International Trade

Question 1

Free Trade

Answer 1

International trade without any restrictions, tariffs, or quotas

Question 2

Exports

Answer 2

Value of goods a country sells to the rest of the world

Question 3

Imports

Answer 3

Value of goods a country buys from the rest of the world

Question 4

Trade Deficit

Answer 4

When the imports of a country are greater than their exports

Question 5

Imports are the value of the goods a country _________ the rest of the world, and exports are the value of the goods a country _________ the rest of the world.

Answer 5

Buys from; Sells to. Imports are the value of the goods that come from another country into this country; exports are the value of the goods that go from this country to another one.

Question 6

Which of the following best describes a country’s trade deficit?

Answer 6

The country’s total imports minus its total exports. A country’s trade deficit is the difference between the value of its imports and the value of its exports.

Question 7

Production Possibilities Frontier

Answer 7

Shows the maximum quantity of one good that can be produced for each possible quantity of the other good produced

Question 8

Increasing Returns to Scale (Economies of Scale)

Answer 8

When multiplying all inputs by N causes output to be multiplied by more than N. Alternatively, when an increase in inputs decreases the average cost of production

Question 9

Decreasing Returns to Scale (Diseconomies of Scale)

Answer 9

When multiplying inputs by N causes output to be multiplied by less than N. Alternatively, when an increase in inputs increases the average cost of production

Question 10

Comparative Advantage

Answer 10

When a country or firm can produce a good at a lower opportunity cost than another country or firm

Question 11

Factor Endowments

Answer 11

A country’s amount of land, capital, and land that contribute to their production capacity and comparative advantage

Question 12

The graph below shows three production possibility frontiers (PPFs), labeled A, B, and C. Each one shows the combination of points a student can get on her exam in a class and points she can get from homework assignments. A student has a given amount of time. She can allocate her time between doing homework and exam studying. If she spends more time on homework, her homework points go up; the same is true for exams.

Which of the three graphs shows a PPF with economies of scope?

Answer 12

A. Economies of scope is a situation in which inputs complement each other. For example, if studying for an exam makes you better at homework, or doing homework helps you during an exam, then there are economies of scope. This leads to a PPF which is bowed outwards. Why? Imagine you spend 100% of your time studying for an exam and 0% on homework. If you add even a little bit of homework time (at the expense of exam studying), you’ll lead to a big boost in your grade, because you give up just a few exam points, add homework points, and then add more exam points because homework helps you on an exam. When the two inputs complement each other, you can get a big boost by doing some of both.

Question 13

Refer to the graph in Question 1A. Which of the three curves shows a PPF with diseconomies of scope?

Answer 13

C. Diseconomies of scope is a situation in which doing one input actually makes the other input less effective. This leads to a PPF which is bowed in, like C. If you spend all your time studying for an exam, it’s best to stay specialized, because starting to do even a little homework will make your exam studying less effective.

Question 14

A country has a comparative advantage in producing a good if it can produce that good __________.

Answer 14

At a lower opportunity cost than can another country. Comparative advantage means that a country can produce a good at a lower opportunity cost than can another country. Being able to produce more of a good or produce a good at a lower monetary cost is more suggestive of absolute, rather than comparative, advantage.

Question 15

Two production possibility frontiers for pears and bread are shown below: PPF 1 and PPF 2.

As more bread is produced, what happens to the opportunity cost of producing bread in each PPF?

Answer 15

Increasing in PPF 1; No change in PPF 2. PPF 1 has increasing opportunity cost as more bread is produced. The best way to see this is to start at a situation where no bread is produced and only pears are produced – at the top left of the graph. Now what happens if a small amount of bread is produced? That is, what happens if you move to the right slightly? There is a drop in amount of pears produced, but it is a shallow drop. As you keep moving to the right, however, and more and more bread gets made, you see steeper drops in the amount of pears produced. Hence, the opportunity cost of producing more bread (i.e., the amount of pears you give up), keeps getting higher. With PPF 2, in contrast, we have a straight line. The opportunity cost doesn’t change as you move up and down the curve.

Question 16

Which of the following is true of an economy’s production possibility curve?

Answer 16

It shows all the combinations of good that can be produced by fully employing scarce resources. A production possibilities frontier sketches out the combination of goods that can be produced using all available resources.

Question 17

If a country develops a new technology that makes it easier to produce all goods, then this would result in ___________.

Answer 17

A production possibility curve shifting outward. A production possibilities curve shows all the combinations of goods that can be produced by fully employing scarce resources. New technology lets you produce more goods from the same amount of inputs. Hence, the production possibilities curve shifts out.

Question 18

Absolute Advantage

Answer 18

When a country or firm has superior production capabilities than other countries or firms in a specific good

Question 19

Comparative Advantage

Answer 19

When a country or firm can produce a good at a lower opportunity cost than another country or firm

Question 20

The table below shows the maximum number of apples or bananas that Will and Andre can produce using all of their time and resources.

What is Will’s opportunity cost of producing 1 apple? What is Andre’s opportunity cost of producing 1 apple?

Answer 20

Will: 5 bananas; Andre: 1 banana. When Will produces 10 apples, he forgoes the chance to produce 50 bananas. That means for each apple he produces, he could have produced 5 bananas instead. When Andre produces 30 apples, he forgoes the chance to produce 30 bananas. That means for each apple he produces, he could have produced 1 banana instead.

Question 21

Refer to the table in Question 1A. What is Will’s opportunity cost of producing 1 banana? What is Andre’s opportunity cost of producing 1 banana?

Answer 21

Will: 0.2 apples; Andre: 1 apple. For every 5 bananas Will produces, there’s 1 apple he could have (but didn’t) produce. 1/5 = 0.2. Using the same reasoning, Andre’s opportunity cost of producing 1 banana is 1 apple.

Question 22

Refer to the table in Question 1A. Who has a comparative advantage in producing apples? Who has a comparative advantage in producing bananas?

Answer 22

Apples: Andre; Bananas: Will. Andre has a lower opportunity cost of producing apples (1 banana vs. 5 bananas), and Will has a lower opportunity cost of producing bananas (0.2 apples vs 1 apple). Therefore, Andre has a comparative advantage in apples, and Will has a comparative advantage in bananas.

Question 23

Assume Romania and Hungary both produce only two goods: hats and pairs of shoes. If Romania holds a comparative advantage in making hats, then which of the following statements is NOT true?

Answer 23

Romania must hold an absolute advantage in making hats. When there are only two countries and two goods, if one country has a comparative advantage in one good, then the other country has a comparative advantage in the other good – so Hungary must hold a comparative advantage in making pairs of shoes. The definition of comparative advantage tells us that Romania’s opportunity cost of producing a hat is lower than Hungary’s, and it tells us that Hungary’s opportunity cost of producing a pair of shoes is lower than Romania’s. We also know that if each side has a comparative advantage, they’ll be better off if they specialize and trade. That leaves “Romania must hold an absolute advantage in making hats” as the one statement that need not be true. A country can have a comparative advantage in making a good without having an absolute advantage in making that good.

Question 24

Jay and Tyler both produce t-shirts and flip-flops. In one day, Jay can make 200 t-shirts or 100 pairs of flip-flops. In one day, Tyler can make 180 t-shirts or 60 pairs of flip-flops. Which of the following statements is true?

Answer 24

Tyler has a comparative advantage in making t-shirts but not an absolute advantage. For Jay, the opportunity cost of making 1 t-shirt is 0.5 flip-flops. For Tyler, it’s only .33 flip-flops, so Tyler has a comparative advantage in t-shirts. But if both specialize in t-shirts, Tyler would only make 180 while Jay would make 200. Hence, Jay has an absolute advantage in t-shirts (since he can make more in one day), but not a comparative advantage.

Question 25

The table below shows how many units of heavy machinery and agricultural products Country A and B can produce in a day.

According to the information in the table, which of the following statements is true?

Answer 25

Country B has an absolute and a comparative advantage in making agricultural products. Country B clearly has an absolute advantage in both goods since it can make more of each in one day compared to Country A. For Country B, the opportunity cost of making one unit of agricultural products is 0.5 units of heavy machinery (1000 / 2000). For Country A, this opportunity cost of agricultural products is higher: 2.5 units of heavy machinery (500 / 200). Therefore, Country B also has a comparative advantage in agricultural products.

Question 26

If countries specialize according to their comparative advantage and engage in trade, then each country can __________.

Answer 26

Consume outside its production possibility frontier. Specializing and trading means that a country can end up consuming more than it could produce on its own. A production possibility frontier shows all the possible bundles a country can produce on its own, so trade allows countries to consume outside this frontier.