1. Free trade refers to a situation where a government does not attempt to influence through quotas

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1 Chapter 06 International Trade Theory True / False Questions 1. Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country. True False 2. The theories of Smith and Ricardo show that countries should not engage in international trade for products that it is able to produce for itself. True False 3. David Ricardo's theory of comparative advantage explains international trade in terms of international differences in political environments. True False 4. New trade theory stresses that in some cases countries specialize in the production and export of particular products because the world market can support only a limited number of firms. True False

2 5. Porter's theory of national competitive advantage recommends unrestricted free trade between countries. True False 6. Heckscher-Ohlin theory supports the case for unrestricted free trade between nations. True False 7. Mercantilism supports the idea that countries should export more than what they import. True False 8. Mercantilist doctrine advocates unrestricted free trade between countries. True False 9. The principle of mercantilism views trade as a positive-sum game. True False 10. A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it. True False 11. Adam smith argued that countries should specialize in the production of goods for which they have an absolute advantage. True False

3 12. According to Ricardo's theory of comparative advantage, countries should produce all the products for which they have an absolute advantage. True False 13. According to Ricardo's theory of comparative advantage, countries shall not produce a good even if they have an absolute advantage in its production. True False 14. The theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains. True False 15. Simple model of free trade assumed away transportation costs between countries. True False 16. Resources always move easily from one economic activity to another. True False 17. The production possibility frontier will be parabolic if constant return to specialization is observed. True False 18. The production possibility frontier will be convex if constant return to specialization is observed. True False

4 19. Diminishing returns show that it is feasible for a country to specialize to the degree suggested by the simple Ricardian model. True False 20. The simple comparative advantage model assumed that trade does not change a country's stock of resources or the efficiency with which it utilizes those resources. True False 21. According to Paul Samuelson's critique, a poor country will rapidly improve its productivity if a rich country enters into a free trade agreement with it. True False 22. Paul Samuelson's critique argues that trade is a positive-sum game in which all countries that participate realize economic gains. True False 23. A rich country improves its productivity by engaging in free trade with a poor country. This situation supports Paul Samuelson's critique. True False 24. Factor endowments refer to the extent to which a country is gifted with such resources as land, labor, and capital. True False

5 25. The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally scarce. True False 26. Heckscher-Ohlin theory stresses that comparative advantage arises from differences in productivity. True False 27. The Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments. True False 28. Ricardo's theory makes fewer simplifying assumptions compared to Heckscher-Ohlin theory. True False 29. A capital intensive country exports products that are capital intensive. This is an example of Leontief Paradox. True False 30. A key assumption in the Heckscher-Ohlin theory is that technologies are the same across countries. True False

6 31. The product life-cycle theory argues that a large proportion of the world's new products had been developed by U.S. firms. True False 32. The product life-cycle theory argues that the developing nations will not produce a product if the product is highly standardized. True False 33. Some of the arguments made by the product life-cycle theory seems ethnocentric and increasingly dated when viewed from an Asian or European perspective. True False 34. Economies of scale are unit cost reductions associated with a large scale of output. True False 35. Companies that trade small volumes of product can benefit from economies of scale. True False 36. Variety of goods that a country can produce is limited by the size of the market in industries where economies of scale are important. True False

7 37. First-mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. True False 38. New trade theory suggests that nations cannot benefit from trade when they do not differ in resource endowments or technology. True False 39. According to the new trade theory, firms that establish a first-mover advantage with regard to the production of a particular new product may subsequently dominate global trade in that product. True False 40. The theories of international trade claim that promoting free trade is generally in the best interests of an individual firm, although it may not always be in the best interest of a country. True False Multiple Choice Questions

8 41. Which of the following refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country? A. Economic patriotism B. Protectionism C. Free trade D. Offshoring 42. Which of the following is a major benefit of engaging in free trade? A. It helps to reduce the financial volatility in global markets. B. It helps the countries protect the jobs that are available to their citizens. C. It gives countries access to products that they cannot produce. D. It allows the governments to exert more control on businesses. 43. David Ricardo's theory of comparative advantage explains global trade in terms of the. A. first mover advantage that certain countries and firms enjoy B. geographical differences between various countries C. international differences in labor productivity D. late mover advantage that certain countries and firms possess

9 44. Which of the following theories emphasizes the interplay between the proportions in which the factors of production are available in different countries and the proportions in which they are needed for producing particular goods? A. Porter's theory B. Smith's theory C. Ricardo's theory D. Heckscher-Ohlin theory 45. Identify the theory that supports the view that in some cases countries export for the reason that the world market can support only a limited number of firms. A. Heckscher-Ohlin theory B. Smith's theory C. Ricardo's theory D. New trade theory 46. Country A exports electronic goods from Country B although there are no underlying differences in factor endowments between the two countries. Which of the following theories explains this anomaly? A. Comparative advantage theory B. New trade theory C. Ricardo's theory D. Smith's theory

10 47. Which of the following observations is consistent with Michael Porter's theory of national competitive advantage? A. Factors such as domestic demand and domestic rivalry determine nations' dominance on production. B. Countries should produce only those goods for which they have a comparative advantage. C. Interplay between the factors of production cause international marketing decisions. D. International differences in labor productivity determine nations' supremacy in production. 48. Which of the following is a theory that can be used to justify limited government intervention to support the development of certain export-oriented industries? A. Comparative advantage theory B. Ricardo's theory C. New trade theory D. Heckscher-Ohlin theory 49. Which of the following is the main principle of mercantilism? A. Protection of domestic industries is not essential for a nation's welfare. B. Government intervention is not required in global trade. C. Countries should encourage absolute free trade. D. It is in a country's best interests to maintain a trade surplus.

11 50. Which of the following is a major flaw associated with mercantilism? A. Mercantilists do not support government intervention in trade. B. Mercantilists view trade as a zero-sum game. C. Mercantilists recommend policies to maximize imports. D. Mercantilists recommend countries to maintain a negative trade balance. 51. A country has an absolute advantage in the production of a product when it. A. has the capability to produce the product within its boundaries B. is more efficient than any other country in producing it C. has the largest domestic demand for the product D. has access to the raw materials needed to produce the product 52. According to Adam Smith, A country should specialize in the production of a good when it has. A. an absolute advantage in the production of the good B. a strong domestic demand for the good C. the ability to help country increase its national output D. the necessary raw materials for production

12 53. Country A can produce product X, but it can also buy it at a cheap rate from Country B. Which of the following courses of action is suitable in this situation according to Adam Smith's theory of absolute advantage? A. Country A should import product X from country B and it should not attempt to produce it at home. B. Country A should partly import the product and produce it domestically. C. Country A should produce more of product X and should attempt to obtain an absolute advantage for the product. D. Country A should subsidize the production of product X to obtain an absolute advantage over country B. 54. According to Ricardo's theory of comparative advantage, a country should produce goods. A. for which it has access to raw materials B. that it produces most efficiently C. that have the highest domestic demand D. for which it has an absolute advantage 55. Which of the following is a statement that supports the theory of comparative advantage? A. International trade is a zero-sum gain where one nation's gain is another's loss. B. Domestic industries are at risk when a country engages in free trade. C. A country should maintain trade surplus to succeed in global trade. D. Global production is greater with free trade than it is with restricted trade.

13 56. The theory of comparative advantage provides strong rationale for supporting the idea of. A. business nationalism B. free trade C. protectionism D. governmental intervention in trade 57. Diminishing returns to specialization occurs when. A. each additional unit is produced with lesser number of laborers B. a nation's gross domestic product declines for a few years C. production possibility frontier appears as a rectangle D. more units of resources are required to produce each additional unit 58. Which of the following is a major limitation of the simple Ricardian model of comparative advantage? A. The model ignores the principle of diminishing marginal returns. B. The model recommends excessive governmental intervention in trade. C. The outcome of the model suggested by Ricardo is a zero-sum game. D. The model is against the idea of engaging in free trade with nations.

14 59. What will happen, according to Paul Samuelson's critique, if a rich country enters into a free trade agreement with a poor country? A. Both the countries will incur losses due to the exchanges between them. B. The productivity of the poor country will decline rapidly. C. The poor country will rapidly improve its productivity. D. Both the countries will garner benefits from the exchanges between them. 60. Which of the following arguments supports the Paul Samuelson's critique? A. A rich country cannot produce net gains by engaging in free trade with a poor country. B. Governmental intervention will reduce the likeliness of countries' economic success. C. Countries should attempt to specialize in the production of goods and services. D. Trade is a positive-sum game in which all countries that participate realize economic gains. 61. Which of the following terms refers to the extent to which a country is gifted with such resources as land, labor, and capital? A. Current accounts B. Factor endowments C. National balance D. National accounts

15 62. Identify the theory that predicts that countries will export those goods that make intensive use of factors that are locally abundant. A. Theory of comparative advantage B. Ricardo theory C. New trade theory D. Heckscher-Ohlin theory 63. Which of the following is the reason why most economists prefer Heckscher-Ohlin theory to Ricardo's theory? A. Heckscher-Ohlin stresses on the differences in productivity between nations. B. Ricardo's theory considers factor endowments to describe national competitiveness. C. Heckscher-Ohlin theory makes fewer simplifying assumptions. D. Ricardo's theory considers the law of marginal returns. 64. Which of the following statements is true of the Leontief Paradox? A. It shows an anomaly that occurs when a nation has high domestic demand for a product. B. It explains the relationship between domestic demand and comparative advantage. C. It disproved Ricardo's theory of comparative advantage. D. It raised questions about the validity of the Heckscher-Ohlin theory.

16 65. Identify the theory that argues that advanced nations have an incentive to develop a new offering and hence such nations always tend to create a good or service for the first time. A. Absolute advantage B. Ricardo C. Product life-cycle D. Heckscher-Ohlin 66. Country X, a poor country, invents a revolutionary electronic product. The country markets this new product in other poor countries to garner large profits. This occurrence is against the idea of. A. product life-cycle theory B. Ricardo's theory C. theory of absolute advantage D. theory of comparative advantage 67. Which of the following is a major disadvantage of the product life-cycle theory introduced by Vernon? A. The theory's arguments seem ethnocentric and increasingly dated. B. The theory failed to explain the dominance of developed nations. C. The theory applies only when a poor nation invents a new product. D. The theory cannot be used to explain the production of luxury products.

17 68. Which of the following terms refers to the unit cost reductions associated with large sized outputs? A. Absolute advantage of production B. Economies of scale C. Constant marginal returns D. Diminishing marginal returns 69. Wal-Mart makes bulk purchases from its vendors and hence it is able to get better deals than its competitors. This allows Wal-Mart to offer greater discounts to its customers. In this case, Wal- Mart benefits from. A. first mover advantage B. constant marginal returns C. economies of scale D. absolute advantage of production 70. Company A entered the production of office software before its competitors. Because of this, the company's products are more familiar among and favored by customers. This situation exemplifies the. A. first mover advantage B. diminishing marginal returns C. economies of scale D. constant marginal returns

18 71. Which of the following theories suggests that first mover advantage is significant in the export of a good? A. Product life-cycle theory B. Ricardo's theory C. New trade theory D. Theory of comparative advantage 72. Which of the following theories stress the role of luck, entrepreneurship, and innovation in the production and export of a good or service by the firms in a country? A. Product life-cycle theory B. Ricardo's theory C. Theory of comparative advantage D. New trade theory 73. Which of the following is one of the four attributes present in Porter's diamond? A. Economies of scale B. Factor endowments C. Structural innovation D. Procedural innovation

19 74. Which of the following is an example of a basic factor that a nation will possess as proposed by Porter? A. Communication infrastructure B. Skilled labor C. Natural resources D. Technological knowledge 75. Which of the following factors, according to Porter's national Diamond, is most likely to give a country competitive advantage over another country? A. Natural resources B. Climate C. Skilled labor D. Demographics 76. Porter argues that a nation's firms gain competitive advantage if. A. their domestic consumers lack technical awareness B. they function in a labor intensive market C. the country has abundant supply of unskilled workers D. their domestic consumers are demanding

20 77. Textile industry in a nation is characterized by vigorous domestic rivalry. Which of the following observations of this nation's international competency is most likely to be true? A. The nation will have access to such basic factors of textile industry as natural resources. B. The nation's textile firms will have a competitive advantage in international trade. C. The domestic customers of the textile firms will be less demanding. D. The nation's textile industry will lack the advanced factors that are necessary to be internationally competent. 78. A country's balance-of-payments accounts keep track of the. A. basic factor endowments and advanced factor endowments that the nation possesses B. payments to and receipts from other countries for a particular time period C. income taxes paid by domestic firms and the spending on the firms D. total value of taxes paid by domestic firms and the spending on the firms 79. Which of the following balance-of-payment accounts records one-time changes in the stock of assets? A. Capital account B. Current account C. Financial account D. Monetary account

21 80. Which of the following accounts records transactions that involve the purchase or sale of assets? A. Capital account B. Current account C. Principal account D. Financial account Essay Questions 81. Explain the concept of free trade. 82. How does the Heckscher-Ohlin theory explain international trade?

22 83. Explain how the theories of trade differ in terms of their support to governmental intervention. 84. What is the main principle of mercantilism? 85. Identify a major flaw associated with mercantilism.

23 86. Explain Smith's theory of absolute advantage. 87. Explain Ricardo's theory of comparative advantage. 88. What are the assumptions that we make when we discuss a simple Ricardian model to support free trade?

24 89. Briefly differentiate between constant returns to specialization and diminishing returns to specialization. 90. Explain how the principle of diminishing returns weakens the Ricardian model. 91. Explain the dynamic gains that are generated by opening an economy to trade.

25 92. Explain the Paul Samuelson's critique. 93. What are factor endowments? 94. Briefly explain Vernon's product life-cycle theory.

26 95. Identify a major disadvantage of the product life-cycle theory. 96. What are the sources of economies of scale? 97. What are first-mover advantages?

27 98. Do you think a new trade theorist would stress the role of luck and entrepreneurship? Explain. 99. What are the four attributes that are discussed in Porter's diamond? 100.Explain how the rivalry within an industry affects international competence.

28 Chapter 06 International Trade Theory Answer Key True / False Questions 1. Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country. TRUE Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory 2. The theories of Smith and Ricardo show that countries should not engage in international trade for products that it is able to produce for itself. FALSE The theories of Smith, Ricardo, and Heckscher-Ohlin show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself. Blooms: Understand

29 Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory 3. David Ricardo's theory of comparative advantage explains international trade in terms of international differences in political environments. FALSE David Ricardo's theory of comparative advantage explains international trade in terms of international differences in labor productivity. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory 4. New trade theory stresses that in some cases countries specialize in the production and export of particular products because the world market can support only a limited number of firms. TRUE New trade theory stresses that in some cases countries specialize in the production and export of particular products not because of underlying differences in factor endowments, but because in certain industries the world market can support only a limited number of firms. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory

30 5. Porter's theory of national competitive advantage recommends unrestricted free trade between countries. FALSE Porter's theory of national competitive advantage can be interpreted as justifying some limited government intervention to support the development of certain export-oriented industries. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory 6. Heckscher-Ohlin theory supports the case for unrestricted free trade between nations. TRUE The theories of Smith, Ricardo, and Heckscher-Ohlin support the case for unrestricted free trade. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory

31 7. Mercantilism supports the idea that countries should export more than what they import. TRUE The main tenet of mercantilism was that it is in a country's best interests to maintain a trade surplus, to export more than it imported. Blooms: Understand Topic: Mercantilism 8. Mercantilist doctrine advocates unrestricted free trade between countries. FALSE Mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade. Blooms: Understand Difficulty: 2 Medium Topic: Mercantilism 9. The principle of mercantilism views trade as a positive-sum game. FALSE The flaw with mercantilism was that it viewed trade as a zero-sum game. Blooms: Understand

32 Difficulty: 2 Medium Topic: Mercantilism 10. A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it. TRUE A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it. Topic: Mercantilism 11. Adam smith argued that countries should specialize in the production of goods for which they have an absolute advantage. TRUE According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries. Topic: Absolute Advantage

33 12. According to Ricardo's theory of comparative advantage, countries should produce all the products for which they have an absolute advantage. FALSE According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries. Topic: Comparative Advantage 13. According to Ricardo's theory of comparative advantage, countries shall not produce a good even if they have an absolute advantage in its production. TRUE According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries even if the country has an absolute advantage over its production. Topic: Comparative Advantage

34 14. The theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains. TRUE The theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains. Blooms: Understand Topic: Comparative Advantage 15. Simple model of free trade assumed away transportation costs between countries. TRUE Simple model of free trade assumed away transportation costs between countries. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 16. Resources always move easily from one economic activity to another. FALSE Resources do not always move easily from one economic activity to another.

35 Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 17. The production possibility frontier will be parabolic if constant return to specialization is observed. FALSE Constant returns to specialization mean that the units of resources required to produce a good are assumed to remain constant no matter where one is on a country's production possibility frontier. Thus the production possibility frontier will be a straight line. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 18. The production possibility frontier will be convex if constant return to specialization is observed. FALSE Constant returns to specialization means that the units of resources required to produce a good (cocoa or rice) are assumed to remain constant no matter where one is on a country's production possibility frontier (PPF). In this case, the PPF will be a straight line. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of

36 countries that participate in a free trade system. Topic: Comparative Advantage 19. Diminishing returns show that it is feasible for a country to specialize to the degree suggested by the simple Ricardian model. FALSE Diminishing returns show that it is not feasible for a country to specialize to the degree suggested by the simple Ricardian model. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 20. The simple comparative advantage model assumed that trade does not change a country's stock of resources or the efficiency with which it utilizes those resources. TRUE The simple comparative advantage model assumed that trade does not change a country's stock of resources or the efficiency with which it utilizes those resources. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage

37 21. According to Paul Samuelson's critique, a poor country will rapidly improve its productivity if a rich country enters into a free trade agreement with it. TRUE Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a poor country, there will be a dynamic gain in the efficiency with which resources are used in the poor country. The poor country's productivity will improve rapidly. Blooms: Understand Difficulty: 2 Medium Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 22. Paul Samuelson's critique argues that trade is a positive-sum game in which all countries that participate realize economic gains. FALSE Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a poor country, only the poor country benefits from the relationship. Blooms: Understand Difficulty: 2 Medium Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage

38 23. A rich country improves its productivity by engaging in free trade with a poor country. This situation supports Paul Samuelson's critique. FALSE Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a poor country, only the poor country benefits from the relationship. Blooms: Understand Difficulty: 2 Medium Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 24. Factor endowments refer to the extent to which a country is gifted with such resources as land, labor, and capital. TRUE Factor endowments refer to the extent to which a country is endowed with such resources as land, labor, and capital. Topic: Heckscher-Ohlin Theory

39 25. The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally scarce. FALSE The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. Topic: Heckscher-Ohlin Theory 26. Heckscher-Ohlin theory stresses that comparative advantage arises from differences in productivity. FALSE Unlike Ricardo's theory, however, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments, rather than differences in productivity. Topic: Heckscher-Ohlin Theory

40 27. The Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments. TRUE The Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments. Topic: Heckscher-Ohlin Theory 28. Ricardo's theory makes fewer simplifying assumptions compared to Heckscher-Ohlin theory. FALSE Most economists prefer the Heckscher-Ohlin theory to Ricardo's theory because it makes fewer simplifying assumptions. Topic: Heckscher-Ohlin Theory

41 29. A capital intensive country exports products that are capital intensive. This is an example of Leontief Paradox. FALSE The Leontief Paradox explains a deviation of the Heckscher-Ohlin theory. The given situation follows the Heckscher-Ohlin theory. Blooms: Understand Difficulty: 2 Medium Topic: Heckscher-Ohlin Theory 30. A key assumption in the Heckscher-Ohlin theory is that technologies are the same across countries. TRUE A key assumption in the Heckscher-Ohlin theory is that technologies are the same across countries. Blooms: Understand Difficulty: 2 Medium Topic: Heckscher-Ohlin Theory

42 31. The product life-cycle theory argues that a large proportion of the world's new products had been developed by U.S. firms. TRUE The product life-cycle theory argues that a large proportion of the world's new products had been developed by U.S. firms. Topic: The Product Life-Cycle Theory 32. The product life-cycle theory argues that the developing nations will not produce a product if the product is highly standardized. FALSE The product life-cycle theory argues that the developing nations will produce a product only when the product becomes highly standardized. Blooms: Understand Difficulty: 2 Medium Topic: The Product Life-Cycle Theory

43 33. Some of the arguments made by the product life-cycle theory seems ethnocentric and increasingly dated when viewed from an Asian or European perspective. TRUE Viewed from an Asian or European perspective, the theory's argument that most new products are developed and introduced in the United States seems ethnocentric and increasingly dated. Topic: The Product Life-Cycle Theory 34. Economies of scale are unit cost reductions associated with a large scale of output. TRUE Economies of scale are unit cost reductions associated with a large scale of output. Topic: New Trade Theory

44 35. Companies that trade small volumes of product can benefit from economies of scale. FALSE Economies of scale are unit cost reductions associated with a large scale of output. This means that companies that trade in large volumes benefit from the economies of scale. Blooms: Understand Difficulty: 2 Medium Topic: New Trade Theory 36. Variety of goods that a country can produce is limited by the size of the market in industries where economies of scale are important. TRUE In industries where economies of scale are important, both the variety of goods that a country can produce and the scale of production are limited by the size of the market. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: New Trade Theory

45 37. First-mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. TRUE First mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: New Trade Theory 38. New trade theory suggests that nations cannot benefit from trade when they do not differ in resource endowments or technology. FALSE New trade theory suggests that nations may benefit from trade even when they do not differ in resource endowments or technology. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: New Trade Theory

46 39. According to the new trade theory, firms that establish a first-mover advantage with regard to the production of a particular new product may subsequently dominate global trade in that product. TRUE According to the new trade theory, firms that establish a first-mover advantage with regard to the production of a particular new product may subsequently dominate global trade in that product. Learning Objective: Understand the important implications that international trade theory holds for business practice. Topic: Implications for Managers 40. The theories of international trade claim that promoting free trade is generally in the best interests of an individual firm, although it may not always be in the best interest of a country. FALSE The theories of international trade claim that promoting free trade is generally in the best interests of a country, although it may not always be in the best interest of an individual firm. Learning Objective: Understand the important implications that international trade theory holds for business practice. Topic: Implications for Managers

47 Multiple Choice Questions 41. Which of the following refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country? A. Economic patriotism B. Protectionism C. Free trade D. Offshoring Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory

48 42. Which of the following is a major benefit of engaging in free trade? A. It helps to reduce the financial volatility in global markets. B. It helps the countries protect the jobs that are available to their citizens. C. It gives countries access to products that they cannot produce. D. It allows the governments to exert more control on businesses. Countries can benefit from exchanging goods that they can produce efficiently to obtain products that they cannot produce. Blooms: Understand Difficulty: 2 Medium Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory 43. David Ricardo's theory of comparative advantage explains global trade in terms of the. A. first mover advantage that certain countries and firms enjoy B. geographical differences between various countries C. international differences in labor productivity D. late mover advantage that certain countries and firms possess David Ricardo's theory of comparative advantage offers an explanation in terms of international differences in labor productivity. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory

49 44. Which of the following theories emphasizes the interplay between the proportions in which the factors of production are available in different countries and the proportions in which they are needed for producing particular goods? A. Porter's theory B. Smith's theory C. Ricardo's theory D. Heckscher-Ohlin theory The Heckscher-Ohlin theory emphasizes the interplay between the proportions in which the factors of production (such as land, labor, and capital) are available in different countries and the proportions in which they are needed for producing particular goods. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory

50 45. Identify the theory that supports the view that in some cases countries export for the reason that the world market can support only a limited number of firms. A. Heckscher-Ohlin theory B. Smith's theory C. Ricardo's theory D. New trade theory New trade theory stresses that in some cases countries specialize in the production and export of particular products not because of underlying differences in factor endowments, but because in certain industries the world market can support only a limited number of firms. Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory

51 46. Country A exports electronic goods from Country B although there are no underlying differences in factor endowments between the two countries. Which of the following theories explains this anomaly? A. Comparative advantage theory B. New trade theory C. Ricardo's theory D. Smith's theory New trade theory stresses that in some cases countries specialize in the production and export of particular products not because of underlying differences in factor endowments, but because in certain industries the world market can support only a limited number of firms. Blooms: Apply Difficulty: 2 Medium Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory

52 47. Which of the following observations is consistent with Michael Porter's theory of national competitive advantage? A. Factors such as domestic demand and domestic rivalry determine nations' dominance on production. B. Countries should produce only those goods for which they have a comparative advantage. C. Interplay between the factors of production cause international marketing decisions. D. International differences in labor productivity determine nations' supremacy in production. Michael Porter's theory of national competitive advantage attempts to explain why particular nations achieve international success in particular industries. In addition to factor endowments, Porter points out the importance of country factors such as domestic demand and domestic rivalry in explaining a nation's dominance in the production and export of particular products. Blooms: Understand Difficulty: 2 Medium Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory

53 48. Which of the following is a theory that can be used to justify limited government intervention to support the development of certain export-oriented industries? A. Comparative advantage theory B. Ricardo's theory C. New trade theory D. Heckscher-Ohlin theory Both the new trade theory and Porter's theory of national competitive advantage can be interpreted as justifying some limited government intervention to support the development of certain export-oriented industries. Blooms: Understand Difficulty: 2 Medium Learning Objective: Understand why nations trade with each other. Topic: An Overview of Trade Theory 49. Which of the following is the main principle of mercantilism? A. Protection of domestic industries is not essential for a nation's welfare. B. Government intervention is not required in global trade. C. Countries should encourage absolute free trade. D. It is in a country's best interests to maintain a trade surplus. The main tenet of mercantilism was that it was in a country's best interests to maintain a trade surplus, to export more than it imported. By doing so, a country would accumulate gold and silver and, consequently, increase its national wealth, prestige, and power.

54 Blooms: Understand Difficulty: 2 Medium Topic: Mercantilism 50. Which of the following is a major flaw associated with mercantilism? A. Mercantilists do not support government intervention in trade. B. Mercantilists view trade as a zero-sum game. C. Mercantilists recommend policies to maximize imports. D. Mercantilists recommend countries to maintain a negative trade balance. The flaw with mercantilism was that it viewed trade as a zero-sum game. A zero-sum game is one in which a gain by one country results in a loss by another. Blooms: Understand Difficulty: 2 Medium Topic: Mercantilism 51. A country has an absolute advantage in the production of a product when it. A. has the capability to produce the product within its boundaries B. is more efficient than any other country in producing it C. has the largest domestic demand for the product D. has access to the raw materials needed to produce the product A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it.

55 Topic: Absolute Advantage 52. According to Adam Smith, A country should specialize in the production of a good when it has. A. an absolute advantage in the production of the good B. a strong domestic demand for the good C. the ability to help country increase its national output D. the necessary raw materials for production According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries. Topic: Absolute Advantage

56 53. Country A can produce product X, but it can also buy it at a cheap rate from Country B. Which of the following courses of action is suitable in this situation according to Adam Smith's theory of absolute advantage? A. Country A should import product X from country B and it should not attempt to produce it at home. B. Country A should partly import the product and produce it domestically. C. Country A should produce more of product X and should attempt to obtain an absolute advantage for the product. D. Country A should subsidize the production of product X to obtain an absolute advantage over country B. Smith's basic argument is that a country should never produce goods at home that it can buy at a lower cost from other countries. Blooms: Apply Difficulty: 2 Medium Topic: Absolute Advantage

57 54. According to Ricardo's theory of comparative advantage, a country should produce goods. A. for which it has access to raw materials B. that it produces most efficiently C. that have the highest domestic demand D. for which it has an absolute advantage According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself. Topic: Comparative Advantage 55. Which of the following is a statement that supports the theory of comparative advantage? A. International trade is a zero-sum gain where one nation's gain is another's loss. B. Domestic industries are at risk when a country engages in free trade. C. A country should maintain trade surplus to succeed in global trade. D. Global production is greater with free trade than it is with restricted trade. The basic message of the theory of comparative advantage is that potential world production is greater with unrestricted free trade than it is with restricted trade.

58 Blooms: Understand Difficulty: 2 Medium Topic: Comparative Advantage 56. The theory of comparative advantage provides strong rationale for supporting the idea of. A. business nationalism B. free trade C. protectionism D. governmental intervention in trade The theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains. As such, this theory provides a strong rationale for encouraging free trade. Topic: Comparative Advantage

59 57. Diminishing returns to specialization occurs when. A. each additional unit is produced with lesser number of laborers B. a nation's gross domestic product declines for a few years C. production possibility frontier appears as a rectangle D. more units of resources are required to produce each additional unit Diminishing returns to specialization occurs when more units of resources are required to produce each additional unit. Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 58. Which of the following is a major limitation of the simple Ricardian model of comparative advantage? A. The model ignores the principle of diminishing marginal returns. B. The model recommends excessive governmental intervention in trade. C. The outcome of the model suggested by Ricardo is a zero-sum game. D. The model is against the idea of engaging in free trade with nations. Diminishing returns show that it is not feasible for a country to specialize to a great extent. Ricardian model ignores this principle of diminishing returns. Blooms: Analyze Difficulty: 2 Medium

60 Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 59. What will happen, according to Paul Samuelson's critique, if a rich country enters into a free trade agreement with a poor country? A. Both the countries will incur losses due to the exchanges between them. B. The productivity of the poor country will decline rapidly. C. The poor country will rapidly improve its productivity. D. Both the countries will garner benefits from the exchanges between them. Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a poor country, there will be a dynamic gain in the efficiency with which resources are used in the poor country. The poor country's productivity will improve rapidly. Blooms: Understand Difficulty: 2 Medium Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage

61 60. Which of the following arguments supports the Paul Samuelson's critique? A. A rich country cannot produce net gains by engaging in free trade with a poor country. B. Governmental intervention will reduce the likeliness of countries' economic success. C. Countries should attempt to specialize in the production of goods and services. D. Trade is a positive-sum game in which all countries that participate realize economic gains. Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a poor country, only the poor country benefits from the relationship. Blooms: Understand Difficulty: 2 Medium Learning Objective: Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system. Topic: Comparative Advantage 61. Which of the following terms refers to the extent to which a country is gifted with such resources as land, labor, and capital? A. Current accounts B. Factor endowments C. National balance D. National accounts Factor endowments refer to the extent to which a country is endowed with such resources as land, labor, and capital.

62 Topic: Heckscher-Ohlin Theory 62. Identify the theory that predicts that countries will export those goods that make intensive use of factors that are locally abundant. A. Theory of comparative advantage B. Ricardo theory C. New trade theory D. Heckscher-Ohlin theory The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. Topic: Heckscher-Ohlin Theory

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