Multiple Choice Questions

Question 1

Which of the following is true for a linear production possibility curve?

1. A linear production possibility curve is drawn as a positively sloped straight line.
2. Along a linear production possibilities curve, the opportunity cost of producing more of a good is constant.
3. When a country engages in free trade, the linear production-possibility curve shifts to the right.
4. A country with a linear production-possibility curve partially specializes in the production of goods when it engages in free trade with other nations.

Question 2

The figure below shows the export supply (XS) and import demand (MD) curve for rice. P indicates price and Q indicates quantity. Which of the following statements is true at a price of P1?

1. Area B indicates the net gain from trade in the exporting country.
2. Area A indicates the net gain from trade in the exporting country.
3. Area A indicates the consumer surplus in the importing country.
4. Area B indicates the producer surplus in the exporting country.

Scenario 1
A small country imports computer chips. With free trade at a world price of 400 dollars, domestic production is 1 million chips and domestic consumption is 4.2 million chips. The country’s government now decides to impose a quota to limit computer chip imports to 2 million per year. With the import quota in place, the domestic price rises to $480 per chip and domestic production rises to 1.5 million chips per year.

Question 3

Refer to Scenario 1. If the government auctions the import licenses competitively, the national well-being will _____ by _____.

1. increase; $100 million
2. decrease; $48 million
3. increase; $160 million
4. decrease; $208 million

Question 4

One of the reasons that protectionists and government officials may favor using a quota instead of a tariff is:

1. quotas generate more revenue for the government than tariffs.
2. quotas limit imports indirectly via higher prices.
3. quotas create less market distortions than tariffs.
4. quotas give more power to politicians than tariffs.

The figure given above shows the market for DVD imports in a large country. MD and XS are the domestic demand for imports and export supply curves respectively. There is an import quota imposed on DVDs and the government auctions the import licenses competitively.

Question 5

Refer to Figure 1. As a result of the quota being imposed on DVD imports by this country, the exporting country will in terms of net welfare:

1. lose $3 million.
2. lose $4 million.
3. gain $1.6 million.
4. gain $2.6 million.

Question 6

Refer to Figure 1. As a result of the quota being imposed on DVD imports by this country, the importing
country will in terms of net welfare:

1. lose $3 million.
2. lose $4 million.
3. gain $1.6 million.
4. gain $2.6 million.

Question 7

The Heckscher-Ohlin theory predicts that trade between similar industrialized countries should:

1. be much greater than trade between developed and developing countries.
2. be rather limited in volume.
3. consists mainly of highly sophisticated manufactured goods.
4. be of intra-industry nature.

Scenario 2
Suppose that the unit cost (UC) curve of a representative producer of laptop computers has the form: UC = nF / S + 800
while the market price (P) of laptops is determined by the following equation: P = 800 + 16200 / n
F indicates the fixed cost of production, which are equal to EUR 25 Million. n indicates the number of different varieties of laptops in the market and S indicates the total market size. The market for laptops is characterized by monopolistic competition.

Question 8

Refer to Scenario 2. In a country whose market size is equal to 0.5 Million laptop sales per year, how many different variants of laptops will be available in the market?

1. 9
2. 18
3. 22
4. 36

Question 9

What will happen in the market for laptops in the country described above in Q.8 when this country starts trading with another country whose laptop-producing firms are characterized by similar unit cost (UC) and price (P) equations as the ones described above in Scenario 2?

1. The price of laptops will increase and total the number of varieties of laptops available in the market will increase.
2. The price of laptops will fall and the total number of varieties of laptops available in the market will increase.
3. The price of laptops will fall and the total number of varieties of laptops available in the market will fall.
4. The price of laptops will increase and the total number of varieties of laptops available in the market will increase.

Question 10

Which of the following is true of intra-industry trade?

1. Intra-industry trade is mostly based on the differences stressed in the Heckscher-Ohlin trade theory.
2. The share of intra-industry trade in total world trade has substantially declined over time.
3. Intra-industry trade is said to occur when the United States exports Ford (US) automobiles and imports Honda (Japan) automobiles.
4. Intra-industry trade is said to occur when the United States exports Ford automobiles and imports car seats.

The table given above shows the export and import values in three types of service sectors in country A.

Question 11

Refer to Table 1. In country A, the sector with the highest intra-industry trade (IIT) share is _____ and the sector with the lowest IIT share is _____.

1. Hotel accommodations; business consulting
2. Business consulting; financial services
3. Business consulting; hotel accommodations
4. Financial services; hotel accommodations

Question 12

Refer to Table 1. The economy-wide value of the Grubel-Lloyd index in country A is:

1. a. 0.59.
2. b. 0.7.
3. c. 0.41.
4. d. 0.3.

The figure above shows the demand, marginal revenue (MR), marginal cost and average cost curves of a representative firm.

Question 13

Refer to Figure 2. Which of the following statements is true for a firm that is a monopolist?

1. The firm would produce the quantity F and charge the price C.
2. The firm would produce the quantity E and charge the price A.
3. The firm would produce the quantity E and charge the price B.
4. The firm would produce the quantity E and charge the price D.

Question 14

Refer to Figure 2. Which area in the figure indicates the total production costs of the monopolistic firm?

1. Area DAGK.
2. Area BAGH.
3. Area OCIF.
4. Area OBHE.

Question 15

Suppose the global market for smart phones is monopolistically competitive. If a country engages in two-way trade in smart phones, such trade is usually based on _____.

1. increasing average production costs
2. product differentiation
3. differences in factor endowments
4. differences in labor productivity

Question 16

In a monopolistically competitive market, as the number of product variants decreases, the price of a particular firm’s product is likely to_____ because the demand for each variety becomes more _____.

1. increase; elastic
2. decrease; elastic
3. increase; inelastic
4. decrease; inelastic

Question 17

Which of the following statements is true for trade in a monopolistically competitive market?

1. Trade increases the profits of the producers of exported varieties.
2. Consumers of imported varieties gain welfare but consumers of exported varieties lose welfare.
3. The producers of imported varieties experience an increase in their average production costs.
4. Consumers gain from lower prices and increased variety.

Question 18

Suppose that Norway starts trading with Switzerland and that in Switzerland there is currently also only one single supplier of solar panels. Which of the following statements is correct in this context ?

1. The profits of the Norwegian firm will fall, but the net welfare of Norway as a whole will increase.
2. The profits of the Norwegian firm will increase, but the net welfare of Norway as a whole will fall.
3. The profits of the Norwegian firm may rise or fall; the net welfare of Norway as a whole will increase.
4. The profits of the Norwegian firm will fall; the net welfare of Norway as a whole may increase or decrease.

Figure 3 shows the supply curves of weapons produced in China (CHN) and the United States (USA) that are available for exports to Indonesia (IDN). It also shows the import demand curve for weapons in Indonesia.

Question 19

Refer to Figure 3. Suppose that the United States imposes an embargo on weapon exports to Indonesia, while China continues to export weapons to Indonesia. How will the net welfare of the United States, China, and Indonesia be affected by this embargo?

1. Welfare in the United States will fall by the area c+b, welfare in China will increase by the area a and welfare in Indonesia will fall by the area b.
2. Welfare in the United States will increase by the area c, welfare in China will fall by the area a+b and welfare in Indonesia will fall by the area b.
3. Welfare in the United States will fall by the area c, welfare in China will increase by the area a and welfare in Indonesia will fall by the area a+b.
4. Welfare in the United States will increase by the area b, welfare in China will fall by the area a and welfare in Indonesia will fall by the area c.

Question 20

Which of the following trade embargoes is most likely to be successful?

1. An embargo imposed by a small country on another small country.
2. An embargo imposed by a large country on another large country.
3. An embargo imposed by a small country onto a large country.
4. An embargo imposed by a large country onto a small country.

Open Questions

Question 1

Consider two countries, Malaysia and Singapore, producing two goods, bicycles and motorcycles. Malaysia needs 30 hours to produce one bicycle and 60 labour hours to produce one motorcycle, while Singapore needs respectively 15 and 45 labour hours to produce bicycles and motorcycles. Assume that Malaysia and Singapore possess, respectively, 2,700,000 and 135,000 labor-hours in terms of endowments.

a. Complete the table below by adding the maximum number of units of bicycles and motorcycles that can be produced by each country with the labor endowments mentioned above. Indicate your calculations below the table.

b. Calculate the relative prices per country under autarky and add them to the table below. Show each calculation below the table.

c. Which country has a comparative advantage in which product? Which country has an absolute advantage in which product?

d. Indicate exactly what range of relative prices of both motorcycles and bicycles should be offered on international markets for both countries to benefit from international trade. What will happen to production in Malaysia and in Singapore when prices are in this range and which product will each country import and export respectively in this case?

e. e) Draw the production possibility curves for each country in the two panels below. Choose a possible relative price of motorcycles from the range that you indicated above in d) and add the corresponding trade line to each of your graphs. Explain why both countries gain from free trade at this price?

Question 2

Consider two economies, Canada and United States (U.S.), with different endowments in factor inputs. Canada is natural resources abundant, while the U.S. is capital abundant. Furthermore, assume that the two economies produce and consumer two goods, fuel and cars. The production of fuel is relatively natural resources-intensive, while that of cars is relatively capital intensive.

a.

1. Using production possibilities curves and indifference curves, show in the diagrams below graphically the situation of these two economies under autarky in terms of production and consumption of fuel and cars. Make sure that all elements of the graph are properly represented and labeled.
2. Under autarky, is the relative price of fuel in the U.S. higher or lower than the relative price of fuel in Canada? Explain briefly why (intuitive answer – no reference to the graph, please!).
3. How can you see this price difference in your graphs?

b.

1. Explain what will happen to the relative prices of fuel and cars in the U.S. following the implementation of free trade between the two economies.
2. What effect will free trade have on the consumption and production of fuel and cars in the U.S. and Canada? Adding trade lines and new indifference curves to the graphs you used in part a), indicate the new consumption and production point in the U.S. Make sure your graph is neat and very clear, e.g. by using different colors or distinguishing between dashed lines and solid lines.
3. Is it welfare-improving for the U.S. to trade with Canada? How can you see this in your graph?

c. Suppose now that instead of two production factors, cars and fuel production involve three production factors: labor, capital, and natural resources. Suppose that for each 1 dollar value of fuel, the total natural resource input is 0.70 dollar, the total labor input is 0.05 dollar and the total capital input is 0.25 dollar. For each 1 dollar value of cars, on the other hand, the total capital input is 0.60 dollar, the total natural resource input is 0.00 dollar and the total labor input is 0.40 dollar. In the event where the relative price of fuel decreases, which factors would gain in the long-run, which factors would lose in the long run, and why?

Question 3

The following figure shows the domestic demand and supply curve for a certain type of car in the Netherlands. The Netherlands decide to open up their car market to free trade. The world price for this type of car is € 3,000.

a. Using the graph below, explain how moving from autarky to free trade will change the welfare in the Netherlands. You should indicate the correct “areas” in your graph (referring to the welfare changes for consumers, producers, the government, and the country as a whole) and also calculate these welfare changes.

The Dutch government notices that free trade is disrupting their own car production too much and they soon decide to introduce a tariff of € 2,000 per car.

b. Using a graph like the previous one, explain what happens to welfare in the Netherlands (compared to free trade) when the government introduces the tariff. You should indicate the correct “areas” in your graph (referring to the welfare changes for consumers, producers, the government, and the country as a whole) and also calculate these welfare changes.

c. Describe the term “deadweight loss” and calculate the deadweight loss that results from the introduction of the tariff described in question b.

d. As you know, the Netherlands is a small country. Explain what would happen to the welfare in the rest of the world (the countries exporting cars to the Netherlands) if the Netherlands were a large country and imposed the tariff mentioned above in question b.

The Netherlands decides to form a trade union with Australia. Australia sells their cars for €4,000 per car.

e. Using the previous graph, indicate how forming a trade union with Australia would change the welfare for the Netherlands (compared to the situation when the tariff was in place). You should indicate the correct “areas” in your graph (referring to the welfare changes for consumers, producers, the government, and the country as a whole) and also calculate these welfare changes.

f. Explain the term “trade diversion” and calculate the welfare loss from trade diversion for the Netherlands in the context of the formation of the trade union with Australia described in question e.

Multiple Choice Answers

Open Question Answers

Answers question 1

a.

Malaysia bicycles: 2,700,000/30=90,000; motorcycles 2,700,000/60
Singapore bicycles 135,000/15; motorcycles 135,000/45

b.

Malaysia bicycles: 45,000/90,000; motorcycles: 90,000/45,000
Singapore bicycles: 3,000/9,000; motorcycles: 9,000/3,000

c. Malaysia has a comparative advantage in motorcycles, Singapore in bicycles. Singapore has an absolute advantage in both products.

d. Bicycles: between 0.5 – 0.33 motorcycles per bicycle; motorcycles between 2 – 3 bicycles per motorcycle. Both countries will completely specialize. Malaysia will export motorcycles and import bicycles, Singapore will export bicycles and import motorcycles.

e. Assuming an international relative price of 2.5 B/M (0.4 M/B), we get the following solution. Solutions using other values for the international relative price that fall within the range indicated in question d are also correct:

Answers question 2

a. 1)

a. 2) Under autarky, the price of fuel (expressed relatively to that of cars) is higher in the U.S. than in Canada. This is the case because Canada is relatively rich in terms of natural resources, which makes the production of fuel relatively cheap in this economy. Therefore producing the natural resources intensive good, fuel in this case, is relatively cheap in Canada.

a. 3) The relative price of cars is given by the slope of the line tangent to the IC and the PPC. It can be seen that this line is steeper in Canada, so fuel is relatively cheap in Canada compared to the U.S.

b. 1) When Canada and the U.S. enter into a free trade environment, the relative price of fuel decreases in the U.S, while the relative price of cars increases.

b. 2) Trade increases the relative price of cars in the U.S. and the relative price of fuel in Canada. This leads to an increase in the production of cars and a decrease in the consumption of cars in the U.S., while the production of fuel decreases and its consumption increases. In Canada the opposite happens: Fuel production increases, car production falls; fuel consumption decreases, car consumption increases.

b. 3) Yes, it is welfare-improving. This is visible in the graph from the fact that under free trade, the U.S. reaches a higher indifference curve than under autarky.

c. Fuel production is relatively natural resource-intensive and car production is capital-intensive. The contraction of production of fuel releases a massive amount of natural resources which cannot be employed in the car sector, leading to a decrease in the real return to natural resources. The extra demand for capital as car production expands relative to the smaller amount released as the fuel industry shrinks leads to an increase in the real return to capital. The overall demand for labor augments as fuel production shrinks and car production expands. Thus, real wages throughout the economy are going to increase.

Answers question 3

a. CS increase = A+B+C = 4x3 + 0.5x3x3 = 16.5 → 16.5 million

PS decrease = A = 1x3 + 0.5x3x3 = 7.5 → 7.5 million
Government = 0
Net = B+C = 9 → 9 million gain

b. CS decrease = A+B+C+D = 5x2 + 0,5x2x2 = 12 → 12 million
PS increase = A = 1x2 + 0.5x2x2 = 4 → 4 million
Government increase = C = 2x2 = 4 → 4 million
Net = -B-D = 2 x (0.5x2x2) = 4 → 4 million loss

c. The term “deadweight loss” refers to the loss (as measured on a supply and demand graph) associated with government intervention in a perfect market. Deadweight losses in question b) are the areas B and D and are equal to 4 million (= same as total net loss of the country)

d. If the Netherlands were a large country, the tariff would lead to a large drop in demand in the world market, resulting in a drop in the world price, which would reduce welfare in the rest of the world.

e. CS increase = A+B+C+E = 5x1 + 0.5x1x1 = 5.5 → 5.5 million
PS decrease = A = 2x1 + 0.5x1x1 = 2.5→ 2.5 million
Government decrease = C+D = 2x2 = 4 → 4 million
Net = B+E-D = 2x (0.5x1x1) - (2x1) = -1 → 1 million loss

f. Trade diversion is the welfare loss associated with forming a trade union and results from the fact that low-cost external production is replaced with less efficient production from the partner country. In the above case, it corresponds to the area D = 2 million.