Chapter 5 The Standard Trade Model
5.1 A Standard Model of a Trading Economy
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 divided by the price of its imports.
D) the quantities of imports received in free trade.
E) None of the above.
Answer: C
Question Status: Previous Edition
2) A country cannot produce a mix of products with a higher value than where
A) the isovalue line intersects the production possibility frontier.
B) the isovalue line is tangent to the production possibility frontier.
C) the isovalue line is above the production possibility frontier.
D) the isovalue line is below the production possibility frontier.
E) the isovalue line is tangent with the indifference curve.
Answer: B
Question Status: Previous Edition
3) Tastes of individuals are represented by
A) the production possibility frontier.
B) the isovalue line.
C) the indifference curve.
D) the production function.
E) None of the above.
Answer: C
Question Status: Previous Edition
4) If PC/PF were to increase in the international marketplace, then
A) all countries would be better off.
B) the terms of trade of cloth exporters improve.
C) the terms of trade of food exporters improve.
D) the terms of trade of all countries improve.
E) None of the above.
Answer: B
Question Status: Previous Edition
5) If PC/PF were to increase,
A) the cloth exporter would increase the quantity of cloth exports.
B) the cloth exporter would increase the quantity of cloth produced.
C) the food exporter would increase the quantity of food exports.
D) Both A and C.
E) None of the above.
Answer: B
Question Status: Previous Edition
1
6) If PC/PF were to increase,
A) world relative quantity of cloth supplied and demanded would increase.
B) world relative quantity of cloth supplied and demanded would decrease.
C) world relative quantity of cloth supplied would increase.
D) world relative quantity of cloth demanded would decrease.
E) None of the above.
Answer: C
Question Status: Previous Edition
7) A country will be able to consume a bundle which is not attainable solely from domestic production only if
A) the world terms of trade differ from its domestic relative costs.
B) the country specializes in one product.
C) the country avoids international trade.
D) the world terms of trade equal the domestic relative costs.
E) None of the above.
Answer: A
Question Status: Previous Edition
8) Terms of trade refers to
A) what goods are imported.
B) what goods are exported.
C) the volume of trade.
D) the prices at which trade occurs.
E) None of the above.
Answer: D
Question Status: Previous Edition
9) If points A and B are both on the production possibility frontier of a country, then
A) consumers are indifferent between the two bundles.
B) producers are indifferent between the two bundles.
C) at any point in time, the country could produce both.
D) Both cost the same.
E) The country could produce either of the two bundles.
Answer: E
Question Status: Previous Edition
10) If the economy is producing at point a on its production possibility frontier, then
A) all of the country's workers are specialized in one product.
B) all of the county's capital is used for one product.
C) all of the county's workers are employed.
D) all of its capital is used, but not efficiently.
E) None of the above.
Answer: C
Question Status: Previous Edition
2
11) If at point A on the production possibility frontier, and the community indifference curve cuts through point
a from northwest 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.
D) to the northeast of point A.
E) to the southwest of point A.
Answer: B
Question Status: Previous Edition
12) If two countries with diminishing returns and different marginal rates of substitution between two products
were to engage in trade, then
A) the shapes of their respective production possibility frontiers would change.
B) the marginal rates of substitution of both would become equal.
C) the larger of the two countries would dominate their trade.
D) the country with relatively elastic supplies would export more.
E) None of the above.
Answer: B
Question Status: Previous Edition
13) If a country began exporting product A and importing product B, then, as compared to the autarky (notrade) situation, the marginal cost of product A will
A) increase.
B) decrease.
C) shift outward.
D) shift inward.
E) None of the above.
Answer: A
Question Status: Previous Edition
14) If a small country were to levy a tariff on its imports then this would
A) have no effect on that country's economic welfare.
B) increase the country's economic welfare.
C) decrease the country's economic welfare.
D) change the terms of trade.
E) None of the above.
Answer: C
Question Status: Previous Edition
15) An increase in a country's net commodity terms of trade will always
A) increase the country's economic welfare.
B) increase the country's real income.
C) increase the country's quantity of exports.
D) increase the country's production of its import competing good.
E) None of the above.
Answer: E
Question Status: Previous Edition
3
16) If the United States exports skilled-labor intensive products and services, then we should expect unions
representing skilled labor to
A) lobby in favor of tariffs.
B) lobby against the imposition of tariffs.
C) be indifferent to the issue of tariffs.
D) lobby in favor of improved terms of trade.
E) Not enough information.
Answer: E
Question Status: Previous Edition
17) Suppose now that Home experiences growth strongly biased toward its export, cloth,
A) this will tend to worsen Home's terms of trade.
B) this will tend to improve Home's terms of trade.
C) this will tend to worsen Foreign's terms of trade.
D) this will have no effect on Foreign's terms of trade.
E) None of the above.
Answer: A
Question Status: New
18) Suppose that Home is a "small country," and it experiences growth strongly biased toward its export, cloth
A) this will tend to worsen Home's terms of trade
B) this will tend to improve Home's terms of trade
C) this will tend to worsen Foreign's terms of trade
D) this will have no effect on Foreign's terms of trade
E) None of the above
Answer: D
Question Status: New
19) 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: 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 Status: Previous Edition
4
20) Refer to above figure. 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 P A/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: 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 Status: Previous Edition
21) Refer to above figure. 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: 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 Status: Previous Edition
5.2 International Transfers of Income: Shifting of the RD Curve
1) When the production possibility frontier shifts out relatively more in one direction, we have
A) biased growth.
B) unbiased growth.
C) immiserizing growth.
D) balanced growth.
E) imbalanced growth.
Answer: A
Question Status: Previous Edition
5
2) Export-biased growth in Country H will
A) improve the terms of trade of Country H.
B) trigger anti-bias regulations of the WTO.
C) worsen the terms of trade of Country F (the trade partner).
D) improve the terms of trade of Country F.
E) decrease economic welfare in Country H.
Answer: D
Question Status: Previous Edition
3) Immiserizing growth 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 when terms of trade change.
D) likely to occur if relative supplies are elastic.
E) None of the above.
Answer: E
Question Status: Previous Edition
4) If the poor USAID recipient countries have a higher marginal propensity to consume each and every product
than does the United States, then such aid will
A) worsen the U.S. terms of trade.
B) improve the U.S. terms of trade.
C) leave the world terms of trade unaffected.
D) worsen the terms of trade of both donor and recipient countries.
E) None of the above.
Answer: B
Question Status: Previous Edition
5) If the U.S. has a higher marginal propensity to consume (MPC) imports as compared to both its MPC for
exportables and nontradables, then such aid will
A) worsen the U.S. terms of trade.
B) improve the U.S. terms of trade.
C) leave the world terms of trade unaffected.
D) worsen the terms of trade of both donor and recipient countries.
E) None of the above.
Answer: B
Question Status: Previous Edition
6) If, beginning from a free trade equilibrium, the (net barter) terms of trade improve for a country, then it will
A) increase production of its import competing good.
B) increase consumption of its export good.
C) increase the quantity of its imports.
D) experience an export-biased shift in its production possibility frontier.
E) None of the above.
Answer: C
Question Status: Previous Edition
6
7) After WWI, Germany was forced to make large reparations-transfers of real income- to France. If the
marginal propensity to consume was equal in both countries, and if France's demand was biased toward
food (relative to Germany's demand pattern) then we would expect to find
A) the world's relative price for food remains unchanged.
B) the world's relative price for food increase.
C) the world's relative price for food decrease.
D) the world relative price for both food and non-food rise.
E) None of the above.
Answer: B
Question Status: Previous Edition
8) If France exported manufactures, whereas Germany exported food, then the reparations from Germany to
France would
A) improve France's international terms of trade.
B) cause France' terms of trade to deteriorate.
C) cause both France' and Germany's terms of trade to deteriorate.
D) cause both France' and Germany's terms of trade to improve.
E) None of the above.
Answer: B
Question Status: Previous Edition
9) If a country lent money to another, this must
A) lower the terms of trade of the recipient country.
B) lower the terms of trade of both countries.
C) improve the terms of trade of the recipient country.
D) improve the terms of trade of the donor country.
E) None of the above.
Answer: E
Question Status: Previous Edition
10) During the 19th Century, economic growth of the major trading countries was biased toward manufactures
and away from food. The less developed countries of that time were net exporters of food. From this
information, we would expect to have observed
A) falling terms of trade for the less developed countries.
B) improving (rising) terms of trade for the less developed countries.
C) no change at all in the terms of trade of the less developed countries.
D) a decrease in the relative price of food.
E) None of the above.
Answer: B
Question Status: Previous Edition
11) Immiserizing growth could occur to
A) a poor country experiencing export-biased economic growth.
B) a poor country experiencing import-biased economic growth.
C) a poor country experiencing growth in its non-traded sector.
D) a poor country experiencing capital-intensive biased growth.
E) None of the above.
Answer: A
Question Status: Previous Edition
7
12) A large country experiencing import-biased economic growth will tend to experience
A) positive terms of trade.
B) deteriorating terms of trade.
C) improving terms of trade.
D) immiserizing terms of trade.
E) None of the above.
Answer: C
Question Status: Previous Edition
13) In the period preceding the recent Financial Crisis in Asia, the South East Asian countries were receiving
large inflows of financial capital. Following John Maynard Keynes' theory, this should have caused
A) a glut in their banking asset situation.
B) an improvement in their terms of trade.
C) deterioration in their terms of trade.
D) a fluctuation upward and then downward in their terms of trade.
E) None of the above.
Answer: B
Question Status: Previous Edition
14) If a there are no international loans or capital flows, then if a country's terms of trade improve, we would
find that
A) the value of its exports exceeds the value of its imports.
B) the value of its exports becomes less than that of its imports.
C) the value of its exports exactly equals that of its imports.
D) the quantity of its exports equals that of its imports.
E) None of the above.
Answer: C
Question Status: Previous Edition
15) If the U.S. Agency for International Development transfers funds to poor countries in Sub-Saharan Africa,
the conventional assumption, following Keynes' analysis would presume that this would tend to
A) worsen the U.S. terms of trade.
B) improve the U.S. terms of trade.
C) worsen the terms of trade of the African aid recipients.
D) improve the terms of trade of the African aid recipients.
E) None of the above.
Answer: A
Question Status: Previous Edition
16) If a country's growth is biased in favor of its import, this should unequivocally improve its terms of trade
and its economic welfare. Discuss.
Answer: Suppose Japan experiences economic growth biased in favor of its import substitutes. For example,
assume that Japan imports components and exports final goods, but that it experiences a major growth
in its components manufacture sector. Since Japan is internationally a large country in these markets,
this would tend to hurt its component supplier's terms of trade (and help Japan's). However, such a
bias in economic growth may tend to lessen the volume of international trade. At an extreme, Japan
may become an exporter of components and an importer of final goods. If the result is a lessening of
specialization and of the volume of trade, then this effect will lower Japan's welfare associated with
gains from trade. If an actual change in the pattern of comparative advantage occurs (a possibility) this
may cause dynamic dislocations whose harm overpowers static gains for a relatively long period of
time.
Question Status: Previous Edition
8
17) It is impossible for economic growth in a small country to lower that country's economic welfare, regardless
of the bias of the growth. Explain.
Answer: This is a true statement. The reason economic growth may hurt a country is if the terms of trade effect
counters and dominates the growth effect. In the case of the small country there is no terms of trade
effect.
Question Status: Previous Edition
18) At the conclusion of World War I, Germany, as a punishment, was obliged to make a large transfer to France
in the form of reparations. Is it possible that the actual reparations may have improved Germany's economic
welfare?
Answer: Such a result is not likely. However, theoretically, if France's income elasticity of demand for
Germany's exports was higher than Germany's income elasticity of demand for its own exportable,
then the real income transfer associated with these reparations may have improved Germany's terms
of trade, and improved its balance of payments, thus helping Germany in manner unanticipated in the
Treaty of Verssaille. Explain.
Question Status: Previous Edition
19) If a country's net barter terms of trade improve (increase), it is possible that this could decrease the value of
its exports demanded, and hence harm its economic welfare. Discuss this possibility. What alternative
measure for "terms of trade" does this suggest?
Answer: An "improvement" in the terms of trade occurs when the price of a country's exports rises by more
than the price of its imports. If demand for this country's exports is inelastic, then this could decrease
demand for its exports in the world. This is treated under the topics of the Marshal-Lerner conditions
for the effects of a depreciation on the balance of payments. This suggests that we may wish to use
some kind of "income terms of trade," the would explicitly consider both changes in relative tradables
prices, and also quantities of export (the latter not dealt with by the net barter terms of trade).
Question Status: Previous Edition
5.3 Tariffs and Export Subsidies: Simultaneous Shifts in RS and RD
1) If the U.S. (a large country) imposes a tariff on its imported good, this will tend to
A) have no effect on terms of trade.
B) improve the terms of trade of all countries.
C) improve the terms of trade of the United States.
D) cause a deterioration of U.S. terms of trade.
E) raise the world price of the good imported by the United States.
Answer: C
Question Status: Previous Edition
2) 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) have no effect on its terms of trade.
B) improve its terms of trade.
C) deteriorate its terms of trade.
D) decrease its marginal propensity to consume.
E) None of the above.
Answer: A
Question Status: Previous Edition
9
3) 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) have no effect on its terms of trade.
B) improve its terms of trade.
C) deteriorate its terms of trade.
D) decrease its marginal propensity to consume.
E) None of the above.
Answer: B
Question Status: Previous Edition
4) If Slovenia were a large country in world 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 Slovenia's real income.
C) improve Slovenia's real income.
D) improve the real income of its trade partners.
E) None of the above.
Answer: E
Question Status: Previous Edition
5) 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) improve its terms of trade.
C) deteriorate its terms of trade.
D) decrease its marginal propensity to consume.
E) None of the above.
Answer: C
Question Status: Previous Edition
6) If Slovenia were a large country in world 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 Slovenia's real income.
C) improve Slovenia's real income.
D) improve the real income of its trade partners.
E) None of the above.
Answer: D
Question Status: Previous Edition
7) 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: 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 Status: Previous Edition
10
8) 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 exportbiased 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: 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 Status: Previous Edition
9) 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 exportbiased 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: 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 Status: Previous Edition
10) 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: 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 Status: Previous Edition
11
5.4 Appendix to Chapter 5: Representing International Equilibrium with Other Curves
1) Home's offer curve shows
A) how Home's desired exports vary with biased growth in Foreign.
B) how Foreign's desired imports vary with Home’s level of exports.
C) how Home's desired exports vary with the terms of trade.
D) how Foreign's desired imports vary with the relative price.
E) None of the above.
Answer: C
Question Status: New
2) As one moves from the origin up Home's offer curve, Foreign's terms of trade
A) remain constant.
B) worsen.
C) improve.
D) may improve or worsen.
E) None of the above.
Answer: B
Question Status: New
3) If a straight line (a ray) from the origin does not cross through the point where the offer curves of the two
trading countries intersect then
A) there will be an excess demand for both products.
B) there will be an excess supply of both products.
C) there will be an excess demand for one of the traded products.
D) the terms of trade represented by the slope of the ray will represent the equilibrium terms of trade.
E) None of the above.
Answer: C
Question Status: New
12