The Standard trade model

Question 1

The meaning of “terms of trade” is
A) the amount of exports sold by a country.
B) the tariffs in place between two trading countries.
C) the quantities of imports received in free trade.
D) the price of a country’s exports divided by the price of its imports.
E) the price conditions bargained for in international markets.

Answer 1

D) the price of a country’s exports divided by the price of its imports

Question 2

A country cannot produce a mix of products with a higher value than where A) the isovalue line is above the production possibility frontier.
B) the isovalue line is below the production possibility frontier.
C) the isovalue line is tangent with the indifference curve.
D) the isovalue line is tangent to the production possibility frontier.
E) the isovalue line intersects the production possibility frontier.

Answer 2

The isovalue line is tangent to the production possibility frontier.

Question 3

Tastes of individuals are represented by A) isovalue lines.
B) production possibility frontiers.
C) production functions.
D) indifference curves. 
E) the terms of trade.

Answer 3

D) indifference curves.

Question 4

If the ratio of price of cloth (PC) divided by the price of food (PF) increases in the international marketplace, then
A) the terms of trade of food exporters will improve.
B) the terms of trade of all countries will improve.
C) the terms of trade of cloth exporters will worsen.
D) all countries would be better off.
E) the terms of trade of cloth exporters will improve.

Answer 4

E) the terms of trade of cloth exporters will improve.

Question 5

If the ratio of price of cloth (PC) divided by the price of food (PF) increases in the
international marketplace, then
A) the country would import more cloth.
B) the food exporter will increase the quantity of food exported.
C) the cloth exporter will increase the quantity of cloth produced.
D) the cloth exporter will increase the quantity of cloth exported.
E) the cloth exporter will decrease the quantity of cloth exported.

Answer 5

C) the cloth exporter will increase the quantity of cloth produced.

Question 6

If the ratio of price of cloth (PC) divided by the price of food (PF) increases in the international marketplace, then
A) world relative quantity of cloth demanded will decrease.
B) world relative quantity of cloth supplied will increase.
C) world relative quantity of cloth supplied and demanded will decrease.
D) world relative quantity of cloth supplied and demanded will increase.
E) world relative quantity of food will increase.

Answer 6

B) world relative quantity of cloth supplied will increase.

Question 7

A country will be able to consume a combination of goods that is NOT attainable solely from domestic production if
A) the country avoids international trade.
B) the country specializes in one product.
C) the world terms of trade equal the domestic relative costs.
D) the world terms of trade differ from its domestic relative costs.
E) the country’s domestic production value equals world relative value.

Answer 7

D) the world terms of trade differ from its domestic relative costs.

Question 8

Terms of trade refers to
A) what goods are exported.
B) the volume of trade.
C) the relative price at which trade occurs. 
D) the tariffs applied to trade.
E) what goods are imported.

Answer 8

C) the relative price at which trade occurs.

Question 9

If points A and B are two locations on a country’s production possibility frontier, then
A) at any point in time, the country could produce both.
B) both bundles must have the same relative cost.
C) consumers are indifferent between the two bundles.
D) the country could produce either of the two bundles.
E) producers are indifferent between the two bundles.

Answer 9

D) the country could produce either of the two bundles.

Question 10

If the economy is producing at point a on its production possibility frontier, then
A) all of its capital is used, but not efficiently.
B) all of the country’s capital is used for one product.
C) all of the country’s workers are employed.
D) all of the country’s workers are specialized in one product. E) all of the country’s exports are produced in equal amounts.

Answer 10

C) all of the country’s workers are employed.

Question 11

(f1) which shows a country's possible production possibility frontiers and indifference curves. If the country is producing at \_\_\_\_\_\_\_\_, then moving to \_\_\_\_\_\_\_\_ will cause utility to \_\_\_\_\_\_\_\_.
A) point c; point b; decrease
B) point b; point c; remain unchanged 
C) point a; point b; increase
D) point a; point c; remain unchanged 
E) point c; point b; increase

Answer 11

B) point b; point c; remain unchanged

Question 12

When the production possibility frontier shifts out relatively more in one direction, we have A) immiserizing growth.
B) unbiased growth.
C) imbalanced growth.
D) biased growth. 
E) balanced growth.

Answer 12

D) biased growth.

Question 13

Suppose that a country experiences growth strongly biased toward its export, cloth, A) this will tend to leave the country’s terms of trade unchanged.
B) this will tend to improve the country’s terms of trade.
C) this will increase the price of cloth relative to the imported good.
D) this will tend to worsen the terms of trade for the country’s trading partner.
E) this will tend to worsen the country’s terms of trade.

Answer 13

E) this will tend to worsen the country’s terms of trade.

Question 14

Other things being equal, a rise in a country’s terms of trade increases its welfare. What would happen if we relax the ceteris paribus assumption, and allow for the law of demand to operate internationally?

Answer 14

Let us assume that the terms of trade (or technically the net commodity terms of trade) improve, thus the relative price of a country’s exports increase. This would, logically, lead to a shift away by world consumers to substitute goods. If the demand for a country’s exports is elastic, the quantity decrease would be proportionally larger than the per unit price increase. This term of trade effect would actually lower the country’s real income and economic welfare.

Question 15

(f2) Albania refused to engage in international trade for ideological reasons. To maximize its economic welfare it would choose to produce at which point in the diagram above? Suppose the PA/PB at point a was equal to 1. Given this information, in which
good (A or B) does Albania enjoy a comparative advantage?
Now that the Cold War is over, Albania is interested in obtaining economic welfare gains from trade. The relevant international relative price is PA/PB = 2. Albania would therefore choose to produce at which point (a, b, or c)? Given this additional information, in which good does Albania enjoy a comparative advantage?

Answer 15

Albania would choose to produce at point a. With no reference to world terms of trade, one cannot establish Albania’s comparative advantage.
Later, when Albania discovers that the relative price of A equals twice the price of B, it knows that it has a comparative advantage in A. Therefore Albania would produce at production point b.

Question 16

(f2) Now, suppose that the relative price of A is actually not higher than Albania’s autarkic level of 1, but quite the opposite (e.g., PA/PB = 0.5). Would Albania still be
able to gain from trade? If so, where would be its production point? Given the information in this question, where is Albania’s comparative advantage?

Answer 16

Yes. As long as the world’s terms of trade differed from those of Albania, that country stands to gain from international trade. In this particular case, its point of production with trade would be at point c.

Question 17

(f3) which shows a country's possible production possibility frontiers and indifference curves. If the country is producing at \_\_\_\_\_\_\_\_, then moving to \_\_\_\_\_\_\_\_ will cause utility to \_\_\_\_\_\_\_\_.
A) point c; point b; remain unchanged
B) point a; point b; increase
C) point c; point b; increase
D) point c; point b; decrease
E) point a; point c; remain unchanged

Answer 17

A) point c; point b; remain unchanged

Question 18

(f3) which shows a country's possible production possibility frontiers and indifference curves. If the country is producing at \_\_\_\_\_\_\_\_, then moving to \_\_\_\_\_\_\_\_ will cause utility to \_\_\_\_\_\_\_\_.
A) point b; point a; increase
B) point a; point b; increase
C) point c; point b; increase
D) point c; point b; decrease
E) point a; point c; remain unchanged

Answer 18

A) point b; point a; increase

Question 19

(f4) Suppose, as a result of various dynamic factors associated with exposure to international competition, Albania’s economy grew, and is now represented by the rightmost production possibility frontier in the figure above. If its point of production with trade was point c, would you consider this growth to be export-biased or import biased? If Albania were a large country with respect to the world trade of A and B, how would this growth affect Albania’s terms of trade? Its real income?

Answer 19

If point c is the production point with trade, then Albania has a comparative advantage in good B. Therefore, from the shape of the new production possibility frontier (as compared to the original one), this is clearly an export-biased growth. This ceteris paribus would tend to worsen Albania’s terms of trade. The terms of trade effect would, again ceteris paribus, worsen its real income. However, the growth itself acts in the opposite direction.

Question 20

(f4) Suppose, as a result of various dynamic factors associated with exposure to international competition, Albania’s economy grew, and is now represented by the rightmost production possibility frontier in the figure above. If its point of production with trade was point b, would you consider this growth to be export-biased or import biased? If Albania were a large country with respect to the world trade of A and B, how would this growth affect Albania’s terms of trade? Its real income? What if Albania were a small country?

Answer 20

If the production with trade point was point b, then the observed growth is a case of import-biased growth, and would improve Albania’s terms of trade. If Albania were a small country, the world’s terms of trade would not change at all. In such a case, economic growth (with no induced change in income distributions) would always increase its real income.

Question 21

(f4) Suppose Albania is exporting product B, and experienced economic growth biased in favor of product B as seen in the figure above. We are also told that Albania’s new consumption point is at point d. Would you still consider the economic growth, which took place biased in favor of B? If Albania were a large country how would this growth affect its terms of trade?

Answer 21

This is a relatively difficult case. On the one hand, the growth is still technically export biased. However, Albania’s consumption clearly shifted in favor of its import product, A. In this case, the deterioration in the terms of trade would be much more pronounced than before, and may lead to a case of immiserizing growth. However, for this to occur, there must have been a major shift in the taste patterns (the old community indifference map is not longer applicable). Therefore, when we try to judge the direction and magnitude of the welfare change, we are comparing the old versus new taste preferences, which raises the classic index number problem.

Question 22

An increase in a country’s net commodity terms of trade will
A) not always guarantee positive changes in the country’s economy.
B) always increase the country’s economic welfare.
C) always increase the country’s real income.
D) never increase the country’s quantity of exports.
E) always increase the country’s production of its import competing good.

Answer 22

A) not always guarantee positive changes in the country’s economy.

Question 23

If the U.S. (a large country) imposes a tariff on its imported good, this will tend to
A) cause a deterioration of U.S. terms of trade.
B) have no effect on terms of trade.
C) improve the terms of trade of all countries.
D) raise the world price of the good imported by the United States.
E) improve the terms of trade of the United States.

Answer 23

E) improve the terms of trade of the United States.

Question 24

If Slovenia is a small country in world trade terms, then if it imposes a large series of tariffs on many of its imports, this would
A) decrease its marginal propensity to consume.
B) deteriorate its terms of trade.
C) increase its exports.
D) have no effect on its terms of trade.
E) improve its terms of trade.

Answer 24

D) have no effect on its terms of trade.

Question 25

If Slovenia is a large country in world trade, then if it imposes a large set of tariffs on many of
its imports, this would
A) increase its exports.
B) have no effect on its terms of trade.
C) harm its terms of trade.
D) improve its terms of trade.
E) decrease its marginal propensity to consume.

Answer 25

D) improve its terms of trade

Question 26

If Slovenia were a large country in world trade, then if it imposes a large set of tariffs on its imports, this must
A) decrease the internal price of imports below the world market rate.
B) improve the real income of its trade partners.
C) harm Slovenia’s real income.
D) improve Slovenia’s real income.
E) cause retaliation on the part of its trade partners.

Answer 26

A) decrease the internal price of imports below the world market rate.

Question 27

If Slovenia were a large country in world trade, then if it instituted a large set of subsidies for its exports, this must
A) have no effect on its terms of trade.
B) harm world terms of trade.
C) harm its terms of trade.
D) decrease its marginal propensity to consume.
E) improve its terms of trade.

Answer 27

C) harm its terms of trade.

Question 28

If Slovenia were a large country in world trade, then if it instituted a large set of subsidies for its exports, this must
A) increase internal prices above the world market rate.
B) harm Slovenia’s real income.
C) improve Slovenia’s real income.
D) improve the real income of its trade partners.
E) cause retaliation on the part of its trade partners.

Answer 28

D) improve the real income of its trade partners.

Question 29

An export subsidy has the opposite effect on terms of trade to the effect of an import tariff. Domestically a tariff will raise the price of the import good, deteriorating the domestic terms of trade. A production subsidy for the export product will lower the local price of the export good, lowering the domestic terms of trade for the country. Hence the export subsidy and the import tariff have the same effect. This analysis seems to contradict the first sentence in this paragraph. Discuss this paradox.

Answer 29

While this (Lerner) equivalence may well occur domestically, internationally the tariff will improve a country’s terms of trade. An export subsidy on the other hand will in fact lower the international price of the (now readily available) export good, hence hurting a country’s terms of trade.

Question 30

If a small country were to levy a tariff on its imports then this would
A) decrease the country’s economic welfare.
B) change the terms of trade.
C) have no effect on that country’s economic welfare.
D) raise prices on its exports in other countries.
E) increase the country’s economic welfare.

Answer 30

A) decrease the country’s economic welfare.

Question 31

An import tariff will cause the relative demand for \_\_\_\_\_\_\_\_ to \_\_\_\_\_\_\_\_ and the relative supply for \_\_\_\_\_\_\_\_ to \_\_\_\_\_\_\_\_.
A) exports; decrease; exports; increase
B) imports; increase; imports; decrease
C) exports; increase; exports; decrease 
D) imports; decrease; imports; increase 
E) exports; increase; imports; decrease

Answer 31

D) imports; decrease; imports; increase

Question 32

An export subsidy will cause the relative demand for \_\_\_\_\_\_\_\_ to \_\_\_\_\_\_\_\_ and the relative supply for \_\_\_\_\_\_\_\_ to \_\_\_\_\_\_\_\_.
A) imports; decrease; imports; increase
B) exports; increase; imports; decrease
C) exports; increase; exports; decrease 
D) exports; decrease; exports; increase 
E) imports; increase; imports; decrease

Answer 32

D) exports; decrease; exports; increase

Question 33

An import tariff will cause the terms of trade of the ________ country to ________ and will ________ the country.
A) importing; improve; benefit
B) importing; improve; harm
C) exporting; improve; benefit D) exporting; improve; harm
E) importing; suffer; harm

Answer 33

A) importing; improve; benefit

Question 34

An export subsidy will cause the terms of trade of the \_\_\_\_\_\_\_\_ country to \_\_\_\_\_\_\_\_ and will \_\_\_\_\_\_\_\_ the country.
A) importing; suffer; benefit
B) importing; improve; harm
C) exporting; suffer; harm
D) importing; suffer; harm
E) exporting; improve; benefit

Answer 34

C) exporting; suffer; harm

Question 35

International borrowing and lending may be interpreted as one form of 
A) unrequited international transfers.
B) aid to offset trade advantages.
C) intertemporal trade.
D) intermediate trade. 
E) trade in services.

Answer 35

C) intertemporal trade.

Question 36

If one observes that Japan was traditionally a net foreign lender, one could conclude that relative to its international trade and financial partners
A) Japan’s intertemporal production possibilities are biased toward present consumption.
B) Japan’s intertemporal production possibilities are not biased.
C) Japan preferred to consume beyond its production in the present.
D) Japan’s intertemporal production possibilities are larger than that of the other countries.
E) Japan’s intertemporal production possibilities are biased toward future consumption.

Answer 36

A) Japan’s intertemporal production possibilities are biased toward present consumption.

Question 37

Rapidly growing developing countries tend to be borrowers on the international capital markets. From this information we may surmise that they have a comparative advantage in 
A) capital goods.
B) future income.
C) consumer goods. 
D) present income.
E) disposable income.

Answer 37

B) future income.

Question 38

It may be argued that theoretically, international capital movements A) tend to hurt the recipient countries.
B) tend to hurt labor in donor countries.
C) increase future production in donor countries.
D) tend to hurt the donor countries.
E) tend to hurt labor in recipient countries.

Answer 38

B) tend to hurt labor in donor countries.

Question 39

The intertemporal tradeoff between present and future consumption is measured by the
A) nominal interest rate.
B) real interest rate.
C) terms of trade.
D) rate of economic growth. 
E) inflation rate.

Answer 39

B) real interest rate.

Question 40

A fall in the real interest rate, all other things held constant, will cause a country's \_\_\_\_\_\_\_\_ to \_\_\_\_\_\_\_\_.
A) current consumption: decrease
B) welfare level; improve
C) current consumption: increase 
D) terms of trade; worsen
E) terms of trade; improve

Answer 40

C) current consumption: increase

Question 41

An increase in the real interest rate, all other things held constant, will cause a country's \_\_\_\_\_\_\_\_ to \_\_\_\_\_\_\_\_.
A) current consumption: increase
B) current consumption: decrease
C) terms of trade; improve 
D) terms of trade; worsen 
E) welfare level; improve

Answer 41

B) current consumption: decrease

Question 42

What is intertemporal comparative advantage?

Answer 42

Intertemporal comparative advantage arises when a country can produce goods for future consumption at a relatively low cost in terms of current consumption. Such a country can import investments (loans) from other countries with intertemporal comparative disadvantages at terms of trade that benefit both countries.

Question 43

The price of \_\_\_\_\_\_\_\_ consumption in terms of \_\_\_\_\_\_\_\_ consumption is \_\_\_\_\_\_\_\_. 
A) future; current; r
B) present; future; r
C) future; current; 1 + r
D) future; current; 1/(1 + r) 
E) present; future; 1/(1 + r)

Answer 43

D) future; current; 1/(1 + r)

Question 44

The intertemporal budget constraint is defined as: 
A) V = DP + DF/(1 + r)
B) DP + DF(1 + r) = QP + QF(1 + r)
C) DP + DF/(1 + r) = QP + QF/(1 + r)
D) DF + DP/(1 + r) = QF + QP/(1 + r) 
E) V = QP + QF/(1 + r)

Answer 44

C) DP + DF/(1 + r) = QP + QF/(1 + r)

Question 45

Describe the nature of trade between two countries based on intertemporal comparative advantage.

Answer 45

Intertemporal comparative advantage arises when a country can produce goods for future consumption at a relatively low cost in terms of current consumption when compared with its trading partner. This implies that the first country offers a relatively high return on investment when compared to the second. As a result, the first country will import goods for current consumption (investments or loans) and will export goods for future consumption (return on investment or interest). The resulting pattern of trade is one which will tend to equalize returns on investment in the two countries.