssume 199; to be the base year. If by the end of &;;- a country*s export price index rose from 1;; to
1-; while its import price index rose from 1;; to 13;( its terms of trade would equal 1&;.
!"#: F %T#: 1
38. !ssume 199; to be the base year. If by the end of &;;- a country*s export price index rose from 1;; to
1&0 while its import price index rose from 1;; to 1&0( its terms of trade would equal 1;;.
!"#: T %T#: 1
39. The commodity terms of trade are found by dividing a country*s import price index by its export price
index.
!"#: F %T#: 1
4;. For the commodity terms of trade to improve( a country*s export price index must rise relative to its
import price index over a given time period.
!"#: T %T#: 1
41. For the commodity terms of trade to improve( a country*s import price index must rise relative to its
export price index over a given time period.
!"#: F %T#: 1
SHORT ANS0ER
1. Is it possible to add up the preferences of all consumers in an entire nation=
!"#:
"o. It is impossible to mae interpersonal comparisons of satisfaction( and thus it is not possible to add
up preferences.
%T#: 1
&. 1ho gains more from trade( when nations are of unequal economic si/e=
!"#:
If one nation is significantly larger than the other( the larger nation attains fewer gains from trade(
while the smaller nation captures most of the gains from trade.
%T#: 1
,. Is it possible for comparative advantage to change( thus changing the direction of trade=
!"#:
2agging productivity growth may cause a country to lose its comparative advantage. In a two5product(
two5country model( this would change the direction of trade.
%T#: 1
-. $o national security concerns lead to incomplete speciali/ation=
!"#:
Jes. "ational security concerns may lead a country to produce some of the commodity in which it has
comparative disadvantage( thus leading to incomplete speciali/ation.
%T#: 1
ESSAY
1. 1ill it be impossible to eep low5silled jobs in the '.#.=
!"#:
If tax credits or other incentives are made available to '.#. companies( it would be possible for those
companies to invest in training or technology for low5silled worers. That would improve the
efficiency of the worers. #uch improvements in productivity can more than outweigh the wage
advantage that is enjoyed by low5silled worers overseas. "ew 7alance !thletic #hoe +o. Inc.(
headquartered in 7oston( <assachusetts( has been successful in retaining low5silled production in the
'nited #tates by increasing worer productivity.
%T#: 1
&. Is it possible to estimate the gains from trade=
!"#:
1hen a nation trades( it enjoys a larger income( owing to a wider range of goods available to
consumers. Trade also has a positive influence on productivity levels. Eowever( it is extremely
difficult to measure these gains( since it requires nowledge of what a nation*s imports would cost if it
produced them itself( instead of purchasing them from a less expensive source abroad.
%T#: 1