ECON Exam 1- Ch. 1-3 Study Question Explanations and Answers

assume that by devoting all of its resources to the production of steel, France can produce 40,000 tons of steel, and that by devoting all of its resources to TV sets, France can produce 600,000 TV sets. Similarly, by devoting all of its resources to the production of either steel or TV sets, Japan can produce either 20,000 tons of steel or 100,000 TV sets. In this example, France has _______________ advantage in the production of steel and TV sets and ________________ advantage in the production of TV sets.

an absolute; a comparative

________ costs occur when resources are completely adaptable to alternative uses.

constant

True or False: Economies of scale exist when expansion of the scale of production causes total production costs to increase more than proportionately to output, which causes long-run average costs of production to increase.

false

True or False: The product life cycle theory maintains that if a nation initially begins as an exporter of a manufactured good, it always remains an exporter of this good.

false

Which of the following factors influence the rate of growth in the volume of world trade?

he level of domestic economic activity; Restrictions imposed by countries on their import

Which of the following are correct descriptions of the effects of economies of scale on world trade patterns?

Economies of scale are a source of comparative advantage; Internal economies of scale provide additional cost incentives for specialization in production.

What significance does growing economic interdependence have for a country like the United States?

Exports and imports increase as a share of national input; international political and economic events have an increasingly important effect on energy prices in the United States

What do researchers say about the relation between a firm's productivity and exposure to global competition?

Exposure to global competition increases a company's productivity.

volume of trade

Factors that influence the volume of international trade include the level of domestic economic activity (for example, prosperity versus recession), which influences the level of demand of one nation's residents for the goods and services of other nations; and restrictions (such as tariffs and quotas) imposed by countries on their imports.

True or False: The Leontief tests, as well as a number of empirical tests that followed, found that a large amount of international trade is between industrialized and developing countries and not among industrialized countries with similar resource endowments, as was assumed in the basic factor-endowment model. Thus, such factors as technology, economies of scale, and demand conditions do not have much influence on international trade patterns.

False

Growing economic interdependence

Growing economic interdependence internationally has had various effects on the United States. Exports and imports have increased as a share of national output; profits of domestic firms and wages of domestic workers are increasingly affected by foreign competition; and political and economic events play increasingly important roles in the operations of some sectors of the U.S. economy, such as energy and agriculture (for example, the U.S. agricultural sector demands heavy protection from the government against lower prices of foreign imports).

Which of the following are problems encountered when attempting to implement industrial policy?

Identifying growth-oriented industries is a difficult task; Government policy makers may be unduly influenced by their voting constituents; If all countries utilized industrial policy, a "beggar-thy-neighbor" process of trade-inhibiting protectionism would ensue

Under increasing-cost conditions, specialization is ________ because:

partial; As production costs rise with expanded production, the home country eventually loses its comparative advantage

The gains from specialization and trade are discussed in terms of ________ _______ and _______ ________

production gains; consumption gains

The concept of _______ _______ refers to the actual terms of trade being determined by the relative strength of each country's demand for the other country's product.

reciprocal demand

Consumption gains

refer to the increased amount of goods made available to consumers as a result of international trade

production gains

refer to the increased output of goods and services made possible by the international division of labor and specialization

Industrial policy

refers to a governmental strategy intended to revitalize, improve, and/or develop an industry. Governmental policies intended to foster an industry's development include loan guarantees, research and development subsidies, low interest rate loans, trade protection, and the like. Creating comparative advantage requires the government to identify industries with the highest growth prospects.

Concave production possibilities frontiers are explained by:

Increasing opportunity costs

internal and external economies

Internal economies of scale arise within a firm itself and are built into the shape of its long-run average cost curve. External economies of scale exist when the firm's average costs decrease as the industry's output increases. A key aspect of economies of scale is the home market effect, the tendency of countries to specialize in products for which there is significant domestic demand. In particular, by locating near its largest market, an industry can minimize shipping costs even as it takes advantage of economies of scale

argument for open trade

Proponents of an open trading system maintain that free trade leads to lower prices, the development of more efficient production methods, and a greater range of consumption choices. More generally, they contend that free trade permits resources to move from low productivity to high productivity uses. Critics of an open trading system maintain that import competition may displace domestic firms and workers. It is also argued that during periods of national emergency, it is in the best interest of a nation to protect strategic industries.

Productivity and global competition

Researchers have found that global competitiveness benefits companies exposed to intense global competition by increasing their productivity. In a sense, global competitiveness can be compared to sports: You get better by playing against those who are better than you. An open economy promotes technological development and innovation with fresh ideas from abroad. However, blue collar jobs, service jobs, and white collar jobs are increasingly vulnerable to operations being sent overseas.

Stolper-Samuelson Theorem

states that the export of products embodying large amounts of relatively cheap, abundant factors makes those factors less abundant domestically, leading to higher prices and thus an increased share of national income for these factors. The magnification effect is an extension of the Stolper-Samuelson theorem that suggests that the change in the price of a resource is greater than the change in the price of the good that uses the resource relatively intensively in its production process.

Intro to transportation costs

the low-cost exporting nation produces less, consumes more, and exports less; the high-cost importing nation produces more, consumes less, and imports less. The degree of specialization in production between the two nations decreases, as do the gains from trade.

Which of the following is one of the arguments for why with a given level of world resources, international trade may bring about an increase in total world output?

trade allows countries to specialize

Transportation costs

transportation costs refer to the costs of moving goods, including freight charges, packing and handling expenses, and insurance premiums. These costs are an obstacle to trade and impede the realization of gains from trade liberalization. Differences across countries in transportation costs are a source of comparative advantage and affect the volume and composition of trade. Transportation costs also affect the location of industry since firms recognize that transportation costs in addition to production costs affect profitability. A firm achieves its best location when it can minimize its total operating costs, including production and transportation costs. When transportation costs are added to the prices of traded goods, a nation's volume of trade decreases.

The product life cycle theory

views a variety of manufactured goods as going through a trade cycle, during which a nation initially is an exporter, then loses its export markets, and finally becomes an importer of the product

Linder's theory of overlapping demand

Staffan Linder, a Swedish economist in the 1960s, maintained that the factor-endowment theory is valid for trade in primary products, but the theory of overlapping demands best applies to trade in manufactured goods. Linder states that a nation's exports are thus an extension of the production for the domestic market

What is meant by the theory of reciprocal demand?

The actual terms of trade are determined by the relative strength of each country's demand for the other country's product.

Factor endowment theory

The factor-endowment theory provides a comprehensive way to analyze gains and losses from trade. The effects of trade on the distribution of income are summarized in the Stolper-Samuelson theorem, an extension of the theory of factor-price equalization. The theorem suggests that a capital-abundant nation enjoys relatively cheap capital and thus specializes in and exports capital-intensive goods. This leads to increased demand for capital, which forces up the price of capital and thus the price of capital-intensive goods. The opposite occurs in the capital-scarce country. The basis for further specialization and trade ceases when the capital prices and product prices in each nation equate.

International trade increasing output

The most important benefit of free trade, according to free trade advocates, is that it permits countries to specialize in the production of goods in which they have a comparative advantage—that is, the lowest opportunity costs. With resources thus transferred to their most productive uses under an international division of labor, world output rises above autarky levels. Since the expansion of world output permits greater consumption by all countries, all nations potentially benefit from free trade, according to free trade advocates.

What is meant by increasing opportunity costs?

The opportunity cost of an additional unit of a product, in terms of the lost output of another product, increases as more of the product is produced.

opportunity cost

The principle of comparative advantage can be explained in terms of opportunity cost, which is the amount of one product that must be sacrificed to release enough resources to be able to produce one more unit of another product. The slope of the production possibilities frontier (that is, the marginal rate of transformation, or MRT) indicates this rate of sacrifice—in other words, the opportunity cost of producing a specific quantity of the product.

Which of the following are major misconceptions about international trade?

Trade is a zero-sum activity; Imports reduce employment

T/F: A trade triangle is an area in a country's production possibilities diagram that displays the country's expanded consumption possibilities that result from trade.

True

T/F: One of the major misconceptions about international trade is that tariffs and quotas save jobs and promote a higher level of employment.

True

T/F: a country can have an absolute disadvantage in both goods, but still have a comparative advantage in one of them

True

True or False: According to Linder's theory of overlapping demands, the foreign markets with the greatest export potential are found in nations with consumer demands similar to those of domestic consumers.

True

True or False: The Heckscher-Ohlin theory maintains that factor endowments determine a nation's comparative advantage.

True

True or False: The Stolper-Samuelson theorem states that the abundant resource that fosters comparative advantage realizes an increase in income and the scarce resource realizes a decrease in its income regardless of industry.

True

complete or partial specialization

Under conditions of constant opportunity cost, specialization is complete. A country can devote all of its resources to the production of a good without losing its comparative advantage. Under increasing-cost conditions, however, specialization tends to be partial. As production costs rise with expanded production, the home country eventually loses its comparative advantage.

Leontief paradox

Wassily Leontief found that the capital/labor ratio for U.S. export industries was lower than that of U.S. import-competing industries. He thus concluded that U.S. exports were less capital intensive than its import-competing goods, a conclusion known as the Leontief paradox because it contradicted the predictions of the factor-endowment theory. Leontief's empirical findings brought into question the applicability of the factor-endowment theory by suggesting that the United States predominantly exported labor-intensive goods. This conclusion contradicted the prediction of the factor-endowment theory when applied to the United States. To strengthen his conclusion, Leontief repeated his tests only to again find that U.S. import-competing goods were more capital intensive than U.S. exports. Leontief's discovery was that America's comparative advantage lay in something other than capital-intensive goods. The empirical tests highlighted the importance of the fact that a large amount of international trade is not between industrialized and developing countries but is among industrialized countries with similar resource endowments. Thus, the determinants of trade are more complex than those identified by the basic factor-endowment theory, as factors such as technology, economies of scale, and demand conditions must also be included in the model.

With the introduction of transportation costs, the degree of specialization in production between the two nations________ , the volume of trade____________ , and the gains from trade____________

decreases; decreases; decreases

Economies of scale

economies of scale (increasing returns to scale) exist when an expansion of the scale of productive capacity of a firm or industry causes total production costs to increase less than proportionately to output. Thus, long-run average costs of production decrease.

In absence of transportation costs

free trade results in the equalization of prices of traded goods, as well as resource prices, in the trading nations.

Problems of industrial policy

(1) difficulties in identifying growth-oriented industries and (2) the potential for government policy makers to be unduly influenced by their voting constituents.

Misconceptions about trade

1. Trade is a zero-sum activity. In fact, if countries specialize in and trade products for which they have a comparative advantage, all countries will produce more efficiently, and more goods and services will be available to all countries. 2. Imports reduce employment and act as a drag on the economy. This view misses the link between imports and exports. When a country imports a product, the exporting country receives foreign currency needed to buy the importing country's exports. 3. Tariffs and quotas will save jobs and promote a higher level of employment. In fact, trade restrictions decrease not only imports but exports, as well. Under such restrictions, foreign nationals fail to acquire the foreign exchange needed to buy a country's exports. Additionally, trade restrictions often lead to retaliation in the form trade restrictions imposed by other countries. Such restrictions, of course, adversely affect domestic employment.

Production possibilities curve

A nation facing a straight-line production possibilities frontier produces under conditions of constant costs: Inputs are fully interchangeable, so the opportunity cost of producing a good in terms of lost output of another good doesn't change as more of it is produced. By contrast, a nation facing a bowed-out (concave) production possibilities frontier produces under conditions of increasing costs: Resources are somewhat specialized, so in shifting inputs from the production of one good to that of another, some productivity is lost, and hence, the opportunity cost of producing the good in terms of lost output of another good increases as more of it is produced (and the productions possibilities frontier becomes steeper)

Which of the following are effects of transportation costs on international trade patterns?

A nation may export and import the same product because of transportation costs; High transportation costs reduce a nation's volume of trade.

Trade Triangle

A trade triangle is an area in a country's production possibilities diagram that displays the country's expanded consumption possibilities that result from trade. A trade triangle is bounded on the right by the trading possibilities line given by the terms of trade and on the two remaining sides by the country's imports and exports. It thus indicates a country's exports, imports, and equilibrium terms of trade.

In a two-nation, two-product world, what is meant by the term trade triangle?

An area in a production possibilities diagram showing a country's exports, imports, and equilibrium terms of trade

Constant and increasing opportunity costs

Constant opportunity costs refer to a situation in which the cost of each additional unit of one product, in terms of lost output of another product, is unchanged as more of the product is produced. Constant costs occur when resources are completely adaptable to alternative uses. Under increasing-cost conditions, a nation must sacrifice more and more of one product to produce each additional unit of another product. Increasing costs occur when resources are not fully adaptable to alternative uses.

Reciprocal demand

The theory of reciprocal demand suggests that if we know the domestic demands expressed by both trading partners for both products, the equilibrium terms of trade can be defined. This provides a meaningful explanation of the international terms of trade.

The exchange of products of similar industries is called ______ trade, whereas the exchange of products of different industries is called ________ trade.

intra-industry; inter-industry

Which of the following are major arguments for an open trading system?

it leads to lower prices; it enables the development of more efficient production methods

calculating opportunity cost

large / small amount (i.e tons over singular) is easiest; The smaller the number for that numerator is that one that has the comparative advantage for that numerator

The product life cycle theory views a variety of ___________ goods as going through a trade cycle, during which a nation initially is an___________ , then loses its markets, and finally becomes an____________ of the product

manufactured; exporter; importer

A production possibilities frontier (PPF) illustrates the costs of producing one good relative to another. The slope of the production possibilities frontier illustrates the

marginal rate of transformation

The Stolper-Samuelson theorem predicts that the export of a product that embodies large amounts of a relatively cheap, abundant resource makes this resource ______________. This leads to______________ in the price of this resource and ______________ in its income. At the same time, the income of the resource used intensively in the import-competing product (the initially scarce resource) ____________ as its demand _____________

more scarce in the domestic market; an increase; an increase; decreases; falls