ECO361 Chapter 2

When a nation requires fewer resources than another nation to produce a product, the nation is said to have a:

Absolute advantage in the production of the product

The trading principle formulated by Adam Smith maintained that:

Absolute cost differences determine the immediate basis for trade

unlike the mercantilists, Adam Smith maintained that:

All nations can gain from free international trade

The use of indifference curves helps us determine the point:

Along the terms-of-trade line a country will choose

Discuss the pitfalls of outsourcing, especially as experienced by Boeing.

Boeing outsourced its production capabilities for the Boeing 787 Dreamliner to facilities in several different countries, each of which made one component part of the aircraft. The plane would be assembled in the U.S. Boeing also required these manufacturers, as a condition of getting the contract for production, to fund part of the development of the plane. To save money, some manufacturers outsourced a portion of their part of the job, causing quality problems and production delays. B giving up control over its supply chain, Boeing suffered from delays and parts that did not meet the requirements, and could not be assembled. Production of the planes was 4 years behind schedule, and costly.

concerning international trade restrictions, which of the following is false? Trade restrictions:

Cause nations to produce inside their production possibilities curves

The earliest statement of the principle of comparative advantage is associated with:

David Ricardo

Modern trade theory contends that the pattern of world trade is governed by

Differences in supply conditions and demand conditions

Who gains more from trade, when nations are of unequal economic size?

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.

Is it possible for comparative advantage to change, thus changing the direction of trade?

Lagging productivity growth may cause a country to lose its comparative advantage. In a two-product, two-country model, this would change the direction of trade.

Is it possible to add up the preferences of all consumers in an entire nation?

No. It is impossible to make interpersonal comparisons of satisfaction, and thus it is not possible to add up preferences.

The terms of trade is given by the prices:

Received for exports and paid for imports

According to the principle of comparative advantage, specialization and trade increase a nation's total output since:

Resources are directed to their highest productivity

Explain the Law of Comparative Advantage.

The Law of Comparative Advantage asserts that with trade, each country will find it favorable to specialize in the production of the good of its comparative advantage, and will trade part of this for the good of its comparative disadvantage. Taking advantage of specialization can result in production gains.

The gains from international trade increase as:

The international terms of trade rises above the nation's autarky price

If the international terms of trade settle at a level that is between each country's opportunity cost:

both countries gain from trade

The best explanation of the gains from trade that David Ricardo could provide was to describe only the outer limits within which the equilibrium terms of trade would fall. This is because Ricardo's theory did not recognize how market prices are influenced by:

demand conditions

Although J. S. Mill recognized that the region of mutually beneficial trade is bounded by the cost ratios of two countries, it was not until David Ricardo developed the theory of reciprocal demand that the equilibrium terms of trade could be determined.

false

Assume 1990 to be the base year. If by the end of 2004 a country's export price index rose from 100 to 140 while its import price index rose from 100 to 160, its terms of trade would equal 120.

false

Assume that Canada has a comparative advantage in wheat and a comparative disadvantage in autos. As the Canadian demand for wheat increases, Canada's equilibrium terms of trade improves.

false

Assume that the United States and Canada engage in trade. If the international terms of trade coincides with the U.S. cost ratio, the United States realizes all of the gains from trade with Canada.

false

Because the Ricardian 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.

false

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.

false

If Canada has a higher wage level and higher labor productivity than Mexico, Canada will necessarily produce a good at a higher labor cost than Mexico.

false

If a country's terms of trade improve, it must exchange more exports for a given amount of imports.

false

If a country's terms of trade worsen, it must exchange fewer exports for a given amount of imports.

false

In autarky equilibrium, a nation realizes the lowest possible level of satisfaction given the constraint of its production possibilities schedule.

false

The Ricardian theory of comparative advantage could fully explain the distribution of the gains from trade among trading partners.

false

The commodity terms of trade are found by dividing a country's import price index by its export price index.

false

The expression "importance of being unimportant" suggests that if one nation is much larger than the other, the larger nation realizes most of the gains from trade while the smaller nation realizes fewer gains from trade.

false

The theory of reciprocal demand asserts that as the U.S. demand for Canadian wheat rises, the equilibrium terms of trade improve for the United States.

false

The theory of reciprocal demand best applies when one country has a "large" economy and the other country has a "small" economy.

false

A nation that gains from trade will find its consumption point being located:

outside its PPS

A nation achieves autarky equilibrium at the point where its community indifference curve is tangent to its production possibilities schedule.

true

A nation benefits from international trade if it can achieve a higher indifference curve than it can in autarky.

true

A nation realizes maximum gains from trade at the point where the international terms-of-trade line is tangent to its community indifference curve.

true

According to J. S. Mill, if we know the domestic demand expressed by both trading partners for both products, the equilibrium terms of trade can be defined.

true

An 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.

true

Assume 1990 to be the base year. If by the end of 2004 a country's export price index rose from 100 to 125 while its import price index rose from 100 to 125, its terms of trade would equal 100.

true

Assume 1990 to be the base year. If by the end of 2004 a country's export price index rose from 100 to 130 while its import price index rose from 100 to 115, its terms of trade would equal 113.

true

Assume that Germany has higher labor productivity and higher wage levels than France. Germany can produce a commodity more cheaply than France if its productivity differential more than offsets its wage differential.

true

Assume that the United States and Canada engage in trade. If the international terms of trade coincides with the Canadian cost ratio, the United States realizes all of the gains from trade with Canada.

true

Because the Ricardian 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.

true

By reducing the overall volume of trade, import restrictions tend to reduce a nation's gains from trade.

true

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.

true

If Argentina has a comparative advantage over Brazil in beef relative to coffee, Argentina will specialize in beef production.

true

If the international terms of trade lies beneath (inside) the Mexican cost ratio, Mexico is worse off with trade than without trade

true

If two nations of approximately the same size and with similar taste patterns participate in international trade, the gains from trade tend to be shared about equally between them.

true

Modern trade theory recognizes that the pattern of world trade is governed by both demand conditions and supply conditions.

true

Mutually beneficial trade for two countries occurs if the equilibrium terms of trade lies between the two countries' domestic cost ratios.

true

Ricardo's theory of comparative advantage does not take into account demand conditions when determining relative commodity prices.

true

The domestic cost ratios of nations set the outer limits to the equilibrium terms of trade.

true

The terms of trade represents the rate of exchange between a country's exports and imports.

true

The theory of reciprocal demand best applies when two countries are of equal economic size, so that the demand conditions of each nation have a noticeable impact on market prices.

true

A rise in the price of imports or a fall in the price of exports will:

worsen the terms of trade

The terms of trade is given by:

(Price of exports/price of imports) × 100

Improvements in productivity may lead to decreasing comparative costs if

All of the above; The assumption of fixed technologies under constant costs is relaxed, Technologies available to each nation is allowed to differ, and Resource endowments are allowed to vary

Concerning possible determinants of international trade, which are sources of comparative advantage? Differences in:

All of the above; methods and productions, tastes and preferences, and technological know-how

John Stuart Mill's theory of reciprocal demand best applies when trading partners:

Are of equal size and importance in the market

When nations are of similar size, and have similar taste patterns, the gains from trade

Are shared equally between them

As a result of international trade, specialization in production tends to be:

Complete with constant costs--incomplete with increasing costs

Given free trade, small nations tend to benefit the most from trade since they:

Enjoy terms of trade lying near the opportunity costs of their large trading partners

In a two-country, two-product world, the statement "Japan enjoys a comparative advantage over France in steel relative to bicycles" is equivalent to:

France having a comparative advantage over Japan in bicycles relative to steel

If Japan and France have identical production possibilities curves and identical community indifference curves:

Gainful specialization and trade are not possible

International trade is based on the notion that:

Goods are more mobile internationally than are resources

Assuming increasing cost conditions, trade between two countries would not be likely if they have:

Identical demand conditions and identical supply conditions

Trade between two nations would not be possible if they have:

Identical production possibilities curves and identical community indifference curves

A fall in the price of imports or a rise in the price of exports will:

Improve the terms of trade

The dynamic gains from trade include all of the following except:

Increasing comparative advantage leading to specialization

All of the following may be exit barriers except

Increasing opportunity cost of production

If a production possibilities curve is bowed out (i.e., concave) in appearance, production occurs under conditions of:

Increasing opportunity costs

The mercantilists would have objected to:

International trade based on open markets

The theory of reciprocal demand does not well apply when one country

Is of minor economic importance in the world marketplace

A term-of-trade index that equals 90 indicates that compared to the base year:

It requires a greater output of domestic goods to obtain the same amount of foreign goods

A terms-of-trade index that equals 150 indicates that compared to the base year:

It requires a lesser amount of domestic goods to obtain the same amount of foreign goods

"The equilibrium relative commodity price at which trade takes place is determined by the conditions of demand and supply for each commodity in both nations. Other 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." This statement was first proposed by:

John Stuart Mill with the theory of reciprocal demand

The writings of G. MacDougall emphasized which of the following as an explanation of a country's competitive position?

Labor compensation and productivity levels

Ricardo's model of comparative advantage assumed all of the following except:

Labor is immobile within a country, but is incapable of moving between countries

Ricardo's theory of comparative advantage was of limited real-world validity because it was founded on the:

Labor theory of value

With trade, a country will maximize its satisfaction when it:

Moves to the highest possible indifference curve

In a two-product, two-country world, international trade can lead to increases in:

Output of both products and consumer welfare in both countries

The Ricardian model of comparative advantage is based on all of the following assumptions except:

Product quality varies among nations

Increasing opportunity costs suggest that:

Resources are not perfectly shiftable between the production of two goods

The trading-triangle concept is used to indicate a nation's:

Terms of trade, exports, imports

Because the Ricardian trade theory recognized only how supply conditions influence international prices, it could determine:

The outer limits for the terms of trade

The commodity terms of trade measures

The rate at which exports exchange for imports

If Hong Kong and Taiwan had identical labor costs but were subject to increasing costs of production:

Trade would depend on differences in demand conditions

Under free trade, Sweden enjoys all of the gains from trade with Holland if Sweden:

Trades at Holland's rate of transformation

Given a two-country and two-product world, the United States would enjoy all the attainable gains from free trade with Canada if it:

Trades at the Canadian rate of transformation

Under free trade, Canada would not enjoy any gains from trade with Sweden if Canada:

Trades at the Canadian rate of transformation

assume that labor is the only factor of production and that wages in the United States equal $20 per hour while wages in the United Kingdom equal $10 per hour. Production costs would be lower in the United States than the United Kingdom if:

U.S. labor productivity equaled 40 units per hour while U.K. labor productivity equaled 15 units per hour

If Canada experiences increasing opportunity costs, its supply schedule of steel will be:

Upward-sloping

Introducing indifference curves into our trade model permits us to determine:

Where a nation chooses to locate along its production possibilities curve in autarky

Adam Smith

all of the above; Was a leading advocate of free trade, Developed the concept of absolute advantage, and Maintained that labor costs represent the major determinant of production cost

When a nation is in autarky and maximizes its living standard, its consumption and production points are:

along the PPS

Which of the following terms-of-trade 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 100 to express the terms of trade in percentages?

commodity terms of trade

According to the price-specie-flow-doctrine, a trade-surplus nation would experience gold outflows, a decrease in its money supply, and a fall in its price level.

false

Adam Smith contended that gold, silver, and other precious metals constituted the wealth of a nation.

false

Assume that the United States is more efficient than the United Kingdom in the production of all goods. Mutually beneficial trade is possible according to the principle of absolute advantage, but is impossible according to the principle of comparative advantage.

false

Complete specialization usually occurs under the assumption of increasing opportunity costs.

false

If the U.S. post-trade consumption point lies along its production possibilities schedule, the United States achieves a higher level of welfare with trade than without trade.

false

International trade leads to increased welfare if a nation can achieve a post-trade consumption point lying inside of its production-possibilities schedule.

false

It is possible for a nation not to have an absolute advantage in anything; 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.

false

Ricardo'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.

false

The MacDougall study of comparative advantage hypothesized that in those industries in which U.S. labor productivity was relatively high, U.S. exports to the world should be lower than U.K. exports to the world, after adjusting for wage differentials.

false

The basic idea of mercantilism was that wealth consisted of the goods and services produced by a nation.

false

The basis for trade is explained by the principle of absolute advantage according to David Ricardo and the principle of comparative advantage according to Adam Smith.

false

The mercantilists maintained that a free-trade policy best enhances a nation's welfare.

false

The price-specie-flow mechanism illustrated why one nation's gains from trade were accompanied by another country's losses.

false

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.

false

The principle of comparative advantage contends that a nation should specialize in and export the good in which its absolute advantage is smallest or its absolute disadvantage is greatest.

false

The trade theories of Adam Smith and David Ricardo viewed the determination of competitiveness from the demand side of the market.

false

There are two explanations of constant opportunity costs: (1) factors of production are imperfect substitutes for each other; (2) all units of a given factor have different qualities.

false

With constant opportunity costs, a nation will achieve the greatest possible gains from trade if it partially specializes in the production of the commodity of its comparative disadvantage.

false

With increasing opportunity costs, a nation totally specializes in the production of the commodity of its comparative advantage; with constant opportunity costs, a nation partially specializes in the production of the commodity of its comparative advantage.

false

With increasing opportunity costs, comparative advantage depends on a nation's supply conditions and demand conditions; with constant opportunity costs, comparative advantage depends only on demand conditions.

false

If Canada experiences constant opportunity costs, its supply schedule of steel will be:

horizontal

Incomplete specialization may be caused by

increasing opportunity cost

In the absence of trade, a nation is in equilibrium where a community indifference curve:

is tangent to its production possibilities curve

According to Ricardo, a country will have a comparative advantage in the product in which its:

labor productivity is regularly high

When a nation achieves autarky equilibrium:

production equals consumption

Unlike Adam Smith, David Ricardo's trading principle emphasizes the:

role of comparative costs

The introduction of community indifference curves into our trading example focuses attention on the nation's:

tastes and preferences

The equilibrium prices and quantities established after trade are fully determinate if we know:

the strength of world supply and demand for each good

Ricardo's model of comparative advantage assumed all of the following except:

transportation costs rise as distance increases between countries

A nation's trade triangle denotes its exports, imports, and terms of trade.

true

According to Adam Smith, international trade was a "win-win" situation since all nations could enjoy gains from trade.

true

According to the mercantilists, a nation's welfare would improve if it maintained a surplus of exports over imports.

true

According 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.

true

According 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.

true

Compared to Ricardian 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.

true

Constant 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 production-possibilities schedule.

true

If Japan loses competitiveness in computers, Japanese computer workers lose jobs to foreign computer workers and the wages of Japanese computer workers tend to fall relative to the wages of foreign computer workers.

true

If productivity in the German computer industry grows faster than it does in the Japanese computer industry, the opportunity cost of each computer produced in Japan increases relative to the opportunity cost of a computer produced in Germany.

true

MacDougall'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.

true

The Ricardian theory of comparative advantage assumes only two nations and two products, labor can move freely within a nation, and perfect competition exists in all markets.

true

The existence of exit barriers tends to delay the closing of inefficient firms that face international competitive disadvantages.

true

The marginal rate of transformation equals the absolute slope of a country's production possibilities schedule.

true

The mercantilists contended that because one nation's gains from trade come the expense of its trading partners, not all nations could simultaneously realize gains from trade.

true

The price-specie-flow mechanism illustrated why nations could not maintain trade surpluses or trade deficits over the long run.

true