FACULTY OF COMMERCE
SAMPLE EXAM ANSWERS
ECO320 INTERNATIONAL ECONOMICS
Part A. Multiple Choice.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
d
d
a
d
c
a
d
d
a
b
a
d
c
d
d
b
a
c
c
d
Part B.
Question 1.
a.
Trade is possible. Based on the comparative advantage concept.
b.
Australia gains 1C, while UK gains 4C (This is because 4W that UK obtains from
Australia is equivalent to 4 hrs of labour time which can produce 8C in UK. Of 8C, it
gives 4C to Australia, which results in saving of 4C for UK)
c.
In Australia, costs in terms of labour content of producing one unit of wheat and cloth
are 15 minutes and 20 minutes respectively, while in the UK they are 60 minutes and
30 minutes respectively.
d.
Dollar price of wheat is $1.50 per kg ($6.00/4kg = $1.50), while dollar price of cloth is $2
per yard ($6.00/3 yard = $2.00)
e.
Pound price wheat is 1 pound per kilogram (1pound/1kg = 1pound per kg) while the
pound price of cloth is 0.50 pence per yard (1 pence/2 yards = 0.50 pence)
Question 2
a.
Terms of trade (TOT) show how much a nation is getting for its merchandise exports
and how much it pays for merchandise imports. It is measured as the ratio of the index
price of a nation’s exports to its imports.
b.
If the TOT of a nation improved from 100 to 110, the TOT of the trade partner would
deteriorate by about 9%. Calculated as follows: (100/110)x100 (-100).
c.
A deterioration in TOT of the trade partner can be said to be unfavourable because it
indicates that the country is paying higher prices for imports than what it gets for its
exports. However, this does not mean that the overall welfare has declined. Note that
TOT shows only the performance of foreign trade in an economy. It does not give any
idea about the other indicators such as health, education, etc.
Question 3
a.
Deadweight loss is the protection cost to the economy with the application of a tariff. It
measures the inefficiency of the industry with the tariff eg: the cost of diverting
resources from somewhere else to the inefficient industry.
b.
See diagram on page 241 of the textbook, which gives a deadweight loss of $15
[CMJ=$5 +HNB=$10).
Question 4
a.
ERP shows the actual level of protection granted to a producer. A producer might be
importing inputs at much lower tariff or duty free while there is a high tariff on imported
final goods, making the actual level of protection (effective protection) much high than
what a nominal tariff (or nominal protection) would indicate. See example in the book
(pp 244-245)
b.
Discuss the various forms of protection (ie, tariff and non-tariff barriers such as quota,
dumping, subsidies, VER, cartel etc) .
Question 5
a.
Under the automatic price adjustment mechanism a nation’s BOP deficit is corrected by
a devaluation/depreciation of its currency. This concept is clearly explained in page 549
of the textbook (figure 16.1 of the textbook).
b.
Advantages and disadvantages are:
Advantages: a) It is quick, b) It avoids the possibility of implementing wrong policies
Disadvantage: a) It can lead to a huge instability in the economy.
Question 6
a.
In this situation, he buys pounds in SYD using $2, uses one pound to purchase 270
Japanese Yen in London and uses Yen to purchase $ 2.08 in Tokyo, thus making a
profit of $0.08 for each pound transferred.
b.
The speculator can speculate in the forward market by purchasing pounds forward for
delivery in 3 months at FR=$2/1pound. If he is correct, he earns 5c per pound
purchased. He loses (5 c) if the rate is $1.95/1pound.
PART C
Note: In answering essay question try to justify the statement, using the real life experience
and the knowledge that you have gained from the text book. I look for the strength of your
arguments and not the length. It can be anywhere between 2-4 pages.
1.
This statement is correct. You need to discuss how under the various rounds of trade
negotiations tariffs were brought down (Chapter 9, sections 9.6A-9.6E and 9.7). As
tariffs declined, nations have started imposing several non-tariff means to protect their
markets. These include health and safety standards (including quarantine), VERs,
subsidies etc. Discuss these and explain how these non-tariff barriers have affected
free movement of goods between nations.
2.
In answering this essay, you need to discuss, in brief, how the automatic adjustment
mechanisms by influencing price, income and money supply bring about adjustment in
the BOP. When the exchange rate is not freely flexible, a depreciation of the deficit
nation’s currency corrects a part of the disequilibrium. The deficit then leads to the
reduction in the nation’s money supply and an increase in its interest rate. This induces
a fall in investment, imports and income, which helps reduce the deficit. A higher
interest rate also attracts capital inflows. The reduction in money supply and incomes
reduces prices in the deficit nation relative to prices in the surplus nation, and helps
improve the deficit. Automatic changes in prices, income and money supply by working
together are likely to bring about the adjustment in the BOP. (Read 17.6 of the
textbook).
These adjustment mechanisms, however, can lead to a huge instability in the economy.
For instance, a large depreciation of a nation’s currency can lead to economic instability
as investors lose confidence on the economy. Likewise, high unemployment caused
by a fall in investment (due to higher interest rate) can lead to social problems and
unrest in the deficit nation. However, these unwanted side effects can partly be avoided
by adjustment policies (namely monetary and fiscal policies) and direct
control/interventions (such as welfare benefits, subsidies etc) Discuss these.