Chapter 5: The Standard Trade Model 1. The concept terms of trade means A. the amount of exports sold by a country.

B. the price conditions bargained for in international markets. C. the price of a country's exports di ided by the price of its imports. !. the "uantities of imports recei ed in free trade. #. $one of the abo e. Ans%er& C '. A country cannot produce a mix of products %ith a higher alue than %here A. the iso alue line intersects the production possibility frontier. B. the iso alue line is tangent to the production possibility frontier. C. the iso alue line is abo e the production possibility frontier. !. the iso alue line is belo% the production possibility frontier. #. the iso alue line is tangent %ith the indifference cur e. Ans%er& B (. Tastes of indi iduals are represented by A. the production possibility frontier. B. the iso alue line. C. the indifference cur e. !. the production function. #. $one of the abo e. Ans%er& C ). *f +C , +- %ere to increase in the international marketplace. then A. all countries %ould be better off. B. the terms of trade of cloth exporters impro e. C. the terms of trade of food exporters impro e. !. the terms of trade of all countries impro e. #. $one of the abo e Ans%er& B /. *f +C , +- %ere to increase. A. the cloth exporter %ould increase the "uantity of cloth exports. B. the cloth exporter %ould increase the "uantity of cloth produced. C. the food exporter %ould increase the "uantity of food exports. !. Both A and C. #. $one of the abo e. Ans%er& B

/0

0. *f +C , +A. B. C. !. #.

%ere to increase. %orld relati e "uantity of cloth supplied and demanded increases. %orld relati e "uantity of cloth supplied and demanded decreases. %orld relati e "uantity of cloth supplied increases.. %orld relati e "uantity of cloth demanded decreases . $one of the abo e.

Ans%er& C 1. 2hen the production possibility frontier shifts out relati ely more in one direction. %e ha e A. biased gro%th. B. unbiased gro%th. C. immiseri3ing gro%th. !. balanced gro%th. #. imbalanced gro%th. Ans%er& A 4. #xport5biased gro%th in Country 6 %ill A. impro e the terms of trade of Country 6. B. trigger anti5bias regulations of the 2T7. C. %orsen the terms of trade of Country - 8the trade partner9. !. impro e the terms of trade of Country -. #. decrease economic %elfare in Country 6. Ans%er& ! :. *mmiseri3ing gro%th is A. likely to occur if the exporting country is poor. B. likely to occur if the exporting country is rich. C. likely to occur %hen terms of trade change. !. likely to occur if relati e supplies are elastic. #. $one of the abo e. Ans%er& # 1;. *f the <.=. Agency for *nternational !e elopment transfers funds to poor countries in =ub5=aharan Africa. this must A. %orsen the <.=. terms of trade. B. impro e the <.=. terms of trade. C. %orsen the terms of trade of the African aid recipients. !. impro e the terms of trade of the African aid recipients. #. $one of the abo e. Ans%er& #

/1

11. *f the poor A*! recipient countries ha e a higher marginal propensity to consume each and e ery product than does the <nited =tates. then such aid %ill A. %orsen the <.=. terms of trade. B. impro e the <.=. terms of trade. C. lea e the %orld terms of trade unaffected. !. %orsen the terms of trade of both donor and recipient countries. #. $one of the abo e. Ans%er& B 1'. *f a large country imposes a tariff on its imported good. this %ill tend to A. ha e no effect on terms of trade. B. impro e the terms of trade of all countries. C. impro e the terms of trade of the <nited =tates. !. cause a deterioration of <.=. terms of trade. #. raise the %orld price of the good imported by the <nited =tates. Ans%er& C 1(. A country %ill be able to consume a bundle %hich is not attainable solely from domestic production only if A. the %orld terms of trade differ from its domestic relati e costs. B. the country speciali3es in one product. C. the country a oids international trade. !. the %orld terms of trade e"ual the domestic relati e costs. #. $one of the abo e. Ans%er& A 1). Terms of trade refers to A. %hat goods are imported. B. %hat goods are exported. C. the olume of trade. !. the prices at %hich trade occurs. #. $one of the abo e. Ans%er& ! 1/. *f points a and b are both on the production possibility frontier of a country. then A. consumers are indifferent bet%een the t%o bundles. B. producers are indifferent bet%een the t%o bundles. C. at any point in time. the country could produce both. !. Both cost the same. #. The country could produce either of the t%o bundles. Ans%er& #

/4

10. *f the economy is producing at point a on its production possibility frontier. then A. all of the country's %orkers are speciali3ed in one product. B. all of the county's capital is used for one product. C. all of the county's %orkers are employed. !. all of its capital is used. but not efficiently. #. $one of the abo e. Ans%er& C 11. *f at point A on the production possibility frontier. and the community indifference cur e cuts through point a from north%est to southeast. then the optimal autarky production bundle is A. at point A. B. to the right of point A. C. to the left of point A. !. to the northeast of point A. #. to the south%est of point A. Ans%er& B 14. A bundle indicated by a point to the northeast of the production possibility frontier is A. unattainable at a point in time. B. unattainable at a point in time %ithout international trade. C. unattainable at a point in time %ithout domestic trade. !. unattainable as a consumption point. #. $one of the abo e. Ans%er& B 1:. *f t%o countries %ith diminishing returns and different marginal rates of substitution bet%een t%o products %ere to engage in trade. then A. the shapes of their respecti e production possibility frontiers %ould change. B. the marginal rates of substitution of both %ould become e"ual. C. the larger of the t%o countries %ould dominate their trade. !. the country %ith relati ely elastic supplies %ould export more. #. $one of the abo e. Ans%er& B

/:

';. *f a country began exporting product A and importing product B. then. as compared to the autarky 8no5trade9 situation. the marginal cost of product A %ill A. increase. B. decrease. C. shift out%ard. !. shift in%ard. #. $one of the abo e. Ans%er& A '1. *f. beginning from a free trade e"uilibrium. the terms of trade impro e for a country. then it %ill A. increase production of its import competing good. B. increase consumption of its export good. C. increase the "uantity of its imports. !. experience an export5biased shift in its production possibility frontier. #. $one of the abo e. Ans%er& C ''. An increase in a country's net commodity terms of trade %ill al%ays A. increase the country's economic %elfare. B. increase the country's real income. C. increase the country's "uantity of exports. !. increase the country's production of its import competing good. #. $one of the abo e. Ans%er& # '(. After 22*. >ermany %as forced to make large reparations 5 transfers of real income5 to -rance. *f the marginal propensity to consume %as e"ual in both countries. and if -rance's demand %as biased to%ard food 8relati e to >ermany's demand pattern9 then %e %ould expect to find A. the %orld's relati e price for food remains unchanged. B. the %orld's relati e price for food increase. C. the %orld's relati e price for food decrease. !. the %orld relati e price for both food and non5food rise. #. $one of the abo e. Ans%er& B

0;

'). *f %e add to ?uestion '( that -rance exported manufactures. %hereas >ermany exported food. then the reparations from >ermany to -rance %ould A. impro e -rance's international terms of trade. B. cause -rance' terms of trade to deteriorate. C. cause both -rance' and >ermany's terms of trade to deteriorate. !. cause both -rance' and >ermany's terms of trade to impro e. #. $one of the abo e. Ans%er& B '/. *f a country lent money to another. this must A. lo%er the terms of trade of the recipient country. B. lo%er the terms of trade of both countries. C. impro e the terms of trade of the recipient country. !. impro e the terms of trade of the donor country #. $one of the abo e. Ans%er& # '0. !uring the 1:th Century. economic gro%th of the ma@or trading countries %as biased to%ard manufactures and a%ay from food. The less de eloped countries of that time %ere net exporters of food. -rom this information. %e %ould expect to ha e obser ed A. falling terms of trade for the less de eloped countries. B. impro ing 8rising9 terms of trade for the less de eloped countries. C. no change at all in the terms of trade of the less de eloped countries. !. a decrease in the relati e price of food. #. $one of the abo e. Ans%er& B '1. *mmiseri3ing gro%th could occur to A. a poor country experiencing export5biased economic gro%th. B. a poor country experiencing import5biased economic gro%th. C. a poor country experiencing gro%th in its non5traded sector. !. a poor country experiencing capital5intensi e biased gro%th. #. $one of the abo e. Ans%er& A

01

'4. A large country experiencing import5biased economic gro%th %ill tend to experience A. positi e terms of trade. B. deteriorating terms of trade. C. impro ing terms of trade. !. immiseri3ing terms of trade. #. $one of the abo e. Ans%er& C ':. *n the period preceding the recent -inancial Crisis in Asia. the =outh #ast Asian countries %ere recei ing large inflo%s of financial capital. -ollo%ing Aohn Baynard Ceynes' theory. this should ha e caused A. a glut in their banking asset situation. B. an impro ement in their terms of trade. C. deterioration in their terms of trade. !. a fluctuation up%ard and then do%n%ard in their terms of trade. #. $one of the abo e. Ans%er& B (;. *f =lo enia is a small country in %orld trade terms. then if it imposes a large series of tariffs on many of its imports. this %ould A. ha e no effect on its terms of trade. B. impro e its terms of trade. C. deteriorate its terms of trade. !. decrease its marginal propensity to consume. #. $one of the abo e. Ans%er& A (1. *f =lo enia is a large country in %orld trade. then if it imposes a large set of tariffs on many of its imports. this %ould A. ha e no effect on its terms of trade. B. impro e its terms of trade. C. deteriorate its terms of trade. !. decrease its marginal propensity to consume. #. $one of the abo e. Ans%er& B

0'

('. *f =lo enia %ere a large country in %orld trade. then if it imposes a large set of tariffs on its imports. this must A. cause retaliation on the part of its trade partners. B. harm =lo enia's real income. C. impro e =lo enia's real income. !. impro e the real income of its trade partners. #. $one of the abo e. Ans%er& # ((. *f =lo enia %ere a large country in %orld trade. then if it instituted a large set of subsidies for its exports. this must A. ha e no effect on its terms of trade. B. impro e its terms of trade. C. deteriorate its terms of trade. !. decrease its marginal propensity to consume. #. $one of the abo e. Ans%er& C (). *f =lo enia %ere a large country in %orld trade. then if it instituted a large set of subsidies for its exports. this must A. cause retaliation on the part of its trade partners. B. harm =lo enia's real income. C. impro e =lo enia's real income. !. impro e the real income of its trade partners. #. $one of the abo e. Ans%er& ! (/. *f the <nited =tates exports skilled5labor intensi e products and ser ices. then %e should expect unions representing skilled labor to A. lobby in fa or of tariffs. B. lobby against the imposition of tariffs. C. be indifferent to the issue of tariffs. !. lobby in fa or of impro ed terms of trade. #. $ot enough information. Ans%er& #

0(

(0. *f the <nited =tates exports skilled5labor intensi e products and ser ices. then %e should expect unions representing unskilled labor to A. lobby in fa or of tariffs. B. lobby against the imposition of tariffs. C. be indifferent to the issue of tariffs. !. lobby in fa or of impro ed terms of trade. #. $ot enough information. Ans%er& B (1. *f a there are no international loans or capital flo%s. then if a country's terms of trade impro e. %e %ould find that A. the alue of its exports exceeds the alue of its imports. B. the alue of its exports becomes less than that of its imports. C. the alue of its exports exactly e"uals that of its imports. !. the "uantity of its exports e"uals that of its imports. #. $one of the abo e. Ans%er& C

0)

Essay Questions 1. 7ther things being e"ual. a rise in a country's terms of trade increases its %elfare. 2hat %ould happen if %e relax the ceteris paribus assumption. and allo% for the la% of demand to operate internationallyD

Ans%er& Eet us assume that the terms of trade 8or technically the net commodity terms of trade9 impro e. thus the relati e price of a country's exports increase. This %ould. logically. lead to a shift a%ay by %orld consumers to substitute goods. *f the demand for a country's exports is elastic. the "uantity decrease %ould be proportionally larger than the per unit price increase. This term of trade effect %ould actually lo%er the country's real income and economic %elfare. '. *f a country's gro%th is biased in fa or of its import. this should une"ui ocally impro e its terms of trade and its economic %elfare. !iscuss.

Ans%er& =uppose Aapan experiences economic gro%th biased in fa or of its import substitutes. -or example. assume that Aapan imports components and exports final goods. but that it experiences a ma@or gro%th in its components manufacture sector. =ince Aapan is internationally a large country in these markets. this %ould tend to hurt its component supplier's terms of trade 8and help Aapan's9. 6o%e er. such a bias in economic gro%th may tend to lessen the olume of international trade. At an extreme. Aapan may become an exporter of components and an importer of final goods. *f the result is a lessening of speciali3ation and of the olume of trade. then this effect %ill lo%er Aapan's %elfare associated %ith gains from trade. *f an actual change in the pattern of comparati e ad antage occurs 8a possibility9 this may cause dynamic dislocations %hose harm o erpo%ers static gains for a relati ely long period of time. (. *t is impossible for economic gro%th in a small country to lo%er that country's economic %elfare. regardless of the bias of the gro%th. #xplain.

Ans%er& This is a true statement. The reason economic gro%th may hurt a country is if the terms of trade effect counters and dominates the gro%th effect. *n the case of the small country there is no terms of trade effect.

0/

).

At the conclusion of 2orld 2ar *. >ermany. as a punishment. %as obliged to make a large transfer to -rance in the form of reparations. *s it possible that the actual reparations may ha e impro ed >ermany's economic %elfareD

Ans%er& =uch a result is not likely. 6o%e er. theoretically. if -rance's income elasticity of demand for >ermany's exports %as higher than >ermany's income elasticity of demand for its o%n exportable. then the real income transfer associated %ith these reparations may ha e impro ed >ermany's terms of trade. and impro ed its balance of payments. thus helping >ermany in manner unanticipated in the Treaty of Ferssaille. #xplain. /. An export subsidy has the opposite effect on terms of trade to the effect of an import tariff. !omestically a tariff %ill raise the price of the import good. deteriorating the domestic terms of trade. A production subsidy for the export product %ill lo%er the local price of the export good. lo%ering the domestic terms of trade for the country. 6ence the export subsidy and the import tariff ha e the same effect. This analysis seems to contradict the first sentence in this paragraph. !iscuss this paradox.

Ans%er& 2hile this 8Eerner9 e"ui alence may %ell occur domestically. internationally the tariff %ill impro e a country's terms of trade. An export subsidy on the other hand %ill in fact lo%er the international price of the 8no% readily a ailable9 export good. hence hurting a country's terms of trade.

00

Quantitative/Graphing Problems

1.

Albania refused to engage in international trade for ideological reasons. To maximi3e its economic %elfare it %ould choose to produce at %hich point in the diagram abo eD =uppose the +A,+B at point a %as e"ual to 1. >i en this information. in %hich good 8A or B9 does Albania en@oy a comparati e ad antageD $o% that the Cold 2ar is o er. Albania is interested in obtaining economic %elfare gains from trade. The rele ant international relati e price is +A,+B G'. Albania %ould therefore choose to produce at %hich point 8a. b. or c9D >i en this additional information. in %hich good does Albania en@oy a comparati e ad antageD

Ans%ers& Albania %ould choose to produce at point a. 2ith no reference to %orld terms of trade. one cannot establish Albania's comparati e ad antage. Eater. %hen Albania disco ers that the relati e price of A e"uals t%ice the price of B. it kno%s that it has a comparati e ad antage in A. Therefore Albania %ould produce at production point b. '. $o%. suppose that the relati e price of A is actually not higher than Albania's autarkic le el of 1. but "uite the opposite 8e.g. +A,+B G ;./9. 2ould Albania still be able to gain from tradeD *f so. %here %ould be its production pointD >i en the information in this "uestion. %here is Albania's comparati e ad antageD

Ans%er& Hes. As long as the %orld's terms of trade differed from those of Albania. that country stands to gain from international trade. *n this particular case. its point of production %ith trade %ould be at point c.

01

(.

=uppose. as a result of arious dynamic factors associated %ith exposure to international competition. Albania's economy gre%. and is no% represented by the rightmost production possibility frontier in the -igure abo e. *f its point of production %ith trade %as point c. %ould you consider this gro%th to be export5 biased or import biasedD *f Albania %ere a large country %ith respect to the %orld trade of A and B. ho% %ould this gro%th affect Albania's terms of tradeD *ts real incomeD

Ans%er& *f point c is the production point %ith trade. then Albania has a comparati e ad antage in good B. Therefore. from the shape of the ne% production possibility frontier 8as compared to the original one9. this is clearly an export5biased gro%th. This ceteris paribus %ould tend to %orsen Albania's terms of trade. The terms of trade effect %ould. again ceteris paribus, %orsen its real income. 6o%e er. the gro%th itself acts in the opposite direction. ). =uppose. as a result of arious dynamic factors associated %ith exposure to international competition. Albania's economy gre%. and is no% represented by the rightmost production possibility frontier in the -igure abo e. *f its point of production %ith trade %as point b. %ould you consider this gro%th to be export5 biased or import biasedD *f Albania %ere a large country %ith respect to the %orld trade of and !. ho% %ould this gro%th affect Albania's terms of tradeD *ts real incomeD 2hat if Albania %ere a small countryD

Ans%er& *f the production %ith trade point %as point b" then the obser ed gro%th is a case of import5biased gro%th. and %ould impro e Albania's terms of trade. *f Albania %ere a small country. the %orld's terms of trade %ould not change at all. *n such a case. economic gro%th 8%ith no induced change in income distributions9 %ould al%ays increase its real income.

04

/.

=uppose Albania is exporting product !. and experienced economic gro%th biased in fa or of product ! as seen in the -igure abo e. 2e are also told that Albania's ne% consumption point is at point d. 2ould you still consider the economic gro%th. %hich took place biased in fa or of !D *f Albania %ere a large country ho% %ould this gro%th affect its terms of tradeD

Ans%er& This is a relati ely difficult case. 7n the one hand. the gro%th is still technically export biased. 6o%e er. Albania's consumption clearly shifted in fa or of its import product. A. *n this case. the deterioration in the terms of trade %ould be much more pronounced than before. and may lead to a case of immiseri3ing gro%th. 6o%e er. for this to occur. there must ha e been a ma@or shift in the taste patterns 8the old community indifference map is not longer applicable9. Therefore. %hen %e try to @udge the direction and magnitude of the %elfare change. %e are comparing the old ersus ne% taste preferences. %hich raises the classic index number problem.

0: