International Economics

Question 1

What are the four broad national attributes (factors) identified by Michael Porter as promoting or impeding the creation of competitive advantage by a country?

Answer 1

Porter’s four factors are:

1. Factor endowments - the factors of production;
2. Demand conditions - nature of domestic demand;
3. Relating and supporting industries - the international competitiveness of related industries;
4. Firm strategy, structure and rivalry - how companies are created, organized, managed and compete.

Question 2

Define “absolute advantage”.

Answer 2

Absolute advantage is the ability of a country, business, individual or other entity to produce a particular good or service more efficiently (with fewer resources) than another entity.

Question 3

Identify three major reasons for international economic activity.

Answer 3

1. To develop new markets for the sale of goods and services;
2. To obtain commodities not otherwise available domestically;
3. To obtain goods and services at lower costs than available domestically.

Question 4

Define “comparative advantage”.

Answer 4

Comparative advantage is the ability of a country, business, individual or other entity to produce a particular good or service at a lower opportunity cost than the opportunity cost of producing the good or service by another entity.

Question 5

Identify some of the reasons for comparative advantage between countries.

Answer 5

Differences in availability of economic resources, including:

1. Natural resources;
2. Labor;
3. Technology.

Question 6

Identify and describe the balance of payment accounts.

Answer 6

1. Current Account: Net $ amounts earned from export of goods and services, amounts spent on import of goods and services, and government grants to foreign entities;
2. Capital Account: Net $ amount of inflows from investments and loans by foreign entities, amount of outflows from investments and loans U.S. entities made
3. Financial Account : Net $ amount of U.S.-owned assets abroad and foreign-owned assets in the U.S.

Question 7

What are some of the socio-political issues associated with international trade?

Answer 7

1. Domestic unemployment linked to use of foreign labor
2. Loss of manufacturing capabilities;
3. Reduction of industries essential to national defense;
4. Lack of domestic protection for start-up industries.

Question 8

Distinguish the difference between import quotas and import tariffs.

Answer 8

Import quotas are restrictions on the quantity of goods that can be imported into a country;

Import tariffs are taxes imposed on imported goods as a means of reducing the quantity of goods imported into a country.

Question 9

What is a country’s balance of payments account?

Answer 9

A summary accounting of all of a country’s transactions with other countries.

Question 10

Define a “balance of payments deficit”.

Answer 10

A country has a balance of payments deficit when its imports and investment outflows exceed its exports and investment inflows.

Question 11

Define “indirect (currency) exchange rate”

Answer 11

Currency exchange rate expressed as the foreign currency price of one unit of the domestic currency (e.g., Euro cost of one U.S. dollar).

Question 12

Define “direct (currency) exchange rate”.

Answer 12

Currency exchange rate expressed as the domestic price of one unit of a foreign currency (e.g., U.S. dollar cost of one Euro).

Question 13

Define “currency exchange rate”.

Answer 13

The price of one unit of a country’s currency expressed in units of another country’s currency; the rate at which two currencies will be exchanged.

Question 14

Identify the three specific kinds of risk associated with changes in currency exchange rates.

Answer 14

Kinds of risk associated with changes in currency exchange rates:

1. Transaction risk;
2. Translation risk;
3. Economic risk.

Question 15

Define “transaction risk” as it relates to currency exchange rates.

Answer 15

The possible unfavorable impact of changes in currency exchange rates on transactions denominated in a foreign currency. Exchange rates may change so that transactions to be settled in a foreign currency result in receiving fewer dollars or paying more dollars to settle.

Question 16

Define “translation risk” as it relates to currency exchange rates.

Answer 16

The possible unfavorable impact of changes in currency exchange rates on the financial statements of an entity when those statements are converted from one currency to another currency. Exchange rates may change so that domestic (dollar) values of financial statement items are adversely impacted.

Question 17

Define “economic risk” as it relates to currency exchange rates.

Answer 17

The possible unfavorable impact of change in currency exchange rates on a firm’s future international earning power. Exchange rates may change so that future revenue, costs and prices are adversely impacted.

Question 18

Define “currency exchange rate risk”.

Answer 18

The risk of loss or other unfavorable outcome that results from changes in exchange rates between currencies.

Question 19

Define “foreign currency forward exchange contract”

Answer 19

Agreement to buy or sell a specified amount of a foreign currency at a specified future date at a specified (forward) rate.

Question 20

Define “foreign currency risk hedging”.

Answer 20

A risk management strategy that seeks to offset losses resulting from changes in exchange rates between currencies by using contracts, swaps and other instruments which will result in changes counter to (opposite of) changes in the currency exchange rate.

Question 21

Distinguish between a foreign currency exchange contract and a foreign currency option contract.

Answer 21

Under a foreign currency exchange contract, the obligation to buy or sell a foreign currency is firm; the exchange must occur.

Under a foreign currency option contract, the party holding the option has the right (option) to buy (call) or sell (put), but does not have to exercise that option; the exchange will occur according to a decision made by the option holder.

Question 22

In addition to minimizing total income taxes, what other savings may be accomplished by the setting of transfer prices?

Answer 22

In addition to income taxes, the setting of transfer prices may affect:

1. Withholding taxes, that may apply to the transfer of cash as dividends, interest or royalties;
2. Import duties, which are applied to goods based on transfer prices;
3. Profit repatriation restrictions, which limit the amounts of profits that can be transferred out of a country.

Question 23

Define “transfer price”.

Answer 23

Amount (price) at which goods or services are transferred between affiliated entities.

Question 24

Identify and describe three major bases for setting transfer prices.

Answer 24

1. Cost: The transfer price is a function of the cost to the selling unit;
2. Market Price: The transfer price is based on the price 3. Negotiated Price: The transfer price is based on a negotiated agreement between buying and selling affiliates.

Question 25

What significant outcomes does the setting of transfer prices impact?

Answer 25

1. Profit recognized by separate units;
2. Allocation of taxes between units;
3. Measures of separate unit performance.

Question 26

For U.S. income tax purposes, in setting transfer prices, the resulting income should be allocated based on what factors?

Answer 26

1. Functions performed by separate affiliates;

2. Risks assumed by separate affiliates.