ECO 305 Test Bank Solution All Possible Questions With Answers

ECO 305 Complete Test Bank Chapter 1 Through 17 – Strayer A+ Graded

Click on the Link Below to Purchase A+ Graded Course Material

 

http://budapp.net/ECO-305-Exam-and-Quizzes-Strayer-413.htm

 

For more help Contact us at: budapp247@gmail.com

ECO 305 Week 2 Quiz

CHAPTER 1—THE INTERNATIONAL ECONOMY AND GLOBALIZATION

MULTIPLE CHOICE

1. A primary reason why nations conduct international trade is because:
a. Some nations prefer to produce one thing while others produce other things
b. Resources are not equally distributed among all trading nations
c. Trade enhances opportunities to accumulate profits
d. Interest rates are not identical in all trading nations

2. A main advantage of specialization results from:
a. Economies of large-scale production
b. The specializing country behaving as a monopoly
c. Smaller production runs resulting in lower unit costs
d. High wages paid to foreign workers

3. International trade in goods and services is sometimes used as a substitute for all of the following except:
a. International movements of capital
b. International movements of labor
c. Domestic production of the same goods and services
d. Domestic production of different goods and services

4. If a nation has an open economy, it means that the nation:
a. Allows private ownership of capital
b. Has flexible exchange rates
c. Has fixed exchange rates
d. Conducts trade with other countries

5. International trade forces domestic firms to become more competitive in terms of:
a. The introduction of new products
b. Product design and quality
c. Product price
d. All of the above

6. The movement to free international trade is most likely to generate short-term unemployment in which industries?
a. Industries in which there are neither imports nor exports
b. Import-competing industries
c. Industries that sell to domestic and foreign buyers
d. Industries that sell to only foreign buyers

7. International trade is based on the idea that:
a. Exports should exceed imports
b. Imports should exceed exports
c. Resources are more mobile internationally than are goods
d. Resources are less mobile internationally than are goods

8. Arguments for free trade are sometimes disregarded by politicians because:
a. Maximizing domestic efficiency is not considered important
b. Maximizing consumer welfare may not be a chief priority
c. There exist sound economic reasons for keeping one’s economy isolated from other economies
d. Economists tend to favor highly protected domestic markets

9. How much physical output a worker producers in an hour’s work depends on:
a. The worker’s motivation and skill
b. The technology, plant, and equipment in use
c. How easy the product is to manufacture
d. All of the above

10. The largest amount of trade with the United States in recent years has been conducted by:
a. Canada
b. Germany
c. Chile
d. United Kingdom

11. Increased foreign competition tends to:
a. Intensify inflationary pressures at home
b. Induce falling output per worker-hour for domestic workers
c. Place constraints on the wages of domestic workers
d. Increase profits of domestic import-competing industries

12. ____ is the ability of a firm/industry, under free and fair market conditions, to design, produce, and market goods and services that are better and/or cheaper than those of other firms/industries.
a. Competitiveness
b. Protectionism
c. Comparative advantage
d. Absolute advantage

13. A firm’s ____, relative to that of other firms, is generally regarded as the most important determinant of competitiveness.
a. Income level
b. Tastes and preferences
c. Governmental regulation
d. Productivity

14. Free traders maintain that an open economy is advantageous in that it provides all of the following except:
a. Increased competition for world producers
b. A wider selection of products for consumers
c. The utilization of the most efficient production methods
d. Relatively high wage levels for all domestic workers

15. Recent pressures for protectionism in the United States have been motivated by all of the following except:
a. U.S. firms shipping component production overseas
b. High profit levels for American corporations
c. Sluggish rates of productivity growth in the United States
d. High unemployment rates among American workers

16. International trade tends to cause welfare losses to at least some groups in a country:
a. The less mobile the country’s resources
b. The more mobile the country’s resources
c. The lower the country’s initial living standard
d. The higher the country’s initial living standard

17. For a nation to maximize its productivity in a global economy:
a. Only imports are necessary
b. Only exports are necessary
c. Both imports and exports are necessary
d. Neither imports nor exports are necessary

18. A feasible effect of international trade is that:
a. A monopoly in the home market becomes an oligopoly in the world market
b. An oligopoly in the home market becomes a monopoly in the world market
c. A purely competitive firm becomes an oligopolist
d. A purely competitive firm becomes a monopolist

19. International trade in goods and services tends to:
a. Increase all domestic costs and prices
b. Keep all domestic costs and prices at the same level
c. Lessen the amount of competition facing home manufacturers
d. Increase the amount of competition facing home manufacturers

20. The real income of domestic producers and consumers can be increased by:
a. Technological progress, but not international trade
b. International trade, but not technological progress
c. Technological progress and international trade
d. Neither technological progress nor international trade

21. In the United States, automobiles are
a. Imported, but not exported
b. Exported, but not imported
c. Imported and exported
d. Neither exported nor imported

22. Technological improvements are similar to international trade since they both:
a. Provide benefits for all producers and consumers
b. Increase the nation’s aggregate income
c. Reduce unemployment for all domestic workers
d. Ensure that industries can operate at less than full capacity

23. A sudden shift from import tariffs to free trade may induce short-term unemployment in:
a. Import-competing industries
b. Industries that are only exporters
c. Industries that sell domestically as well as export
d. Industries that neither import nor export

24. Recent empirical studies indicate that productivity performance in industries is:
a. Directly related to globalization of industries
b. Inversely related to globalization of industries
c. Not related to globalization of industries
d. Any of the above

25. Empirical research indicates that ____ best enhances productivity gains for firms and industries.
a. Local competition
b. Regional competition
c. Global competition
d. No competition

26. Increased globalization is fostered by:
a. Increased tariffs and quotas
b. Restrictions on the migration of labor
c. Reduced transportation costs
d. Restrictions on investment flows

27. A reduced share of the world export market for the United States would be attributed to:
a. Decreased productivity in U.S. manufacturing
b. High incomes of American households
c. Relatively low interest rates in the United States
d. High levels of investment by American corporations

28. The dominant trading nation in the world market following World War II was:
a. United Kingdom
b. Germany
c. South Korea
d. United States

29. A closed economy is one in which:
a. Imports exactly equal exports, so that trade is balanced
b. Domestic firms invest in industries overseas
c. The home economy is isolated from foreign trade
d. Saving exactly equals investment at full employment

30. Relative to countries with low ratios of exports to gross domestic product, countries having high export to gross domestic product ratios are ____ vulnerable to changes in the world market.
a. Less
b. More
c. Equally
d. Any of the above

31. Which of the following is a fallacy of international trade?
a. Trade is a zero-sum activity
b. Exports increase employment in exporting industries
c. Import restrictions increase employment in import-competing industries
d. Tariffs and quotas reduce trade volume

32. Foreign ownership of U.S. financial assets
a. Has decreased since the 1960’s
b. Has increased since the 1960’s
c. Has made the U.S. a net borrower since the late 1980’s
d. Both a and c

33. The first wave of globalization was brought to an end by
a. The Great Depression
b. The Second World War
c. The First World War
d. The Smoot-Hawley Act

34. Multilateral trade negotiations have led to
a. Continued trade liberalization
b. Financial liberalization
c. Increased investment
d. All of the above

TRUE/FALSE

1. Important trading partners of the United States include Canada, Mexico, Japan, and China.

2. The United States exports a larger percentage of its gross domestic product than Japan, Germany, and Canada.

3. Opening the economy to international trade tends to lessen inflationary pressures at home.

4. The benefits of international trade accrue in the forms of lower domestic prices, development of more efficient methods and new products, and a greater range of consumption choices.

5. In an open trading system, a country will import those commodities that it produces at relatively low cost while exporting commodities that can be produced at relatively high cost.

6. Although free trade provides benefits for consumers, it is often argued that import protection should be provided to domestic producers of strategic goods and materials vital to the nation’s security.

7. In the long run, competitiveness depends on an industry’s natural resources, its stock of machinery and equipment, and the skill of its workers in creating goods that people want to buy.

8. If a nation has an open economy, it means that the nation allows private ownership of capital.

9. Increased foreign competition tends to increase profits of domestic import-competing companies.

10. Restrictive trade policies have resulted in U.S. producers of minerals and metals supplying all of the U.S. consumers’ needs.

SHORT ANSWER

1. What is the most important factor which contributes to competitiveness?

2. What are the challenges of the international trading system?

ESSAY

1. Does exposure to competition with the world leader in a particular industry improve a firm’s productivity?

2. What are the essential arguments in favor of free trade?

CHAPTER 2—FOUNDATIONS OF MODERN TRADE THEORY: COMPARATIVE ADVANTAGE

MULTIPLE CHOICE

1. The mercantilists would have objected to:
a. Export promotion policies initiated by the government
b. The use of tariffs or quotas to restrict imports
c. Trade policies designed to accumulate gold and other precious metals
d. International trade based on open markets

2. Unlike the mercantilists, Adam Smith maintained that:
a. Trade benefits one nation only at the expense of another nation
b. Government control of trade leads to maximum economic welfare
c. All nations can gain from free international trade
d. The world’s output of goods must remain constant over time

3. The trading principle formulated by Adam Smith maintained that:
a. International prices are determined from the demand side of the market
b. Differences in resource endowments determine comparative advantage
c. Differences in income levels govern world trade patterns
d. Absolute cost differences determine the immediate basis for trade

4. Unlike Adam Smith, David Ricardo’s trading principle emphasizes the:
a. Demand side of the market
b. Supply side of the market
c. Role of comparative costs
d. Role of absolute costs

5. When a nation requires fewer resources than another nation to produce a product, the nation is said to have a:
a. Absolute advantage in the production of the product
b. Comparative advantage in the production of the product
c. Lower marginal rate of transformation for the product
d. Lower opportunity cost of producing the product

6. According to the principle of comparative advantage, specialization and trade increase a nation’s total output since:
a. Resources are directed to their highest productivity
b. The output of the nation’s trading partner declines
c. The nation can produce outside of its production possibilities curve
d. The problem of unemployment is eliminated

7. In a two-product, two-country world, international trade can lead to increases in:
a. Consumer welfare only if output of both products is increased
b. Output of both products and consumer welfare in both countries
c. Total production of both products, but not consumer welfare in both countries
d. Consumer welfare in both countries, but not total production of both products

8. As a result of international trade, specialization in production tends to be:
a. Complete with constant costs–complete with increasing costs
b. Complete with constant costs–incomplete with increasing costs
c. Incomplete with constant costs–complete with increasing costs
d. Incomplete with constant costs–incomplete with increasing costs

9. A nation that gains from trade will find its consumption point being located:
a. Inside its production possibilities curve
b. Along its production possibilities curve
c. Outside its production possibilities curve
d. None of the above

Table 2.1. Output Possibilities of the U.S. and the U.K.

Output per Worker per day
Country Tons of Steel Televisions
United States 15 45
United Kingdom 10 20

10. Referring to Table 2.1, the United States has the absolute advantage in the production of:
a. Steel
b. Televisions
c. Both steel and televisions
d. Neither steel nor televisions

11. Referring to Table 2.1, the United Kingdom has a comparative advantage in the production of:
a. Steel
b. Televisions
c. Both steel and televisions
d. Neither steel nor televisions

12. Refer to Table 2.1. If trade opens up between the United States and the United Kingdom, American firms should specialize in producing:
a. Steel
b. Televisions
c. Both steel and televisions
d. Neither steel nor televisions

13. Referring to Table 2.1, the opportunity cost of producing one ton of steel in the United States is:
a. 3 televisions
b. 10 televisions
c. 20 televisions
d. 45 televisions

14. Refer to Table 2.1. Mutually advantageous trade will occur between the United States and the United Kingdom so long as one ton of steel trades for:
a. At least 1 television, but no more than 2 televisions
b. At least 2 televisions, but no more than 3 televisions
c. At least 3 televisions, but no more than 4 televisions
d. At least 4 televisions, but no more than 5 televisions

15. Referring to Table 2.1, the United Kingdom gains most from trade if:
a. 1 ton of steel trades for 2 televisions
b. 1 ton of steel trades for 3 televisions
c. 2 tons of steel trade for 4 televisions
d. 2 tons of steel trade for 5 televisions

16. Concerning international trade restrictions, which of the following is false? Trade restrictions:
a. Limit specialization and the division of labor
b. Reduce the volume of trade and the gains from trade
c. Cause nations to produce inside their production possibilities curves
d. May result in a country producing some of the product of its comparative disadvantage

17. If a production possibilities curve is bowed out (i.e., concave) in appearance, production occurs under conditions of:
a. Constant opportunity costs
b. Increasing opportunity costs
c. Decreasing opportunity costs
d. Zero opportunity costs

18. Increasing opportunity costs suggest that:
a. Resources are not perfectly shiftable between the production of two goods
b. Resources are fully shiftable between the production of two goods
c. A country’s production possibilities curve appears as a straight line
d. A country’s production possibilities curve is bowed inward (i.e., convex) in appearance

19. The trading-triangle concept is used to indicate a nation’s:
a. Exports, marginal rate of transformation, terms of trade
b. Imports, terms of trade, marginal rate of transformation
c. Marginal rate of transformation, imports, exports
d. Terms of trade, exports, imports

20. Assuming increasing cost conditions, trade between two countries would not be likely if they have:
a. Identical demand conditions but different supply conditions
b. Identical supply conditions but different demand conditions
c. Different supply conditions and different demand conditions
d. Identical demand conditions and identical supply conditions

Table 2.2. Output possibilities for South Korea and Japan

Output per worker per day
Country Tons of steel VCRs
South Korea 80 40
Japan 20 20

21. Referring to Table 2.2, the opportunity cost of one VCR in Japan is:
a. 1 ton of steel
b. 2 tons of steel
c. 3 tons of steel
d. 4 tons of steel

22. Referring to Table 2.2, the opportunity cost of one VCR in South Korea is:
a. 1/2 ton of steel
b. 1 ton of steel
c. 1 1/2 tons of steel
d. 2 tons of steel

23. Refer to Table 2.2. According to the principle of absolute advantage, Japan should:
a. Export steel
b. Export VCRs
c. Export steel and VCRs
d. None of the above; there is no basis for gainful trade

24. Refer to Table 2.2. According to the principle of comparative advantage:
a. South Korea should export steel
b. South Korea should export steel and VCRs
c. Japan should export steel
d. Japan should export steel and VCRs

25. Refer to Table 2.2. With international trade, what would be the maximum amount of steel that South Korea would be willing to export to Japan in exchange for each VCR?
a. 1/2 ton of steel
b. 1 ton of steel
c. 1-1/2 tons of steel
d. 2 tons of steel

26. Refer to Table 2.2. With international trade, what would be the maximum number of VCRs that Japan would be willing to export to South Korea in exchange for each ton of steel?
a. 1 VCR
b. 2 VCRs
c. 3 VCRs
d. 4 VCRs

27. The earliest statement of the principle of comparative advantage is associated with:
a. Adam Smith
b. David Ricardo
c. Eli Heckscher
d. Bertil Ohlin

28. If Hong Kong and Taiwan had identical labor costs but were subject to increasing costs of production:
a. Trade would depend on differences in demand conditions
b. Trade would depend on economies of large-scale production
c. Trade would depend on the use of different currencies
d. There would be no basis for gainful trade

29. If the international terms of trade settle at a level that is between each country’s opportunity cost:
a. There is no basis for gainful trade for either country
b. Both countries gain from trade
c. Only one country gains from trade
d. One country gains and the other country loses from trade

30. International trade is based on the notion that:
a. Different currencies are an obstacle to international trade
b. Goods are more mobile internationally than are resources
c. Resources are more mobile internationally than are goods
d. A country’s exports should always exceed its imports

Figure 2.1. Production Possibilities Schedule

31. Referring to Figure 2.1, the relative cost of steel in terms of aluminum is:
a. 4.0 tons
b. 2.0 tons
c. 0.5 tons
d. 0.25 tons

32. Referring to Figure 2.1, the relative cost of aluminum in terms of steel is:
a. 4.0 tons
b. 2.0 tons
c. 0.5 tons
d. 0.25 tons

33. Refer to Figure 2.1. If the relative cost of steel were to rise, then the production possibilities schedule would:
a. Become steeper
b. Become flatter
c. Shift inward in a parallel manner
d. Shift outward in a parallel manner

34. Refer to Figure 2.1. If the relative cost of aluminum were to rise, then the production possibilities schedule would:
a. Become steeper
b. Become flatter
c. Shift inward in a parallel manner
d. Shift outward in a parallel manner

35. When a nation achieves autarky equilibrium:
a. Input price equals final product price
b. Labor productivity equals the wage rate
c. Imports equal exports
d. Production equals consumption

36. When a nation is in autarky and maximizes its living standard, its consumption and production points are:
a. Along the production possibilities schedule
b. Above the production possibilities schedule
c. Beneath the production possibilities schedule
d. Any of the above

37. If Canada experiences increasing opportunity costs, its supply schedule of steel will be:
a. Downward-sloping
b. Upward-sloping
c. Horizontal
d. Vertical

38. If Canada experiences constant opportunity costs, its supply schedule of steel will be:
a. Downward-sloping
b. Upward-sloping
c. Horizontal
d. Vertical

39. The gains from international trade increase as:
a. A nation consumes inside of its production possibilities schedule
b. A nation consumes along its production possibilities schedule
c. The international terms of trade rises above the nation’s autarky price
d. The international terms of trade approaches the nation’s autarky price

40. In a two-country, two-product world, the statement “Japan enjoys a comparative advantage over France in steel relative to bicycles” is equivalent to:
a. France having a comparative advantage over Japan in bicycles relative to steel
b. France having a comparative disadvantage against Japan in bicycles and steel
c. Japan having a comparative advantage over France in steel and bicycles
d. Japan having a comparative disadvantage against Japan in bicycles and steel

41. Ricardo’s theory of comparative advantage was of limited real-world validity because it was founded on the:
a. Labor theory of value
b. Capital theory of value
c. Land theory of value
d. Entrepreneur theory of value

42. Assume that labor is the only factor of production and that wages in the United States equal $20 per hour while wages in the United Kingdom equal $10 per hour. Production costs would be lower in the United States than the United Kingdom if:
a. U.S. labor productivity equaled 40 units per hour while U.K. labor productivity equaled 15 units per hour
b. U.S. labor productivity equaled 30 units per hour while U.K. labor productivity equaled 20 units per hour
c. U.S. labor productivity equaled 20 units per hour while U.K. labor productivity equaled 30 units per hour
d. U.S. labor productivity equaled 15 units per hour while U.K. labor productivity equaled 25 units per hour

43. According to Ricardo, a country will have a comparative advantage in the product in which its:
a. Labor productivity is relatively low
b. Labor productivity is relatively high
c. Labor mobility is relatively low
d. Labor mobility is relatively high

44. The Ricardian model of comparative advantage is based on all of the following assumptions except:
a. Only two nations and two products
b. Product quality varies among nations
c. Labor is the only factor of production
d. Labor can move freely within a nation

45. The writings of G. MacDougall emphasized which of the following as an explanation of a country’s competitive position?
a. National income levels
b. Relative endowments of natural resources
c. Domestic tastes and preferences
d. Labor compensation and productivity levels

46. The introduction of community indifference curves into our trading example focuses attention on the nation’s:
a. Income level
b. Resource prices
c. Tastes and preferences
d. Productivity level

47. Introducing indifference curves into our trade model permits us to determine:
a. Where a nation chooses to locate along its production possibilities curve in autarky
b. The precise location of a nation’s production possibilities curve
c. Whether absolute cost or comparative cost conditions exist
d. The currency price of one product in terms of another product

48. In the absence of trade, a nation is in equilibrium where a community indifference curve:
a. Lies above its production possibilities curve
b. Is tangent to its production possibilities curve
c. Intersects its production possibilities curve
d. Lies below its production possibilities curve

49. The use of indifference curves helps us determine the point:
a. Along the terms-of-trade line a country will choose
b. Where a country maximizes its resource productivity
c. At which a country ceases to become competitive
d. Where the marginal rate of transformation approaches zero

50. With trade, a country will maximize its satisfaction when it:
a. Moves to the highest possible indifference curve
b. Forces the marginal rate of substitution to its lowest possible value
c. Consumes more of both goods than it does in autarky
d. Finds its marginal rate of substitution exceeding its marginal rate of transformation

51. Trade between two nations would not be possible if they have:
a. Identical community indifference curves but different production possibilities curves
b. Identical production possibilities curves but different community indifference curves
c. Different production possibilities curves and different community indifference curves
d. Identical production possibilities curves and identical community indifference curves

52. Given a two-country and two-product world, the United States would enjoy all the attainable gains from free trade with Canada if it:
a. Trades at the U.S. rate of transformation
b. Trades at the Canadian rate of transformation
c. Specializes completely in the production of both goods
d. Specializes partially in the production of both goods

53. John Stuart Mill’s theory of reciprocal demand best applies when trading partners:
a. Are of equal size and importance in the market
b. Produce under increasing cost conditions
c. Partially specialize in the production of commodities
d. Have similar taste and preference levels

54. The equilibrium prices and quantities established after trade are fully determinate if we know:
a. The location of all countries’ indifference curves
b. The shape of each country’s production possibilities curve
c. The comparative costs of each trading partner
d. The strength of world supply and demand for each good

55. “The equilibrium relative commodity price at which trade takes place is determined by the conditions of demand and supply for each commodity in both nations. Other things being equal, the nation with the more intense demand for the other nation’s exported good will gain less from trade than the nation with the less intense demand.” This statement was first proposed by:
a. Alfred Marshall with offer curve analysis
b. John Stuart Mill with the theory of reciprocal demand
c. Adam Smith with the theory of absolute advantage
d. David Ricardo with the theory of comparative advantage

56. Which of the following terms-of-trade concepts is calculated by dividing the change in a country’s export price index by the change in its import price index between two points in time, multiplied by 100 to express the terms of trade in percentages?
a. Commodity terms of trade
b. Marginal rate of transformation
c. Marginal rate of substitution
d. Autarky price ratio

57. The best explanation of the gains from trade that David Ricardo could provide was to describe only the outer limits within which the equilibrium terms of trade would fall. This is because Ricardo’s theory did not recognize how market prices are influenced by:
a. Demand conditions
b. Supply conditions
c. Business expectations
d. Profit patterns

58. Under free trade, Sweden enjoys all of the gains from trade with Holland if Sweden:
a. Trades at Holland’s rate of transformation
b. Trades at Sweden’s rate of transformation
c. Specializes completely in the production of its export good
d. Specializes partially in the production of its export good

59. Because the Ricardian trade theory recognized only how supply conditions influence international prices, it could determine:
a. The equilibrium terms of trade
b. The outer limits for the terms of trade
c. Where a country chooses to locate along its production possibilities curve
d. Where a country chooses to locate along its trade triangle

60. The terms of trade is given by the prices:
a. Paid for all goods imported by the home country
b. Received for all goods exported by the home country
c. Received for exports and paid for imports
d. Of primary products as opposed to manufactured products

Table 2.3. Terms of Trade

Export Price Index Import Price Index
Country 1990 2004 1990 2004
Mexico 100 220 100 200
Sweden 100 160 100 150
Spain 100 155 100 155
France 100 170 100 230
Denmark 100 120 100 125

61. Referring to Table 2.3, which countries’ terms of trade improved between 1990 and 2004?
a. Mexico and Denmark
b. Sweden and Denmark
c. Sweden and Spain
d. Mexico and Sweden

62. Referring to Table 2.3, which countries’ terms of trade worsened between 1990 and 2004?
a. Spain and Mexico
b. Mexico and France
c. France and Denmark
d. Denmark and Sweden

63. Referring to Table 2.3, which country’s terms of trade did not change between 1990 and 2004?
a. Spain
b. Sweden
c. France
d. Denmark

64. Given free trade, small nations tend to benefit the most from trade since they:
a. Are more productive than their large trading partners
b. Are less productive than their large trading partners
c. Have demand preferences and income levels lower than their large trading partners
d. Enjoy terms of trade lying near the opportunity costs of their large trading partners

65. A terms-of-trade index that equals 150 indicates that compared to the base year:
a. It requires a greater output of domestic goods to obtain the same amount of foreign goods
b. It requires a lesser amount of domestic goods to obtain the same amount of foreign goods
c. The price of exports has risen from $100 to $150
d. The price of imports has risen from $100 to $150

66. A term-of-trade index that equals 90 indicates that compared to the base year:
a. It requires a greater output of domestic goods to obtain the same amount of foreign goods
b. It requires a lesser amount of domestic goods to obtain the same amount of foreign goods
c. The price of exports has fallen from $100 to $90
d. The price of imports has fallen from $100 to $90

67. The theory of reciprocal demand does not well apply when one country:
a. Produces under constant cost conditions
b. Produces along its production possibilities curve
c. Is of minor economic importance in the world marketplace
d. Partially specializes the production of its export good

68. The terms of trade is given by:
a. (Price of exports/price of imports)  100
b. (Price of exports/price of imports) + 100
c. (Price of exports/price of imports)  100
d. (Price of exports/price of imports)  100

69. If Japan and France have identical production possibilities curves and identical community indifference curves:
a. Japan will enjoy all the gains from trade
b. France will enjoy all the gains from trade
c. Japan and France share equally in the gains from trade
d. Gainful specialization and trade are not possible

70. A rise in the price of imports or a fall in the price of exports will:
a. Improve the terms of trade
b. Worsen the terms of trade
c. Expand the production possibilities curve
d. Contract the production possibilities curve

71. A fall in the price of imports or a rise in the price of exports will:
a. Improve the terms of trade
b. Worsen the terms of trade
c. Expand the production possibilities curve
d. Contract the production possibilities curve

72. Under free trade, Canada would not enjoy any gains from trade with Sweden if Canada:
a. Trades at the Canadian rate of transformation
b. Trades at Sweden’s rate of transformation
c. Specializes completely in the production of its export good
d. Specializes partially in the production of its export good

Figure 2.2 illustrates trade data for Canada. The figure assumes that Canada attains international trade equilibrium at point C.

Figure 2.2. Canadian Trade Possibilities

73. Consider Figure 2.2. In the absence of trade, Canada would produce and consume:
a. 8 televisions and 16 refrigerators
b. 12 televisions and 16 refrigerators
c. 8 televisions and 12 refrigerators
d. 12 televisions and 8 refrigerators

74. Referring to Figure 2.2, Canada has a comparative advantage in:
a. Televisions
b. Refrigerators
c. Televisions and refrigerators
d. Neither televisions nor refrigerators

75. Consider Figure 2.2. With specialization, Canada produces:
a. 16 televisions
b. 12 televisions and 8 refrigerators
c. 8 televisions and 16 refrigerators
d. 24 refrigerators

76. Consider Figure 2.2. With trade, Canada consumes:
a. 12 televisions and 8 refrigerators
b. 12 televisions and 16 refrigerators
c. 8 televisions and 16 refrigerators
d. 24 refrigerators

77. According to Figure 2.2, exports for Canada total:
a. 16 refrigerators
b. 8 refrigerators
c. 12 refrigerators
d. 16 refrigerators

78. According to Figure 2.2, imports for Canada total:
a. 6 televisions
b. 8 televisions
c. 12 televisions
d. 16 televisions

79. Concerning possible determinants of international trade, which are sources of comparative advantage? Differences in:
a. Methods of production
b. Tastes and preferences
c. Technological know-how
d. All of the above

80. Ricardo’s model of comparative advantage assumed all of the following except:
a. In each nation, labor is the only input
b. Costs do not vary with the level of production
c. Perfect competition prevails in all markets
d. Transportation costs rise as distance increases between countries

81. Ricardo’s model of comparative advantage assumed all of the following except:
a. Trade is balanced, thus ruling out flows of money between nations
b. Firms make production decisions in an attempt to maximize profits
c. Free trade occurs between nations
d. Labor is immobile within a country, but is incapable of moving between countries

82. The dynamic gains from trade include all of the following except:
a. Economies of large-scale production resulting in decreasing unit cost
b. Increased saving and investment resulting in economic growth
c. Increased competition resulting in lower prices and wider range of output
d. Increasing comparative advantage leading to specialization

83. All of the following may be exit barriers except
a. Employee health benefit costs
b. Treatment, storage and disposal costs
c. Penalties for terminating contracts with raw material suppliers
d. Increasing opportunity cost of production

84. Incomplete specialization may be caused by
a. Increasing opportunity cost
b. Unrestricted trade
c. Constant opportunity cost
d. Decreasing opportunity cost

85. Improvements in productivity may lead to decreasing comparative costs if
a. The assumption of fixed technologies under constant costs is relaxed
b. Technologies available to each nation is allowed to differ
c. Resource endowments are allowed to vary
d. All of the above

86. Adam Smith
a. Was a leading advocate of free trade
b. Developed the concept of absolute advantage
c. Maintained that labor costs represent the major determinant of production cost
d. All of the above

87. Modern trade theory contends that the pattern of world trade is governed by
a. Differences in supply conditions and demand conditions
b. Supply conditions only
c. Demand conditions only
d. None of the above

88. When nations are of similar size, and have similar taste patterns, the gains from trade
a. Are shared equally between them
b. Are impossible to determine
c. Are too small, so that trading is not beneficial
d. Are determined by the nation that has comparative advantage in the more essential product

89. The commodity terms of trade measures
a. The rate at which exports exchange for imports
b. The influence trade has on productivity levels
c. The effect on income of the trading nation
d. The improvement in a nation’s welfare

TRUE/FALSE

1. According to the mercantilists, a nation’s welfare would improve if it maintained a surplus of exports over imports.

2. The mercantilists maintained that a free-trade policy best enhances a nation’s welfare.

3. The mercantilists contended that because one nation’s gains from trade come the expense of its trading partners, not all nations could simultaneously realize gains from trade.

4. According to the price-specie-flow-doctrine, a trade-surplus nation would experience gold outflows, a decrease in its money supply, and a fall in its price level.

5. The trade theories of Adam Smith and David Ricardo viewed the determination of competitiveness from the demand side of the market.

6. According to the principle of absolute advantage, international trade is beneficial to the world if one nation has an absolute cost advantage in the production of one good while the other nation has an absolute cost advantage in the other good.

7. The principle of absolute advantage asserts that mutually beneficial trade can occur even if one nation is absolutely more efficient in the production of all goods.

8. The basis for trade is explained by the principle of absolute advantage according to David Ricardo and the principle of comparative advantage according to Adam Smith.

9. The principle of comparative advantage contends that a nation should specialize in and export the good in which its absolute advantage is smallest or its absolute disadvantage is greatest.

10. The Ricardian theory of comparative advantage assumes only two nations and two products, labor can move freely within a nation, and perfect competition exists in all markets.

11. Assume that the United States is more efficient than the United Kingdom in the production of all goods. Mutually beneficial trade is possible according to the principle of absolute advantage, but is impossible according to the principle of comparative advantage.

12. It is possible for a nation not to have an absolute advantage in anything; but it is not possible for one nation to have a comparative advantage in everything and the other nation to have a comparative advantage in nothing.

13. Ricardo’s theory of comparative advantage was of limited relevance to the real world since it assumed that labor was only one of several factors of production.

14. Compared to Ricardian trade theory, modern trade theory provides a more general view of comparative advantage since it is based on all factors of production rather than just labor.

15. Constant opportunity costs suggest that the relative cost of producing one product in terms of the other will remain the same no matter where a nation chooses to locate on its production-possibilities schedule.

16. There are two explanations of constant opportunity costs: (1) factors of production are imperfect substitutes for each other; (2) all units of a given factor have different qualities.

17. With increasing opportunity costs, a nation totally specializes in the production of the commodity of its comparative advantage; with constant opportunity costs, a nation partially specializes in the production of the commodity of its comparative advantage.

18. A nation’s trade triangle denotes its exports, imports, and terms of trade.

19. International trade leads to increased welfare if a nation can achieve a post-trade consumption point lying inside of its production-possibilities schedule.

20. If the U.S. post-trade consumption point lies along its production possibilities schedule, the United States achieves a higher level of welfare with trade than without trade.

21. If productivity in the German computer industry grows faster than it does in the Japanese computer industry, the opportunity cost of each computer produced in Japan increases relative to the opportunity cost of a computer produced in Germany.

22. If Japan loses competitiveness in computers, Japanese computer workers lose jobs to foreign computer workers and the wages of Japanese computer workers tend to fall relative to the wages of foreign computer workers.

23. With constant opportunity costs, a nation will achieve the greatest possible gains from trade if it partially specializes in the production of the commodity of its comparative disadvantage.

24. By reducing the overall volume of trade, import restrictions tend to reduce a nation’s gains from trade.

25. With increasing opportunity costs, comparative advantage depends on a nation’s supply conditions and demand conditions; with constant opportunity costs, comparative advantage depends only on demand conditions.

26. According to the principle of comparative advantage, an open trading system results in resources being channeled from uses of low productivity to those of high productivity.

27. The existence of exit barriers tends to delay the closing of inefficient firms that face international competitive disadvantages.

28. MacDougall’s empirical study of comparative advantage was based on the notion that a product’s labor cost is underlaid by labor productivity and the wage rate.

29. The MacDougall study of comparative advantage hypothesized that in those industries in which U.S. labor productivity was relatively high, U.S. exports to the world should be lower than U.K. exports to the world, after adjusting for wage differentials.

30. The basic idea of mercantilism was that wealth consisted of the goods and services produced by a nation.

31. According to Adam Smith, international trade was a “win-win” situation since all nations could enjoy gains from trade.

32. The price-specie-flow mechanism illustrated why one nation’s gains from trade were accompanied by another country’s losses.

33. Complete specialization usually occurs under the assumption of increasing opportunity costs.

34. Adam Smith contended that gold, silver, and other precious metals constituted the wealth of a nation.

35. The price-specie-flow mechanism illustrated why nations could not maintain trade surpluses or trade deficits over the long run.

36. The marginal rate of transformation equals the absolute slope of a country’s production possibilities schedule.

37. Assume that Germany has higher labor productivity and higher wage levels than France. Germany can produce a commodity more cheaply than France if its productivity differential more than offsets its wage differential.

38. Ricardo’s theory of comparative advantage does not take into account demand conditions when determining relative commodity prices.

39. If Canada has a higher wage level and higher labor productivity than Mexico, Canada will necessarily produce a good at a higher labor cost than Mexico.

40. If Argentina has a comparative advantage over Brazil in beef relative to coffee, Argentina will specialize in beef production.

41. Modern trade theory recognizes that the pattern of world trade is governed by both demand conditions and supply conditions.

42. A nation achieves autarky equilibrium at the point where its community indifference curve is tangent to its production possibilities schedule.

43. In autarky equilibrium, a nation realizes the lowest possible level of satisfaction given the constraint of its production possibilities schedule.

44. A nation benefits from international trade if it can achieve a higher indifference curve than it can in autarky.

45. A nation realizes maximum gains from trade at the point where the international terms-of-trade line is tangent to its community indifference curve.

46. The Ricardian theory of comparative advantage could fully explain the distribution of the gains from trade among trading partners.

47. Because the Ricardian theory of comparative advantage was based only on a nation’s demand conditions, it could not fully explain the distribution of the gains from trade among trading partners.

48. Because the Ricardian theory of comparative advantage was based only on a nation’s supply conditions, it could only determine the outer limits within which the equilibrium terms of trade would lie.

49. The domestic cost ratios of nations set the outer limits to the equilibrium terms of trade.

50. Mutually beneficial trade for two countries occurs if the equilibrium terms of trade lies between the two countries’ domestic cost ratios.

51. Assume that the United States and Canada engage in trade. If the international terms of trade coincides with the U.S. cost ratio, the United States realizes all of the gains from trade with Canada.

52. Assume that the United States and Canada engage in trade. If the international terms of trade coincides with the Canadian cost ratio, the United States realizes all of the gains from trade with Canada.

53. If the international terms of trade lies beneath (inside) the Mexican cost ratio, Mexico is worse off with trade than without trade.

54. Although J. S. Mill recognized that the region of mutually beneficial trade is bounded by the cost ratios of two countries, it was not until David Ricardo developed the theory of reciprocal demand that the equilibrium terms of trade could be determined.

55. According to J. S. Mill, if we know the domestic demand expressed by both trading partners for both products, the equilibrium terms of trade can be defined.

56. The theory of reciprocal demand asserts that as the U.S. demand for Canadian wheat rises, the equilibrium terms of trade improve for the United States.

57. Assume that Canada has a comparative advantage in wheat and a comparative disadvantage in autos. As the Canadian demand for wheat increases, Canada’s equilibrium terms of trade improves.

58. The theory of reciprocal demand best applies when two countries are of equal economic size, so that the demand conditions of each nation have a noticeable impact on market prices.

59. The theory of reciprocal demand best applies when one country has a “large” economy and the other country has a “small” economy.

60. If two nations of approximately the same size and with similar taste patterns participate in international trade, the gains from trade tend to be shared about equally between them.

61. The expression “importance of being unimportant” suggests that if one nation is much larger than the other, the larger nation realizes most of the gains from trade while the smaller nation realizes fewer gains from trade.

62. An improvement in a nation’s terms of trade occurs if the prices of its exports rise relative to the prices of its imports over a given time period.

63. If a country’s terms of trade worsen, it must exchange fewer exports for a given amount of imports.

64. If a country’s terms of trade improve, it must exchange more exports for a given amount of imports.

65. The terms of trade represents the rate of exchange between a country’s exports and imports.

66. Assume 1990 to be the base year. If by the end of 2004 a country’s export price index rose from 100 to 130 while its import price index rose from 100 to 115, its terms of trade would equal 113.

67. Assume 1990 to be the base year. If by the end of 2004 a country’s export price index rose from 100 to 140 while its import price index rose from 100 to 160, its terms of trade would equal 120.

68. Assume 1990 to be the base year. If by the end of 2004 a country’s export price index rose from 100 to 125 while its import price index rose from 100 to 125, its terms of trade would equal 100.

69. The commodity terms of trade are found by dividing a country’s import price index by its export price index.

70. For the commodity terms of trade to improve, a country’s export price index must rise relative to its import price index over a given time period.

71. For the commodity terms of trade to improve, a country’s import price index must rise relative to its export price index over a given time period.

SHORT ANSWER

1. Is it possible to add up the preferences of all consumers in an entire nation?

2. Who gains more from trade, when nations are of unequal economic size?

3. Is it possible for comparative advantage to change, thus changing the direction of trade?

4. Do national security concerns lead to incomplete specialization?

ESSAY

1. Will it be impossible to keep low-skilled jobs in the U.S.?

2. Is it possible to estimate the gains from trade?

ECO 305 Week 3 Quiz

CHAPTER 3—SOURCES OF COMPARATIVE ADVANTAGE

MULTIPLE CHOICE

1. Which of the following suggests that a nation will export the commodity in the production of which a great deal of its relatively abundant and cheap factor is used?
a. The Linder theory
b. The product life cycle theory
c. The MacDougall theory
d. The Heckscher-Ohlin theory

2. According to Staffan Linder, trade between two countries tends to be most pronounced when the countries:
a. Find their tastes and preferences to be quite harmonious
b. Experience economies of large-scale production over large output levels
c. Face dissimilar relative abundances of the factors of production
d. Find their per capita income levels to be approximately the same

3. Which of the following is a long-run theory, emphasizing changes in the trading position of a nation over a number of years?
a. Theory of factor endowments
b. Comparative advantage theory
c. Theory of the product cycle
d. Overlapping demand theory

4. The Leontief paradox questioned the validity of the theory of:
a. Comparative advantage
b. Factor endowments
c. Overlapping demands
d. Absolute advantage

5. Which of the following would least likely apply to the product life cycle theory?
a. Calculators and computers
b. Coal and crude oil
c. Home movie cameras
d. Office machinery

6. Classical trade theory emphasized which of the following as an underlying explanation of the basis for trade?
a. Productivities of labor inputs
b. Tastes and preferences among nations
c. Changes in technologies over time
d. Quantities of economic resources

7. Concerning the influence that transportation costs have on the location of industry, which of the following industries has generally attempted to locate production facilities close to resource supplies?
a. Autos
b. Steel
c. Soft drinks
d. Valuable electronics goods

8. Assume that Country A, in the absence of trade, finds itself relatively abundant in labor and relatively scarce in land. The factor endowment theory reasons that with free trade, the internal distribution of national income in Country A will change in favor of:
a. Labor
b. Land
c. Both labor and land
d. Neither labor nor land

9. When considering the effects of transportation costs, the conclusions of our trade model must be modified. This is because transportation costs result in:
a. Lower trade volume, higher import prices, smaller gains from trade
b. Lower trade volume, lower import prices, smaller gains from trade
c. Higher trade volume, higher import prices, smaller gains from trade
d. Higher trade volume, lower import prices, greater gains from trade

10. Most economists maintain that the major factor underlying wage stagnation in the United States in the 1990s has been:
a. Import competition
b. Technological change
c. Rising real value of the minimum wage
d. Increasing union membership

11. Assume the cost of transporting autos from Japan to Canada exceeds the pretrade price difference for autos between Japan and Canada. Trade in autos is:
a. Impossible
b. Possible
c. Highly profitable
d. Moderately profitable

12. Eli Heckscher and Bertil Ohlin are associated with the theory of comparative advantage that stresses differences in:
a. Income levels among countries
b. Tastes and preferences among countries
c. Resource endowments among countries
d. Labor productivities among countries

13. Hong Kong is relatively abundant in labor, while Canada is relatively abundant in capital. In both countries the production of shirts is relatively more labor intensive than the production of computers. According to the factor endowment theory, Hong Kong will have a(n):
a. Absolute advantage in the production of shirts and computers
b. Absolute advantage in the production of computers
c. Comparative advantage in the production of shirts
d. Comparative advantage in the production of computers

14. If Japanese workers receive lower wages in the production of autos than do American workers:
a. Japan will have a comparative advantage in the production of autos
b. Japan will have an absolute advantage in the production of autos
c. Production costs will be lower in Japan than in the U.S.
d. Production costs could be lower in the U.S. if American labor productivity is higher than the Japanese

15. Which trade theory suggests that a newly produced good, once exported, could ultimately end up being imported as the technology is transferred to lower- cost nations?
a. Factor endowment theory
b. Product life cycle theory
c. Overlapping demand theory
d. Comparative advantage theory

16. A firm is said to enjoy economies of scale over the range of output for which the long-run average cost is:
a. Increasing
b. Constant
c. Decreasing
d. None of the above

17. A product will be internationally traded as long as the pretrade price differential between the trading partners is:
a. Greater than the cost of transporting it between them
b. Equal to the cost of transporting it between them
c. Less than the cost of transporting it between them
d. None of the above

18. Which of the following suggests that by widening the market’s size, international trade can permit longer production runs for manufacturers, which leads to increasing efficiency?
a. Economies of scale
b. Diseconomies of scale
c. Comparative cost theory
d. Absolute cost theory

19. The Leontief paradox:
a. Was applied to the product life cycle theory
b. Suggested that the U.S. exports labor-intensive goods
c. Found that national income differences underlie world trade patterns
d. Implied that diseconomies of scale occur at low output levels

20. Which of the following best applies to the theory of overlapping demands?
a. Manufactured goods
b. Services
c. Primary products
d. None of the above

21. The Heckscher-Ohlin theory explains comparative advantage as the result of differences in countries’:
a. Economies of large-scale production
b. Relative abundance of various resources
c. Relative costs of labor
d. Research and development

22. Boeing aircraft company was able to cover its production costs of the first “jumbo jet” in the 1970s because Boeing could market it to several foreign airlines in addition to domestic airlines. This illustrates:
a. How economies of scale make possible a larger variety of products in international trade
b. A transfer of wealth from domestic consumers to domestic producers as the result of trade
c. How a natural monopoly is forced to behave more competitively with international trade
d. How a natural monopoly is forced to behave less competitively with international trade

23. Which trade theory contends that a country that initially develops and exports a new product may eventually become an importer of it and may no longer manufacture the product?
a. Theory of factor endowments
b. Theory of overlapping demands
c. Economies of scale theory
d. Product life cycle theory

24. The theory of overlapping demands predicts that trade in manufactured goods is unimportant for countries with very different:
a. Tastes and preferences
b. Expectations of future interest rate levels
c. Per-capita income levels
d. Labor productivities

25. The trade model of the Swedish economists Heckscher and Ohlin maintains that:
a. Absolute advantage determines the distribution of the gains from trade
b. Comparative advantage determines the distribution of the gains from trade
c. The division of labor is limited by the size of the world market
d. A country exports goods for which its resource endowments are most suited

26. According to the factor endowment model, countries heavily endowed with land will:
a. Devote excessive amounts of resources to agricultural production
b. Devote insufficient amounts of resources to agricultural production
c. Export products that are land-intensive
d. Import products that are land-intensive

27. For the United States, empirical studies indicate that over the past two decades the cost of international transportation relative to the value of U.S. imports has:
a. Increased
b. Decreased
c. Not changed
d. None of the above

28. Should international transportation costs decrease, the effect on international trade would include:
a. An increase in the volume of trade
b. A smaller gain from trade
c. A decline in the income of home producers
d. A decrease in the level of specialization in production.

29. That the division of labor is limited by the size of the market best applies to which explanation of trade?
a. Factor endowment theory
b. Product life cycle theory
c. Economies of scale theory
d. Overlapping demand theory

30. A larger variety of products results from international trade especially if:
a. International trade affords producers monopoly power
b. National governments levy import tariffs and quotas
c. Producing goods entails increasing costs
d. Economies of scale exist for producers

31. With economies of scale and decreasing unit costs, a country has the incentive to:
a. Specialize completely in the product of its comparative advantage
b. Specialize partially in the product of its comparative advantage
c. Specialize completely in the product of its comparative disadvantage
d. Specialize partially in the product of its comparative disadvantage

32. Proponents of ____ maintain that government should enact policies that encourage the development of emerging, “sunrise” industries.
a. Product life cycle policy
b. Static comparative advantage policy
c. Intraindustry trade policy
d. Industrial policy

33. Legislation requiring domestic manufacturers to install pollution abatement equipment tends to promote:
a. Higher production costs and an increase in output
b. Higher production costs and a decrease in output
c. Lower production costs and an increase in output
d. Lower production costs and a decrease in output

34. Stringent governmental regulations (e.g., air quality standards) imposed on domestic steel manufacturers tend to:
a. Enhance their competitiveness in the international market
b. Detract from their competitiveness in the international market
c. Increase the profitability and productivity of domestic manufacturers
d. Reduce the market share of foreign firms selling steel in the domestic market

35. Among the determinants underlying a country’s international competitiveness in business services (e.g., construction) are:
a. The potential scale economies afforded by a market’s size
b. Abundance of equipment including data processing facilities and computers
c. Skills and capabilities of employees and their wage rates
d. All of the above

36. The simultaneous import and export of computers by Germany is an example of:
a. Intraindustry trade
b. Interindustry trade
c. Perfect competition
d. Imperfect competition

37. Linder’s theory of overlapping demand provides an explanation of:
a. Product life cycle theory
b. Factor endowment model
c. Economies of large-scale production
d. Intraindustry trade

38. Intraindustry trade can be explained in part by:
a. Adam Smith’s principle of absolute advantage
b. Perfect competition in product markets
c. Diseconomies of large scale production
d. Transportation costs between and within nations

39. The Leontief paradox provided:
a. Support for the principle of absolute advantage
b. Support for the factor endowment model
c. Evidence against the factor endowment model
d. Evidence against the principle of absolute advantage

40. Which trade theory suggests that comparative advantage tends to shift from one nation to another as a product matures?
a. Interindustry trade theory
b. Intraindustry trade theory
c. Product life cycle theory
d. Overlapping demand theory

41. Which trade theory is tantamount to a short-run version of the factor price equalization theory?
a. Specific factors theory
b. Product life cycle theory
c. Economies of scale theory
d. Overlapping demand theory

42. According to the specific factors trade theory:
a. Owners of factors specific to export industries suffer from trade, while owners of factors specific to import-competing industries gain
b. Owners of factors specific to export industries gain from trade, while owners of factors specific to import-competing industries suffer
c. Both owners of factors specific to export industries and owners of factors specific to import-competing industries gain from trade
d. Both owners of factors specific to export industries and owners of factors specific to import-competing industries suffer from trade

43. Which nation has sometimes been characterized as being a “pollution haven” due to its lenient environmental standards that encourage the production of pollution-intensive goods?
a. Japan
b. Canada
c. Germany
d. Mexico

44. Boeing Inc. has criticized The Airbus Company’s competitiveness on the grounds that Airbus benefits from:
a. Import tariffs protecting Airbus in the European market
b. Import quotas protecting Airbus in the European market
c. Lenient environmental standards of European governments
d. Production subsidies supplied by European governments

45. To justify the subsidies it has received from European governments, The Airbus Company has used all of the following arguments except:
a. Its subsidies have prevented U.S. aircraft firms from holding a world-wide monopoly
b. U.S. aircraft firms have benefited from military-sponsored programs of the U.S. government
c. Airbus’ subsidies were totally repaid as the firm realized profits on its aircraft sales
d. Without subsidies to Airbus, Europe would be dependent on the United States as a supplier of aircraft

46. Expanding trade or technological improvements
a. Increases the demand for skilled workers in the U.S.
b. Decreases the demand for unskilled workers in the U.S.
c. Increases the demand for unskilled workers in the U.S.
d. Both a and b.

47. Economists agree that wages of unskilled workers are being held down by
a. International trade
b. Technology improvements
c. Lack of education
d. A combination of a, b, and c

48. The factor endowment theory states that comparative advantage is explained
a. Exclusively by differences in relative supply conditions
b. Exclusively by differences in relative national demand conditions
c. Both supply and demand conditions
d. None of the above

49. The factor endowment theory assumes
a. Same tastes and preferences
b. Factor inputs of uniform quality
c. Same technology
d. All of the above

50. In explaining international trade, the product life cycle theory focuses on
a. Tastes and preferences
b. The role of technological innovation
c. Per-capita income levels of nations
d. Both b and c

TRUE/FALSE

1. According to Ricardian theory, comparative advantage depends on relative differences in labor productivity.

2. The Heckscher-Ohlin theory asserts that relative differences in labor productivity underlie comparative advantage.

3. The factor-endowment theory highlights the relative abundance of a nation’s resources as the key factor underlying comparative advantage.

4. According to the factor-endowment theory, a nation will export that good for which a large amount of the relatively scarce resource is used.

5. According to the factor-endowment theory, a nation will import that good for which a large amount of the relatively abundant resource is used.

6. The Heckscher-Ohlin theory suggests that land-abundant nations will export land-intensive goods while labor-abundant nations will export labor-intensive goods.

7. The Heckscher-Ohlin theory contends that over a period of years a country that initially is an exporter of a product will become an importer of that product.

8. The Heckscher-Ohlin theory emphasizes the role that demand plays in the creation of comparative advantage.

9. The factor-endowment theory asserts that with specialization and trade there tends to occur an equalization in the relative resource prices of trading partners.

10. According to the factor-endowment theory, international specialization and trade cause a nation’s cheap resource to become cheaper and a nation’s expensive resource to become more expensive.

11. Fears about the downward pressure that cheap foreign workers place on U.S. wages have led U.S. labor unions to lobby for import restrictions such as tariffs and quotas.

12. According to the factor-price-equalization theory, international trade results in the relative differences in resource prices between nations being eliminated.

13. Empirical testing by Wassily Leontief gave support to the Heckscher-Ohlin theory of trade.

14. The Leontief Paradox was the first major challenge to the product-life-cycle theory of trade.

15. The Leontief Paradox suggested that, in contrast to the predictions of the factor-endowment theory, U.S. exports were less capital-intensive than U.S. import-competing goods.

16. The specific-factors theory analyzes the income distribution effects of trade in the short run when resources are immobile among industries.

17. Owners of resources specific to export industries tend to lose from international trade, while owners of factors specific to import-competing industries tend to gain.

18. The factor-price-equalization theory is a short-run version of the specific-factors theory.

19. With economies of scale, specialization in a few products allows a manufacturer to benefit from longer production runs which lead to decreasing average cost.

20. With decreasing costs, a country has an incentive to partially specialize in the product of its comparative advantage.

21. By widening the size of the domestic market, international trade permits companies to take advantage of longer production runs and increasing efficiencies such as mass production.

22. The theory of overlapping demands applies best to trade in manufactured goods.

23. Decreasing cost conditions lead to complete specialization in the production of the commodity of comparative advantage.

24. According to Staffan Linder, the factor endowment theory is useful in explaining trade patterns in manufactured goods, but not primary products.

25. The theory of overlapping demands asserts that trade in manufactured goods is stronger the less similar the demand structures of two countries.

26. The theory of overlapping demands contends that international trade in manufactured products is strongest among nations with similar income levels.

27. According to the theory of overlapping demands, trade in manufactured goods would be greater among two wealthy countries than among a wealthy country and a poor country.

28. Recent studies of U.S. resource endowments indicate that the United States is most abundant in unskilled labor, followed by semi-skilled labor and skilled labor.

29. Intraindustry trade would occur if computers manufactured in the United States by IBM are exported to Japan while the United States imports computers manufactured by Hitachi of Japan.

30. Because seasons in the Southern Hemisphere are opposite those in the Northern Hemisphere, one would expect intraindustry trade to occur in agricultural products.

31. Intraindustry trade can be explained by product differentiation, economies of scale, seasons of the year, and transportation costs.

32. According to the theory of intraindustry trade, many manufactured goods undergo a trade cycle in which the home country initially is an exporter and eventually becomes an importer of a product.

33. The product-life-cycle theory applies best to trade in primary products in the short run.

34. According to the product-life-cycle theory, the first stage of a product’s trade cycle is when it is introduced to the home market.

35. According to the product life cycle theory, the last stage of a product’s trade cycle is when it becomes an import-competing good.

36. Ricardo’s theory of comparative advantage is a static theory that does not consider changes in international competitiveness over the long run.

37. Dynamic comparative advantage refers to the creation of comparative advantage through the mobilization of skilled labor, technology, and capital.

38. Industrial policy seeks to direct resources to declining industries in which productivity is low, linkages to the rest of the economy are weak, and future competitiveness is remote.

39. Europe’s jumbo-jet manufacturer, Airbus, has justified receiving governmental subsidies on the grounds that the subsidies prevent the United States from becoming a monopoly in the jumbo-jet market.

40. The imposition of pollution-control regulations on domestic steel manufacturers leads to decreases in production costs and an improvement in the steel manufacturers’ competitiveness.

41. Empirical studies conclude that U.S. environmental policies are a more important determinant of trade performance than capital, raw materials, labor skills, and wages.

42. Most developing countries have pollution-control laws and enforcement policies that are more stringent than those of the major industrial countries.

43. Although the theory of comparative advantage explains trade in manufactured goods, it has no explanatory value for trade in business services.

44. When transportation costs are added to our trade model, the low-cost exporting country produces less, consumes more, and exports less than that which occurs in the absence of transportation costs.

45. When transportation costs are added to our trade model, the degree of specialization in production between two countries increases as do the gains from trade.

46. In the absence of transportation costs, free trade results in the equalization of the prices of traded goods, as well as resource prices, in the trading nations.

47. In industries where the final product is much less weighty or bulky than the materials from which it is made, firms tend to locate production near resource supplies.

48. Industrial processes that add weight or bulk to a commodity are likely to be located near the resource market to minimize transportation costs.

49. A product will be traded only if the cost of transporting it between nations is less than the pretrade difference between their relative product prices.

50. Generally speaking, transportation costs are more important than production costs as a source of comparative advantage.

51. The product-life-cycle model contends that when a new product is introduced to the home market, it generally requires low-skilled labor to produce it.

52. According to the product life cycle model, comparative advantage shifts from cheap-labor countries to high-technology countries after a manufactured good becomes standardized.

SHORT ANSWER

1. Does factor price equalization occur in the real world?

2. What is the focus of the product life cycle theory, and where is it applicable?

ESSAY

1. Explain how immigration and trade may worsen wage inequality, and how college education may mitigate against that.

2. How does Staffan Linder explain world trade patterns?

CHAPTER 4—TARIFFS

MULTIPLE CHOICE

1. The imposition of tariffs on imports results in deadweight welfare losses for the home economy. These losses consist of the:
a. Protective effect plus consumption effect
b. Redistribution effect plus revenue effect
c. Revenue effect plus protective effect
d. Consumption effect plus redistribution effect

2. Suppose that the United States eliminates its tariff on steel imports, permitting foreign-produced steel to enter the U.S. market. Steel prices to U.S. consumers would be expected to:
a. Increase, and the foreign demand for U.S. exports would increase
b. Decrease, and the foreign demand for U.S. exports would increase
c. Increase, and the foreign demand for U.S. exports would decrease
d. Decrease, and the foreign demand for U.S. exports would decrease

3. A $100 specific tariff provides home producers more protection from foreign competition when:
a. The home market buys cheaper products rather than expensive products
b. It is applied to a commodity with many grade variations
c. The home demand for a good is elastic with respect to price changes
d. It is levied on manufactured goods rather than primary products

4. A lower tariff on imported aluminum would most likely benefit:
a. Foreign producers at the expense of domestic consumers
b. Domestic manufacturers of aluminum
c. Domestic consumers of aluminum
d. Workers in the domestic aluminum industry

5. When a government allows raw materials and other intermediate products to enter a country duty free, its tariff policy generally results in a:
a. Effective tariff rate less than the nominal tariff rate
b. Nominal tariff rate less than the effective tariff rate
c. Rise in both nominal and effective tariff rates
d. Fall in both nominal and effective tariff rates

6. Of the many arguments in favor of tariffs, the one that has enjoyed the most significant economic justification has been the:
a. Infant industry argument
b. Cheap foreign labor argument
c. Balance of payments argument
d. Domestic living standard argument

7. The redistribution effect of an import tariff is the transfer of income from the domestic:
a. Producers to domestic buyers of the good
b. Buyers to domestic producers of the good
c. Buyers to the domestic government
d. Government to the domestic buyers

8. Which of the following is true concerning a specific tariff?
a. It is exclusively used by the U.S. in its tariff schedules.
b. It refers to a flat percentage duty applied to a good’s market value.
c. It is plagued by problems associated with assessing import product values.
d. It affords less protection to home producers during eras of rising prices.

9. The principal benefit of tariff protection goes to:
a. Domestic consumers of the good produced
b. Domestic producers of the good produced
c. Foreign producers of the good produced
d. Foreign consumers of the good produced

10. Which of the following policies permits a specified quantity of goods to be imported at one tariff rate and applies a higher tariff rate to imports above this quantity?
a. Tariff quota
b. Import tariff
c. Specific tariff
d. Ad valorem tariff

11. Assume the United States adopts a tariff quota on steel in which the quota is set at 2 million tons, the within-quota tariff rate equals 5 percent, and the over-quota tariff rate equals 10 percent. Suppose the U.S. imports 1 million tons of steel. The resulting revenue effect of the tariff quota would accrue to:
a. The U.S. government only
b. U.S. importing companies only
c. Foreign exporting companies only
d. The U.S. government and either U.S. importers or foreign exporters

12. When the production of a commodity does not utilize imported inputs, the effective tariff rate on the commodity:
a. Exceeds the nominal tariff rate on the commodity
b. Equals the nominal tariff rate on the commodity
c. Is less than the nominal tariff rate on the commodity
d. None of the above

13. Developing nations often maintain that industrial countries permit raw materials to be imported at very low tariff rates while maintaining high tariff rates on manufactured imports. Which of the following refers to the above statement?
a. Tariff-quota effect
b. Nominal tariff effect
c. Tariff escalation effect
d. Protective tariff effect

14. Should the home country be “large” relative to the world, its imposition of a tariff on imports would lead to an increase in domestic welfare if the terms-of-trade effect exceeds the sum of the:
a. Revenue effect plus redistribution effect
b. Protective effect plus revenue effect
c. Consumption effect plus redistribution effect
d. Protective effect plus consumption effect

15. Should Canada impose a tariff on imports, one would expect Canada’s:
a. Terms of trade to improve and volume of trade to decrease
b. Terms of trade to worsen and volume of trade to decrease
c. Terms of trade to improve and volume of trade to increase
d. Terms of trade to worsen and volume of trade to increase

16. A beggar-thy-neighbor policy is the imposition of:
a. Free trade to increase domestic productivity
b. Trade barriers to increase domestic demand and employment
c. Import tariffs to curb domestic inflation
d. Revenue tariffs to make products cheaper for domestic consumers

17. A problem encountered when implementing an “infant industry” tariff is that:
a. Domestic consumers will purchase the foreign good regardless of the tariff
b. Political pressure may prevent the tariff’s removal when the industry matures
c. Most industries require tariff protection when they are mature
d. Labor unions will capture the protective effect in higher wages

18. Tariffs are not defended on the ground that they:
a. Improve the terms of trade of foreign nations
b. Protect jobs and reduce unemployment
c. Promote growth and development of young industries
d. Prevent overdependence of a country on only a few industries

19. The deadweight loss of a tariff:
a. Is a social loss since it promotes inefficient production
b. Is a social loss since it reduces the revenue for the government
c. Is not a social loss because society as a whole doesn’t pay for the loss
d. Is not a social loss since only business firms suffer revenue losses

20. Which of the following is a fixed percentage of the value of an imported product as it enters the country?
a. Specific tariff
b. Ad valorem tariff
c. Nominal tariff
d. Effective tariff

21. A tax of 20 cents per unit of imported cheese would be an example of:
a. Compound tariff
b. Effective tariff
c. Ad valorem tariff
d. Specific tariff

22. A tax of 15 percent per imported item would be an example of:
a. Ad valorem tariff
b. Specific tariff
c. Effective tariff
d. Compound tariff

23. Which type of tariff is not used by the American government?
a. Import tariff
b. Export tariff
c. Specific tariff
d. Ad valorem tariff

24. Which trade policy results in the government levying a “two-tier” tariff on imported goods?
a. Tariff quota
b. Nominal tariff
c. Effective tariff
d. Revenue tariff

25. If we consider the impact on both consumers and producers, then protection of the steel industry is:
a. In the interest of the United States as a whole, but not in the interest of the state of Pennsylvania
b. In the interest of the United States as a whole and in the interest of the state of Pennsylvania
c. Not in the interest of the United States as a whole, but it might be in the interest of the state of Pennsylvania
d. Not in the interest of the United States as a whole, nor in the interest of the state of Pennsylvania

26. If I purchase a stereo from South Korea, I obtain the stereo and South Korea obtains the dollars. But if I purchase a stereo produced in the United States, I obtain the stereo and the dollars remain in America. This line of reasoning is:
a. Valid for stereos, but not for most products imported by the United States
b. Valid for most products imported by the United States, but not for stereos
c. Deceptive since Koreans eventually spend the dollars on U.S. goods
d. Deceptive since the dollars spent on a stereo built in the United States eventually wind up overseas

27. The most vocal political pressure for tariffs is generally made by:
a. Consumers lobbying for export tariffs
b. Consumers lobbying for import tariffs
c. Producers lobbying for export tariffs
d. Producers lobbying for import tariffs

28. If we consider the interests of both consumers and producers, then a policy of tariff reduction in the U.S. auto industry is:
a. In the interest of the United States as a whole, but not in the interest of auto-producing states
b. In the interest of the United States as a whole, and in the interest of auto-producing states
c. Not in the interest of the United States as a whole, nor in the interest of auto-producing states
d. Not in the interest of the United States as a whole, but is in the interest of auto-producing states

29. Free traders point out that:
a. There is usually an efficiency gain from having tariffs
b. There is usually an efficiency loss from having tariffs
c. Producers lose from tariffs at the expense of consumers
d. Producers lose from tariffs at the expense of the government

30. A decrease in the import tariff will result in:
a. An increase in imports but a decrease in domestic production
b. A decrease in imports but an increase in domestic production
c. An increase in price but a decrease in quantity purchased
d. A decrease in price and a decrease in quantity purchased

Figure 4.1 illustrates the demand and supply schedules for pocket calculators in Mexico, a “small” nation that is unable to affect the world price.

Figure 4.1. Import Tariff Levied by a “Small” Country

31. Consider Figure 4.1. In the absence of trade, Mexico produces and consumes:
a. 10 calculators
b. 40 calculators
c. 60 calculators
d. 80 calculators

32. Consider Figure 4.1. In the absence of trade, Mexico’s producer surplus and consumer surplus respectively equal:
a. $120, $240
b. $180, $180
c. $180, $320
d. $240, $240

33. Consider Figure 4.1. With free trade, Mexico imports:
a. 40 calculators
b. 60 calculators
c. 80 calculators
d. 100 calculators

34. Consider Figure 4.1. With free trade, the total value of Mexico’s imports equal:
a. $220
b. $260
c. $290
d. $300

35. Consider Figure 4.1. With free trade, Mexico’s producer surplus and consumer surplus respectively equal:
a. $5, $605
b. $25, $380
c. $45, $250
d. $85, $195

36. Consider Figure 4.1. With a per-unit tariff of $3, the quantity of imports decreases to:
a. 20 calculators
b. 40 calculators
c. 50 calculators
d. 70 calculators

37. According to Figure 4.1, the loss in Mexican consumer surplus due to the tariff equals:
a. $225
b. $265
c. $285
d. $325

38. According to Figure 4.1, the tariff results in the Mexican government collecting:
a. $100
b. $120
c. $140
d. $160

39. According to Figure 4.1, Mexican manufacturers gain ____ because of the tariff.
a. $75
b. $85
c. $95
d. $105

40. According to Figure 4.1, the deadweight cost of the tariff totals:
a. $60
b. $70
c. $80
d. $90

41. Consider Figure 4.1. The tariff would be prohibitive (i.e., eliminate imports) if it equaled:
a. $2
b. $3
c. $4
d. $5

Assume the United States is a large consumer of steel that is able to influence the world price. Its demand and supply schedules are respectively denoted by DU.S. and SU.S. in Figure 4.2. The overall (United States plus world) supply schedule of steel is denoted by SU.S.+W.

Figure 4.2. Import Tariff Levied by a “Large” Country

42. Consider Figure 4.2. With free trade, the United States achieves market equilibrium at a price of $____. At this price, ____ tons of steel are produced by U.S. firms, ____ tons are bought by U.S. buyers, and ____ tons are imported.
a. $450, 5 tons, 60 tons, 55 tons
b. $475, 10 tons, 50 tons, 40 tons
c. $525, 5 tons, 60 tons, 55 tons
d. $630, 30 tons, 30 tons, 0 tons

43. Consider Figure 4.2. Suppose the United States imposes a tariff of $100 on each ton of steel imported. With the tariff, the price of steel rises to $____ and imports fall to ____ tons.
a. $550, 20 tons
b. $550, 30 tons
c. $575, 20 tons
d. $575, 30 tons

44. Consider Figure 4.2. Of the $100 tariff, $____ is passed on to the U.S. consumer via a higher price, while $____ is borne by the foreign exporter; the U.S. terms of trade:
a. $25, $75, improve
b. $25, $75, worsen
c. $75, $25, improve
d. $75, $25, worsen

45. Referring to Figure 4.2, the tariff’s deadweight welfare loss to the United States totals:
a. $450
b. $550
c. $650
d. $750

46. According to Figure 4.2, the tariff’s terms-of-trade effect equals:
a. $300
b. $400
c. $500
d. $600

47. According to Figure 4.2, the tariff leads to the overall welfare of the United States:
a. Rising by $250
b. Rising by $500
c. Falling by $250
d. Falling by $500

48. Suppose that the production of $500,000 worth of steel in the United States requires $100,000 worth of iron ore. The U.S. nominal tariff rates for importing these goods are 15 percent for steel and 5 percent for iron ore. Given this information, the effective rate of protection for the U.S. steel industry is approximately:
a. 6 percent
b. 12 percent
c. 18 percent
d. 24 percent

49. Suppose that the production of a $30,000 automobile in Canada requires $10,000 worth of steel. The Canadian nominal tariff rates for importing these goods are 25 percent for automobiles and 10 percent for steel. Given this information, the effective rate of protection for the Canadian automobile industry is approximately:
a. 15 percent
b. 32 percent
c. 48 percent
d. 67 percent

Exhibit 4.1

Assume that the United States imports automobiles from South Korea at a price of $20,000 per vehicle and that these vehicles are subject to an import tariff of 20 percent. Also assume that U.S. components are used in the vehicles assembled by South Korea and that these components have a value of $10,000.

50. Refer to Exhibit 4.1. In the absence of the Offshore Assembly Provision of U.S. tariff policy, the price of an imported vehicle to the U.S. consumer after the tariff has been levied is:
a. $22,000
b. $23,000
c. $24,000
d. $25,000

51. Refer to Exhibit 4.1. Under the Offshore Assembly Provision of U.S. tariff policy, the price of an imported vehicle to the U.S. consumer after the tariff has been levied is:
a. $22,000
b. $23,000
c. $24,000
d. $25,000

52. Suppose an importer of steel is required to pay a tariff of $20 per ton plus 5 percent of the value of steel. This is an example of a (an):
a. Specific tariff
b. Ad valorem tariff
c. Compound tariff
d. Tariff quota

53. A compound tariff is a combination of a (an):
a. Tariff quota and a two-tier tariff
b. Revenue tariff and a protective tariff
c. Import tariff and an export tariff
d. Specific tariff and an ad valorem tariff

Table 4.1. Production Costs and Prices of Imported and Domestic VCRs

Imported VCRs Domestic VCRs
Component parts $150 Imported component parts $150
Assembly cost/profit 50 Assembly cost 50
Nominal tariff 25 Profit 25
____ ____
Import price Domestic price
after tariff 225 after tariff 225

54. Consider Table 4.1. Prior to the tariff, the total price of domestically-produced VCRs is:
a. $150
b. $200
c. $225
d. $250

55. Consider Table 4.1. Prior to the tariff, the total price of imported VCRs is:
a. $150
b. $200
c. $225
d. $235

56. Consider Table 4.1. The nominal tariff rate on imported VCRs equals:
a. 11.1 percent
b. 12.5 percent
c. 16.7 percent
d. 50.0 percent

57. Consider Table 4.1. Prior to the tariff, domestic value added equals:
a. $25
b. $50
c. $75
d. $100

58. Consider Table 4.1. After the tariff, domestic value added equals:
a. $25
b. $50
c. $75
d. $100

59. Consider Table 4.1. The effective tariff rate equals:
a. 11.1 percent
b. 16.7 percent
c. 50.0 percent
d. 100.0 percent

60. If the domestic value added before an import tariff for a product is $500 and the domestic value added after the tariff is $550, the effective rate of protection is:
a. 5 percent
b. 8 percent
c. 10 percent
d. 15 percent

61. When a tariff on imported inputs exceeds that on the finished good,
a. The nominal tariff rate on the finished product would tend to overstate its protective effect
b. The nominal tariff rate would tend to understate it’s protective effect
c. It is impossible to determine the protective effect of a tariff
d. Tariff escalation occurs

62. The offshore assembly provision in the U.S.
a. Provides favorable treatment to U.S. trading partners
b. Discriminates against primary product importers
c. Provides favorable treatment to products assembled abroad from U.S. manufactured components
d. Hurts the U.S. consumer

63. Arguments for U.S. trade restrictions include all of the following except
a. Job protection
b. Infant industry support
c. Maintenance of domestic living standard
d. Improving incomes for developing countries

64. For the United States, a foreign trade zone (FTZ) is
a. A site within the United States
b. A site outside the United States
c. Always located in poorer developing countries
d. Is used to discourage trade

TRUE/FALSE

1. To protect domestic producers from foreign competition, the U.S. government levies both import tariffs and export tariffs.

2. With a compound tariff, a domestic importer of an automobile might be required to pay a duty of $200 plus 4 percent of the value of the automobile.

3. With a specific tariff, the degree of protection afforded domestic producers varies directly with changes in import prices.

4. During a business recession, when cheaper products are purchased, a specific tariff provides domestic producers a greater amount of protection against import-competing goods.

5. A ad valorem tariff provides domestic producers a declining degree of protection against import-competing goods during periods of changing prices.

6. With a compound duty, its “specific” portion neutralizes the cost disadvantage of domestic manufacturers that results from tariff protection granted to domestic suppliers of raw materials, and the “ad valorem” portion of the duty grants protection to the finished-goods industry.

7. The nominal tariff rate signifies the total increase in domestic productive activities compared to what would occur under free-trade conditions.

8. When material inputs enter a country at a very low duty while the final imported product is protected by a high duty, the result tends to be a high rate of protection for domestic producers of the final product.

9. According to the tariff escalation effect, industrial countries apply low tariffs to imports of finished goods and high tariffs to imports of raw materials.

10. Under the Offshore Assembly Provision of U.S. tariff policy, U.S. import duties apply only to the value added in the foreign assembly process, provided that U.S.-made components are used by overseas companies in their assembly operations.

11. Bonded warehouses and foreign trade zones have the effect of allowing domestic importers to postpone and prorate over time their import duty obligations.

12. A nation whose imports constitute a very small portion of the world market supply is a price taker, facing a constant world price for its import commodity.

13. Graphically, consumer surplus is represented by the area above the demand curve and below the product’s market price.

14. Producer surplus is the revenue producers receive over and above the minimum necessary for production.

15. For a “small” country, a tariff raises the domestic price of an imported product by the full amount of the duty.

16. Although an import tariff provides the domestic government additional tax revenue, it benefits domestic consumers at the expense of domestic producers.

17. An import tariff reduces the welfare of a “small” country by an amount equal to the redistribution effect plus the revenue effect.

18. The deadweight losses of an import tariff consist of the protection effect plus the consumption effect.

19. The redistribution effect is the transfer of producer surplus to domestic consumers of the import-competing product.

20. As long as it is assumed that a nation accounts for a negligible portion of international trade, its levying an import tariff necessarily increases its overall welfare.

21. Changes in a “large” country’s economic conditions or trade policies can affect the terms at which it trades with other countries.

22. A “large” country, that levies a tariff on imports, cannot improve the terms at which it trades with other countries.

23. For a “large” country, a tariff on an imported product may be partially absorbed by the domestic consumer via a higher purchase price and partially absorbed by the foreign producer via a lower export price.

24. If a “large” country levies a tariff on an imported good, its overall welfare increases if the monetary value of the tariff’s consumption effect plus protective effect exceeds the monetary value of the terms-of-trade effect.

25. If a “small” country levies a tariff on an imported good, its overall welfare increases if the monetary value of the tariff’s consumption effect plus protective effect is less than the monetary value of the terms-of-trade effect.

26. A tariff on steel imports tends to improve the competitiveness of domestic automobile companies.

27. If a tariff reduces the quantity of Japanese autos imported by the United States, over time it reduces the ability of Japan to import goods from the United States.

28. A compound tariff permits a specified amount of goods to be imported at one tariff rate while any imports above this amount are subjected to a higher tariff rate.

29. A tariff can be thought of as a tax on imported goods.

30. Although tariffs on imported steel may lead to job gains for domestic steel workers, they can lead to job losses for domestic auto workers.

31. Relatively low wages in Mexico make it impossible for U.S. manufacturers of labor-intensive goods to compete against Mexican manufacturers.

32. According to the infant-industry argument, temporary tariff protection granted to an infant industry will help it become competitive in the world market; when international competitiveness is achieved, the tariff should be removed.

Exhibit 4.2

In the absence of international trade, assume that the equilibrium price and quantity of motorcycles in Canada is $14,000 and 10 units respectively. Assuming that Canada is a small country that is unable to affect the world price of motorcycles, suppose its market is opened to international trade. As a result, the price of motorcycles falls to $12,000 and the total quantity demanded rises to 14 units; out of this total, 6 units are produced in Canada while 8 units are imported. Now assume that the Canadian government levies an import tariff of $1,000 on motorcycles.

33. Refer to Exhibit 4.2. As a result of the tariff, the price of imported motorcycles equals $13,000 and imports total 4 cycles.

34. Refer to Exhibit 4.2. The tariff leads to an increase in Canadian consumer surplus totaling $11,000.

35. Refer to Exhibit 4.2. The tariff’s redistribution effect equals $7,000.

36. Refer to Exhibit 4.2. The tariff’s revenue effect equals $6,000.

37. Refer to Exhibit 4.2. All of the import tariff is shifted to the Canadian consumer via a higher price of motorcycles.

38. Refer to Exhibit 4.2. The tariff leads to a deadweight welfare loss for Canada totaling $1,000.

39. Unlike a specific tariff, an ad valorem tariff differentiates between commodities with different values.

40. A limitation of a specific tariff is that it provides a constant level of protection for domestic commodities regardless of fluctuations in their prices over time.

41. A tariff quota is a combination of a specific tariff and an ad valorem tariff.

42. A specific tariff is expressed as a fixed percentage of the total value of an imported product.

43. The protective effect of a tariff occurs to the extent that less efficient domestic production is substituted for more efficient foreign production.

44. A tariff can increase the welfare of a “large” levying country if the favorable terms-of-trade effect more than offsets the unfavorable protective effect and consumption effect.

45. If the world price of steel is $600 per ton, a specific tariff of $120 per ton is equivalent to an ad valorem tariff of 25 percent.

46. An import tariff will worsen the terms of trade for a “small” country but improve the terms of trade for a “large” country.

47. Suppose that the tariff on imported steel is 40 percent, the tariff on imported iron ore is 20 percent, and 30 percent of the cost of producing a ton of steel consists of the iron ore it contains. The effective rate of protection of steel is approximately 49 percent.

48. There is widespread agreement among economists that import tariffs increase overall employment in the levying country.

49. Assume that the United States imports VCRs from South Korea at a price of $200 per unit and that these VCRs are subject to an import tariff of 20 percent. Also assume that U.S. components are used in the VCRs assembled by South Korea and that these components have a value of $100. Under the Offshore Assembly Provision of U.S. tariff policy, the price of an imported VCR to the U.S. consumer after the tariff has been levied is $220.

50. Assume that the United States imports televisions from Taiwan at a price of $300 per unit and that these televisions are subject to an import tariff of 25 percent. Also assume that U.S. components are used in the televisions assembled by Taiwan and that these components have a value of $100. Under the Offshore Assembly Provision of U.S. tariff policy, the price of an imported television to the U.S. consumer after the tariff has been levied is $375

SHORT ANSWER

1. Can import duties have unintended side effects?

2. What happens to effective protection when the value added by the domestic producer declines?

ESSAY

1. Is it possible for a low nominal tariff rate to understate the effective rate of protection? What is tariff escalation?

2. How can tariffs be justified?

ECO 305 Week 4 Quiz

CHAPTER 5—NONTARIFF TRADE BARRIERS

MULTIPLE CHOICE

1. The imposition of a tariff on imported steel for the home country results in:
a. Improving terms of trade and rising volume of trade
b. Higher steel prices and falling steel consumption
c. Lower profits for domestic steel companies
d. Higher unemployment for domestic steel workers

2. Which of the following refers to a market-sharing pact negotiated by trading partners to moderate the intensity of international competition?
a. Orderly marketing agreement
b. Local content requirements
c. Import quota
d. Trigger price mechanism

3. Suppose the United States and Japan enter into a voluntary export agreement in which Japan imposes an export quota on its automakers. The largest share of the export quota’s “revenue effect” would tend to be captured by:
a. The U.S. government
b. Japanese automakers
c. American auto consumers
d. American autoworkers

4. Suppose the government grants a subsidy to domestic producers of an import-competing good. The subsidy tends to result in deadweight losses for the domestic economy in the form of the:
a. Consumption effect
b. Redistribution effect
c. Revenue effect
d. Protective effect

5. Tariffs and quotas on imports tend to involve larger sacrifices in national welfare than would occur under domestic subsidies. This is because, unlike domestic subsidies, import tariffs and quotas:
a. Permit less efficient home production
b. Distort choices for domestic consumers
c. Result in higher tax rates for domestic residents
d. Redistribute revenue from domestic producers to consumers

6. Suppose the government grants a subsidy to its export firms that permits them to charge lower prices on goods sold abroad. The export revenue of these firms would rise if the foreign demand is:
a. Elastic in response to the price reduction
b. Inelastic in response to the price reduction
c. Unit elastic in response to the price reduction
d. None of the above

7. Because export subsidies tend to result in domestic exporters charging lower prices on their goods sold overseas, the home country’s:
a. Export revenues will decrease
b. Export revenues will rise
c. Terms of trade will worsen
d. Terms of trade will improve

8. Which trade restriction stipulates the percentage of a product’s total value that must be produced domestically in order for that product to be sold domestically?
a. Import quota
b. Orderly marketing agreement
c. Local content requirement
d. Government procurement policy

9. The imposition of a domestic content requirement by the United States would cause consumer surplus for Americans to:
a. Rise
b. Fall
c. Remain unchanged
d. None of the above

10. Domestic content legislation applied to autos would tend to:
a. Support wage levels of American autoworkers
b. Lower auto prices for American autoworkers
c. Encourage American automakers to locate production overseas
d. Increase profits of American auto companies

11. Compared to an import quota, an equivalent tariff may provide a less certain amount of protection for home producers since:
a. A tariff has no deadweight loss in terms of production and consumption
b. Foreign firms may absorb the tariff by offering exports at lower prices
c. Tariffs are effective only if home demand is perfectly elastic
d. Quotas do not result in increases in the price of the imported good

12. Empirical studies show that because voluntary export quotas are typically administered by exporting countries, foreign exporters tend to:
a. Raise their export prices, thus capturing much of the quota’s revenue effect
b. Lower their export prices, thus losing much of the quota’s revenue effect
c. Raise their export prices, thus selling more goods overseas
d. Lower their export prices, thus selling fewer goods overseas

13. Concerning the restrictive impact of an import quota, assume there occurs an increase in the domestic demand for the import product. As long as the quota falls short of what would be imported under free market conditions, the economy’s adjustment to the increase in demand would take the form of:
a. A decrease in domestic production of the import good
b. An increase in the amount of the good being imported
c. An increase in the domestic price of the import good
d. A decrease in domestic consumption of the import good

14. Assume the U.S. has a competitive advantage in producing calculators, while the rest of the world has a competitive advantage in steel. Suppose the U.S. and the rest of the world enter into an agreement to lower import quotas below existing levels on calculators and steel. Which of the following would least likely occur for the U.S.? Rising levels of:
a. Consumer surplus for American buyers of steel
b. Producer surplus for American steelmakers
c. Production in the American calculator industry
d. Producer surplus for American calculator producers

15. A firm that faces problems of falling sales and excess productive capacity might resort to international dumping if it:
a. Can charge higher prices in markets that are elastic to price changes
b. Earns revenues on foreign sales that at least cover variable costs
c. Can sell at that price where domestic and foreign demand elasticities equate
d. Is able to force foreign prices below marginal production costs

16. A producer successfully practicing international dumping would charge:
a. A relatively higher price in the more inelastic market
b. A relatively higher price in the more elastic market
c. The same price in all markets, regardless of their elasticities
d. Different prices in all markets, regardless of their elasticities

17. The practice of Canadian firms dumping their products in Sweden poses a problem for economic policymakers since dumping tends to:
a. Favor Swedish consumers over Canadian consumers
b. Favor Swedish producers over Canadian producers
c. Become widespread as firms operate at full productive capacity
d. Result in firms charging prices above the total costs of production

18. The United Auto Workers union attempted to win the approval of legislation that would moderate the practice of foreign sourcing on the part of American auto manufacturers. Which of the following best represents this legislation?
a. Voluntary export quotas
b. Trigger price mechanism
c. Tariff quotas
d. Local content laws

19. A main factor behind the president’s decision to extend relief to steel firms in the form of trigger prices was that:
a. Dumping complaints can be time consuming and expensive to implement
b. The Tokyo Round outlawed the granting of subsidies to steel firms
c. Trigger prices involve zero deadweight welfare loss for the economy
d. Orderly marketing agreements were too costly to administer

20. If a tariff and an import quota lead to equivalent increases in the domestic price of steel, then:
a. The quota results in efficiency reductions but the tariff does not
b. The tariff results in efficiency reductions but the quota does not
c. They have different impacts on how much is produced and consumed
d. They have different impacts on how income is distributed

21. If a tariff and an import quota lead to equivalent increases in the domestic price of steel, then:
a. The quota results in efficiency reductions but the tariff does not
b. The tariff results in efficiency reductions but the quota does not
c. They have identical impacts on how much is produced and consumed
d. They have identical impacts on how income is distributed

22. From the perspective of the American public as a whole, export subsidies levied by overseas governments on goods sold to the United States:
a. Help more than they hurt
b. Hurt more than they help
c. Are equivalent to an import quota
d. Are equivalent to an export quota

23. Export subsidies levied by foreign governments on products in which the United States has a comparative disadvantage:
a. Lower the welfare of all Americans
b. Lead to increases in U.S. consumer surplus
c. Encourage U.S. production of competing goods
d. Encourage U.S. workers to demand higher wages

24. If import licenses are auctioned off to domestic importers in a competitive market, their scarcity value (revenue effect) accrues to:
a. Foreign corporations
b. Foreign workers
c. Domestic corporations
d. The domestic government

25. A specification of a maximum amount of a foreign produced good that will be allowed to enter the country over a given time period is referred to as:
a. A domestic subsidy
b. An export subsidy
c. An import quota
d. An export quota

26. Import quotas tend to lead to all of the following except:
a. Domestic producers of the imported good being harmed
b. Domestic consumers of the imported good being harmed
c. Prices increasing in the importing country
d. Prices falling in the exporting country

27. To maintain that South Koreans are dumping their VCRs in the United States is to maintain that:
a. Koreans are selling VCRs in the United States below their production cost
b. Koreans are selling VCRs in the United States above their production cost
c. The cost of manufacturing VCRs in Korea is lower in Korea than in the United States since wages are lower in Korea
d. The cost of manufacturing VCRs in Korea is higher in Korea than in the United States since wages are higher in Korea

28. If the home country’s government grants a subsidy on a domestically produced good, domestic producers tend to:
a. Capture the entire subsidy in the form of higher profits
b. Increase their level of production
c. Reduce wages paid to domestic workers
d. Consider the subsidy as an increase in production cost

29. For years the U.S. government levied quotas on inexpensive oil imported from the Middle East. The quotas led to cost increases for U.S. consumers totaling $3 billion for oil products. An apparent justification for this policy was that:
a. U.S. oil companies and workers deserved higher incomes
b. U.S. oil was of superior quality and merited higher prices
c. One should not be too dependent on foreign suppliers of crucial resources
d. The U.S. government needed the quota revenue to balance its budget

30. In certain industries, Japanese employers do not lay off workers. Therefore, they sometimes have excess supplies of goods that they cannot sell on the home market without lowering prices. To hold down losses, they sell goods in overseas markets at prices well beneath those in Japan. This practice is best referred to as:
a. Orderly marketing
b. Trigger pricing
c. Domestic content pricing
d. Dumping

Figure 5.1 illustrates the steel market for Mexico, assumed to be a “small” country that is unable to affect the world price. Suppose the world price of steel is given and constant at $200 per ton. Now suppose the Mexican steel industry is able to obtain trade protection.

Figure 5.1. Alternative Nontariff Trade Barriers Levied by a “Small” Country

31. Consider Figure 5.1. With free trade, the quantity of steel imported by Mexico equals:
a. 2 tons
b. 4 tons
c. 6 tons
d. 8 tons

32. Consider Figure 5.1. With free trade, Mexico’s consumer surplus and producer surplus respectively equal:
a. $2000 and $1200
b. $3200 and $200
c. $3600 and $800
d. $4000 and $600

33. Referring to Figure 5.1, suppose the Mexican government imposes an import quota equal to 2 tons of steel.

If Mexican steel importers behave as monopoly buyers and foreign exporters behave as competitive sellers, the overall welfare loss of the quota to Mexico equals:
a. $200
b. $400
c. $600
d. $800

34. Referring to Figure 5.1, suppose the Mexican government imposes an import quota equal to 2 tons of steel.

If foreign exporters behave as monopoly sellers, and Mexican importers behave as competitive buyers, the overall welfare loss of the quota to Mexico equals:
a. $200
b. $400
c. $600
d. $800

35. Referring to Figure 5.1, suppose the Mexican government imposes an import quota equal to 2 tons of steel.

If the Mexican government auctions import licenses to the highest foreign bidder, the overall welfare loss of the quota to Mexico equals:
a. $200
b. $400
c. $600
d. $800

36. Consider Figure 5.1. Suppose the Mexican government provides a subsidy of $200 per ton to its steel producers, as indicated by the supply schedule SM (with subsidy).

The quantity of imports equals:
a. 1 ton
b. 2 tons
c. 3 tons
d. 4 tons

37. Consider Figure 5.1. Suppose the Mexican government provides a subsidy of $200 per ton to its steel producers, as indicated by the supply schedule SM (with subsidy).

The total cost of the subsidy to the Mexican government equals:
a. $200
b. $400
c. $600
d. $800

38. Consider Figure 5.1. Suppose the Mexican government provides a subsidy of $200 per ton to its steel producers, as indicated by the supply schedule SM (with subsidy).

As a result of the subsidy Mexican steel producers gain ____ of producer surplus.
a. $200
b. $400
c. $600
d. $800

39. Consider Figure 5.1. Suppose instead that the Mexican government provides a subsidy of $200 per ton to its steel producers, as indicated by the supply schedule SM (with subsidy).

As a result of the subsidy, the welfare loss to Mexico due to inefficient domestic production equals:
a. $200
b. $400
c. $600
d. $800

40. Consider Figure 5.1. Suppose the Mexican government provides a subsidy of $200 per ton to its steel producers, as indicated by the supply schedule SM (with subsidy).

The overall deadweight welfare loss to Mexico equals:
a. $200
b. $400
c. $600
d. $800

41. Consider Figure 5.1. Suppose the rest of the world voluntarily agrees to reduce steel shipments to Mexico vis-a-vis an export quota equal to 2 tons.

Assuming Mexican importers behave as competitive buyers while foreign exporters behave as monopoly sellers, the overall welfare loss of the quota to Mexico is:
a. $200
b. $400
c. $600
d. $800

42. Consider Figure 5.1. Suppose the rest of the world voluntarily agrees to reduce steel shipments to Mexico vis-a-vis an export quota equal to 2 tons.

Assuming Mexican importers behave as monopoly buyers while foreign exporters behave as competitive sellers, the overall welfare loss of the quota to Mexico is:
a. $200
b. $400
c. $600
d. $800

Figure 5.2 illustrates the revenue and cost conditions of ABC Inc. which sells calculators in Canada and France.

Figure 5.2. International Dumping

43. Consider Figure 5.2. In the absence of international dumping, ABC Inc. maximizes profits by selling ____ calculators at a price of $____; the firm realizes profits totaling $____.
a. 27, $5, $54
b. 27, $5, $36
c. 24, $4, $46
d. 24, $4, $28

44. Referring to Figure 5.2, consider if ABC Inc. sells 27 calculators at a price of $5 each, realizing profits totaling $54. Of this quantity, ABC Inc. sells ____ calculators in Canada and realizes revenues totaling $____; the firm sells ____ calculators in France and realizes revenues totaling $____.
a. 15, $35, 9, $45
b. 15, $45, 9, $35
c. 21, $105, 6, $30
d. 21, $30, 6, $105

45. Consider Figure 5.2. With international dumping, ABC Inc. sells ____ calculators to Canadian buyers at a price of $____ and ____ calculators to French buyers at a price of $____.
a. 15, $4, 12, $7
b. 15, $7, 12, $4
c. 9, $5, 15, $6
d. 9, $6, 15, $5

46. Consider Figure 5.2. Compared with the total revenue and total profit that ABC Inc. realizes in the absence of dumping, with dumping the firm attains a:
a. Fall in revenue of $18; fall in profits of $15
b. Fall in revenue of $18, fall in profits of $18
c. Rise in revenue of $18, rise in profits of $15
d. Rise in revenue of $18, rise in profits of $18

Figure 5.3 illustrates the apple market for Sweden, assumed to be a “small” country that is unable to affect the world price. SSweden is the domestic supply and DSweden is the domestic demand. SSweden+Quota is Sweden’s supply schedule with an import quota.

Figure 5.3. Sweden’s Apple Market

47. Consider Figure 5.3. In the absence of trade, Sweden’s equilibrium price and quantity of apples would be:
a. $0.60 and 22 pounds
b. $0.60 and 14 pounds
c. $1.00 and 18 pounds
d. $1.40 and 14 pounds

48. Consider Figure 5.3. Suppose the rest of the world can supply apples to Sweden at a price of $0.60 per pound. With free trade, Sweden produces ____ pounds of apples and imports ____ pounds of apples.
a. 10, 8
b. 10, 18
c. 6, 22
d. 6, 16

49. Consider Figure 5.3. At the free-trade price of $0.60 per pound, Sweden’s consumer surplus totals $____ and producer surplus totals $____.
a. $10.80, $2.40
b. $14.60, $3.90
c. $24.20, $1.80
d. $32.40, $2.30

50. Consider Figure 5.3. If SSweden+Quota represents the supply schedule after a quota is levied, Sweden’s imports will equal:
a. 6 apples
b. 8 apples
c. 10 apples
d. 12 apples

51. Consider Figure 5.3. After the quota is levied, the price of apples in Sweden will equal:
a. $0.60 per pound
b. $1.00 per pound
c. $1.40 per pound
d. $1.80 per pound

52. Consider Figure 5.3. As a result of the quota, Sweden’s consumer surplus:
a. Increases by $6
b. Increases by $8
c. Decreases by $6
d. Decreases by $8

53. Consider Figure 5.3. The quota leads to a deadweight welfare loss for Sweden of an amount equaling:
a. $0.80
b. $1.60
c. $2.40
d. $3.20

54. Consider Figure 5.3. The quota’s revenue effect equals:
a. $1.60
b. $2.40
c. $3.20
d. $4.00

55. Consider Figure 5.3. Assume that Swedish import companies behave as competitive buyers while foreign export companies behave as a monopoly seller. Compared to free trade, Sweden’s import quota results in domestic welfare:
a. Gains totaling $3.20
b. Gains totaling $4.80
c. Losses totaling $3.20
d. Losses totaling $4.80

56. Consider Figure 5.3. Assume that Swedish import companies behave as a monopoly buyer while foreign export companies behave as competitive sellers. Compared to free trade, Sweden’s import quota results in domestic welfare:
a. Gains totaling $1.60
b. Gains totaling $3.20
c. Losses totaling $1.60
d. Losses totaling $3.20

57. Consider Figure 5.3. If the Swedish government auctions import licenses to the highest bidder in a competitive market, it could realize revenues of up to:
a. $3.20
b. $4.00
c. $4.80
d. $5.60

Figure 5.4 illustrates the calculator market for Venezuela, assumed to be a “small” country that is unable to affect the world price. SVenezuela is the domestic supply schedule and DVenezuela is the domestic demand schedule.

Figure 5.4. Venezuelan Calculator Market

58. Consider Figure 5.4. Suppose the rest of the world supplies calculators to Venezuela at a price of $4 each. With free trade, Venezuelan imports total:
a. 8 calculators
b. 16 calculators
c. 20 calculators
d. 24 calculators

59. Consider Figure 5.4. Assume the Venezuelan government grants its manufacturers a production subsidy of $4 per calculator. After the subsidy is granted, Venezuelan imports total:
a. 8 calculators
b. 12 calculators
c. 16 calculators
d. 20 calculators

60. Consider Figure 5.4. The cost of the production subsidy to the Venezuelan government totals:
a. $32
b. $40
c. $48
d. $54

61. Consider Figure 5.4. The increase in Venezuelan producer surplus under the production subsidy totals:
a. $16
b. $20
c. $24
d. $32

62. Consider Figure 5.4. The production subsidy results in an overall welfare loss for Venezuela totaling:
a. $8
b. $12
c. $16
d. $20

63. A voluntary export agreement
a. Typically applies only to the world’s most important exporting nation(s)
b. Typically applies only to the world’s least important exporting nation (s)
c. Is always more restrictive on trade than a tariff or import quota
d. All of the above

64. When voluntary export limits are imposed on the world’s chief exporter
a. The exports of the non-restrained suppliers may be stimulated
b. A trade diversion effect may occur
c. Both a and b
d. None of the above

65. Subsidies to domestic firms may lead to
a. An increase in prices
b. Higher volume of exports
c. Higher volume of imports
d. Increase in welfare of the trading partner

66. Concerning international dumping, many economists argue that “fair value” should be based on
a. Average variable cost
b. Average fixed cost
c. Marginal cost
d. Total cost

TRUE/FALSE

1. In the post-World War II era, Nontariff trade barriers have decreased in importance relative to tariff barriers.

2. An import quota is a physical restriction on the quantity of goods that may be imported during a specified time period.

3. Today most industrial countries protect their industries via global import quotas rather than selective import quotas.

4. A global import quota permits a specified number of goods to be imported each year, but does not specify where the product is shipped from and who is permitted to import.

5. Import tariffs and import quotas yield identical protection effects, consumption effects, redistribution effects, and revenue effects.

6. Import quotas can yield revenue for the domestic government if it auctions import licenses to the highest bidder in a competitive market.

7. To the extent that domestic importing companies organize as a monopoly buyer, and foreign exporting companies behave as competitive sellers, the importing companies capture the revenue effect of a quota.

8. An import quota tends to reduce the overall welfare of the importing nation by an amount equal to the protective effect, consumption effect, and the portion of the revenue effect that is captured by the domestic government.

9. The sugar import quotas of the U.S. government have tended to increase the market price of sugar, thus reducing the costs to the government of maintaining sugar price supports for domestic growers.

10. During periods of growing demand, a tariff more effectively restricts the volume of imports than an equivalent import quota.

11. With a quota placed on imported sugar, increased domestic demand leads to increased sugar imports but not to higher sugar prices.

12. With a tariff on auto imports, increased domestic demand leads to a fall in the number of autos imported and a rise in the number of autos produced domestically.

13. An orderly marketing agreement is a market-sharing pact negotiated by trading nations, and its effect is to moderate the intensity of international competition.

14. An elimination of nontariff barriers on apples tends to increase apple imports, reduce profits of import-competing apple producers, and generate job losses for domestic apple workers.

15. The distribution of an import quota’s revenue effect depends on the relative concentration of bargaining power between foreign exporters and domestic importers.

16. Voluntary export restraint agreements typically apply to all of the world’s exporting nations rather than only the most important exporting nations.

17. For an export quota applied to manufactured goods, foreign exporters tend to capture only a negligible share of the quota’s revenue effect.

18. When increases in nonrestraint supply offset part of the cutback in shipments that occur under an export quota, the overall inefficiency loss for the importing country is less than that which would have occurred in the absence of nonrestrained exports.

19. Export quotas, placed on Japanese auto shipments to the United States in the 1980s, led to rising prices of both Japanese autos and U.S.-produced autos purchased by the U.S. consumer.

20. Under the Multifiber Arrangement, the United States can export only limited quantities of textiles and apparel to Taiwan, Hong Kong, South Korea, and China.

21. During the 1980s, U.S. steel-using companies (Caterpillar) actively supported the U.S. government’s negotiation of voluntary export agreements with foreign steel-exporting countries.

22. By limiting the amount of foreign sourcing, local content laws are viewed as a means of jobs preservation for domestic workers.

23. Local content laws stipulate the maximum percentage of a product’s total value that must be produced domestically for that product to be sold domestically.

24. Local content laws are consistent with the principle of import substitution, in which domestic production replaces the importation of goods from abroad.

25. To the extent that a local content requirement forces firms to locate production in a high-cost nation, product price rises and consumer surplus falls.

26. A subsidy granted to import-competing producers results in a welfare loss to the economy by an amount equal to the protective effect plus the consumption effect.

27. A subsidy granted to import-competing producers is intended to lead to increased domestic production and decreased imports for the home country.

28. A subsidy granted to an import-competing producer shifts its supply schedule outward to the right.

29. A subsidy granted to an import-competing producer imposes a deadweight loss on the domestic economy equal to the redistribution effect plus consumption effect.

30. A subsidy granted to import-competing producers reduces overall domestic welfare by the same amount as would a tariff or quota that restricts imports by the same amount.

31. To the extent that subsidies granted to exporting firms reduce the foreign price of their goods, the subsidizing country’s terms of trade worsen.

32. If the U.S. demand for Korean steel is price elastic, an export subsidy granted to Korean steel firms will increase Korea’s export revenue.

33. International dumping occurs when foreign buyers are charged higher prices than domestic buyers for an identical product, after allowing for transportation costs and tariff duties.

34. Sporadic (distress) dumping would occur if domestic orange producers dispose of an excess quantity of oranges, resulting from an abnormally large harvest, by selling them at lower prices abroad than at home.

35. Predatory dumping would occur if Toyota Inc. of Japan sells autos to U.S. consumers at lower prices than to Japanese consumers in order to put Chrysler Inc. out of business.

36. A firm would increase profits from dumping if it charges a lower price at home, where demand is inelastic, and a higher price abroad where demand is elastic.

37. The purpose of international dumping is to decrease a firm’s costs and increase its profits, compared to what would be realized in the absence of dumping.

38. A firm granting lifetime employment to its workers has the incentive to engage in international dumping during periods of business recession and excess production capacity.

39. A firm suffering idle plant capacity would minimize losses by selling its product abroad at a lower price than at home, provided that the foreign price more than covers average variable cost.

40. Under U.S. antidumping law, an antidumping duty can be levied when the U.S. Commerce Department determines that a foreign product is being sold in the United States at less than fair value and the U.S. International Trade Commission determines that the dumped product is causing economic harm to domestic producers.

41. The margin of dumping equals the amount by which the foreign price is greater than the domestic price, or the amount by which the foreign price exceeds the cost of production.

42. For most nations, the ratio of imports to total purchases in the public sector is much higher than in the private sector.

43. According to the U.S. Buy American Act, federal government agencies cannot purchase materials and products from U.S. suppliers if their prices are higher than those of foreign competitors.

44. For the United States, the Buy American Act has tended to increase consumer surplus for U.S. buyers of protected merchandise.

45. An effective Buy American law would tend to increase U.S. producer surplus at the expense of U.S. consumer surplus.

46. An effective Buy American law results in deadweight welfare losses for the United States in the form of the protective effect and consumption effect.

47. Although the Tokyo Round of international trade negotiations reduced the Buy-American restrictions of the U.S. government, many state governments have maintained restrictive Buy-American policies.

48. According to the cost-based definition of dumping, dumping begins to occur when a firm sells a product at a price that is less than average variable cost.

49. If the Japanese demand for computers is elastic and the Canadian demand for computers is inelastic, a profit-maximizing firm would charge a higher price to Canadian buyers than to Japanese buyers.

50. If the Australian government imposes a domestic content requirement of 75 percent on autos, at least 25 percent of an auto’s value must be produced in a foreign country if that auto is to be sold in Australia.

51. During the 1980s, the U.S. government imposed sugar import quotas in an attempt to reduce its costs of maintaining price supports for U.S. sugar growers.

Figure 5.5 illustrates the television market for Mexico, assumed to be a small country that is unable to affect the world price. SMexico is the domestic supply schedule and DMexico is the domestic demand schedule. Suppose that Japan can supply televisions to Mexico at a price of $100 per set.

Figure 5.5. Mexico’s Television Market

52. Consider Figure 5.5. With free trade, Mexicans produce 4 TVs, consume 24 TVs, and import 20 TVs.

53. Consider Figure 5.5. With free trade, Mexican producer surplus equals $2450 and Mexican consumer surplus equals $200.

54. Consider Figure 5.5. Suppose that the governments of Mexico and Japan negotiate a voluntary export agreement in which Japanese TV exports to Mexico are limited to 8 units. Under the quota, the price of TVs in Mexico equals $250 while Mexicans produce 10 TVs and purchase 18 TVs.

55. Consider Figure 5.5. Compared to free trade, the Japanese export quota leads to an increase in Mexican consumer surplus of $3150.

56. Consider Figure 5.5. Compared to free trade, the Japanese export quota leads to an increase in Mexican producer surplus of $1050.

57. Consider Figure 5.5. The deadweight welfare loss to Mexico, as a result of the Japanese export quota, totals $1200.

58. Consider Figure 5.5. The Japanese export quota’s revenue effect totals $1200.

59. Consider Figure 5.5. The government of Mexico collects 50 percent of the export quota’s revenue effect, or $600, in the form of tax revenue.

60. Consider Figure 5.5. Assuming that the revenue effect of the export quota accrues to Japanese firms, the overall welfare loss to Mexico equals $2100 as a result of the quota.

SHORT ANSWER

1. Is a tariff-rate quota a two-tier tariff? Why?

2. What is an OMA?

ESSAY

1. Describe some of the differences between tariffs and quotas?

2. What are the intent and impact of domestic content requirements?

CHAPTER 6—TRADE REGULATIONS AND INDUSTRIAL POLICIES

MULTIPLE CHOICE

1. The World Trade Organization was established by the ____ of multilateral trade negotiations:
a. Kennedy Round
b. Tokyo Round
c. Uruguay Round
d. Clinton Round

2. Under U.S. commercial policy, the escape clause results in:
a. Temporary quotas granted to firms injured by import competition
b. Tariffs that offset export subsidies granted to foreign producers
c. Tax advantages extended to minority-owned exporting firms
d. Duties which offset commercial dumping on the part of foreign firms

3. Adjustment assistance is sometimes used to assist:
a. In retraining workers displaced by imports
b. In retraining workers displaced by exports
c. Foreign firms injured by our quotas
d. Foreign firms injured by our tariffs

4. The Export-Import Bank of the United States encourages American firms to sell overseas by providing direct loans and loan guarantees to foreign purchasers of American goods. To American firms, this represents a:
a. Specific subsidy
b. Ad valorem subsidy
c. Domestic subsidy
d. Export subsidy

5. The Smoot-Hawley Tariff Act of 1930 has generally been associated with:
a. Falling tariffs
b. Increases in the volume of trade
c. Intensifying the worldwide depression
d. Efforts to liberalize nontariff trade barriers

6. A trade policy designed to alleviate some domestic economic problem by exporting it to foreign countries is known as a (an):
a. International dumping policy
b. Trade adjustment assistance policy
c. Most-favored-nation policy
d. Beggar-thy-neighbor policy

7. Under U.S. commercial policy, which clause permits the modification of a trade liberalization agreement on a temporary basis if serious injury occurs to domestic producers as a result of the agreement?
a. Adjustment assistance clause
b. Escape clause
c. Most-favored-nation clause
d. Reciprocal-trade clause

8. Which policy reflects the notion that if society enjoys gains due to increased efficiency stemming from trade liberalization, some sort of compensation should be provided to those who are temporarily hurt by import competition?
a. Countervailing duties
b. Trade adjustment assistance
c. Domestic subsidies
d. Most-favored-nation standard

9. The Uruguay Round of Multilateral Trade Negotiations accomplished all of the following except:
a. Placed primary emphasis on nontariff trade barriers
b. Is estimated to yield modest gains in world output and employment
c. Achieved cuts in tariffs but not in nontariff trade barriers
d. Abolished all barriers to trade in agricultural products

10. The General Agreement on Tariffs and Trade and its successor, the World Trade Organization, have resulted in:
a. Termination of export subsidies applied to manufactured goods
b. Termination of import tariffs applied to manufactured goods
c. Encouragement of beggar-thy-neighbor policies
d. Reductions in trade barriers via multilateral negotiations

11. For the United States, which organization makes loans to foreign buyers of U.S. manufactured goods?
a. Export-Import Bank
b. Domestic International Sales Corporation
c. Organization for Economic Cooperation and Development
d. Commodity Credit Corporation

12. The high point of U.S. protection culminated with the passage of the:
a. Smoot-Hawley Act of 1930
b. General Agreements on Tariffs and Trade in 1947
c. Trade Reduction Act of 1962
d. Adjustment Assistance Act of 1970

13. Countervailing duties are intended to neutralize any unfair advantage that foreign exporters might gain over domestic producers because of foreign:
a. Tariffs
b. Subsidies
c. Quotas
d. Buy-national policies

14. Trade theory suggests that the United States would gain from a subsidy provided by Japan to its calculator producers if the gains to American consumers of calculators more than offset the losses to American calculator producers. This occurs as long as the United States:
a. Is a net importer of calculators
b. Is a net exporter of calculators
c. Has an absolute advantage in calculator production
d. Has a comparative advantage in calculator production

15. Under the original provisions of the Reciprocal Trade Agreements Act, the president of the United States was authorized to cut tariffs up to:
a. 10 percent
b. 50 percent
c. 75 percent
d. 100 percent

16. The U.S. “trade-remedy laws” could establish all of the following except:
a. Import tariffs to protect U.S. firms seriously injured by foreign competition
b. Countervailing duties which neutralize foreign export subsidies
c. Antidumping duties which protect U.S. firms from imports sold at less-than-fair-value
d. Economic sanctions levied against hostile nations

17. The principle of normal trade relations (most-favored-nation)treatment was established with the passage of the:
a. Fordney-McCumber Act of 1922
b. Smoot-Hawley Act of 1930
c. Reciprocal Trade Agreements Act of 1934
d. Trade Act of 1974

18. Throughout the post-World War II era, the importance of tariffs as a trade barrier has:
a. Increased
b. Decreased
c. Remained the same
d. None of the above

19. As a way of helping American firms trade in the world market, U.S. trade law provides antitrust exemptions for horizontal combinations of American firms engaged solely in export trade. Such firms are permitted to form:
a. Export trade associations
b. Domestic international sales corporations
c. Export-import banks
d. Commodity sales corporations

20. ____ attempt to produce a fair and free-trading environment in which there exists a level playing field.
a. Trade-remedy laws
b. Industrial policies
c. Strategic trade policies
d. Economic sanctions

21. Suppose the United States imposes trade sanctions (export quotas) on grain sold to the Russians. Assuming other nations do not increase grain exports to the Russians, all of the following would occur except:
a. Grain prices would rise in Russia
b. Consumer surplus would decrease for the Russians
c. Grain prices would rise in the United States
d. Export revenues would decrease for U.S. producers

22. In 1980 the United States announced an embargo on grain exports to the Soviet Union in response to the Soviet armed invasion of Afghanistan. The embargo was mainly resisted by:
a. U.S. grain consumers and producers of bread
b. U.S. farmers and grain companies
c. Grain producers in foreign countries
d. Grain consumers in foreign countries

23. Export embargoes induce greater losses in consumer surplus for the target country:
a. The lesser its initial dependence on foreign produced goods
b. The more elastic the target country’s demand schedule
c. The greater the available output from alternative suppliers
d. The more inelastic the target country’s supply schedule

24. Suppose the president lowers tariffs on radios as the result of negotiations under the trade agreements program. Radio producers in the United States can appeal under the:
a. Escape clause if rising imports substantially injure the U.S. radio industry
b. Escape clause if rising unemployment occurs even though imports remain unchanged
c. Infant industry clause if rising imports cause unemployment to rise among U.S. radio workers
d. Infant industry clause if rising imports result in losses for U.S. radio companies

25. During the past four decades:
a. Nontariff barriers (NTBs) and tariffs have increased in importance
b. NTBs and tariffs have decreased in importance
c. NTBs have increased and tariffs have decreased in importance
d. NTBs have decreased and tariffs have increased in importance

26. The strongest political pressure for a trade policy that results in higher protectionism comes from:
a. Domestic workers lobbying for import restrictions
b. Domestic workers lobbying for export restrictions
c. Domestic consumers lobbying for export restrictions
d. Domestic consumers lobbying for import restrictions

27. The Uruguay Round of trade negotiations was primarily concerned with:
a. Import tariffs
b. Export tariffs
c. Economic sanctions
d. Nontariff trade barriers

28. The Uruguay Round of trade negotiations lowered:
a. Trade sanctions levied against South Africa
b. Trade sanctions levied against the Soviet Union
c. Tariffs, but not nontariff trade barriers
d. Tariffs as well as nontariff trade barriers

29. The average tariff rate today on dutiable imports in the United States is approximately:
a. 5 percent of the value of imports
b. 15 percent of the value of imports
c. 20 percent of the value of imports
d. 25 percent of the value of imports

30. Those who argue in favor of import protection generally give the impression that such restricted trade will:
a. Decrease the level of national security
b. Provide benefits to some particular industry
c. Provide benefits to the entire nation
d. Not yield welfare losses for the nation

31. In 1990 the United States and its allies imposed trade embargoes on exports/imports to/from Iraq in response to its invasion of Kuwait. The embargoes would induce smaller losses in Iraq’s consumer surplus the:
a. Lesser its initial dependence on foreign products
b. Less elastic Iraq’s demand schedule
c. Lesser the available output from alternative suppliers
d. More inelastic Iraq’s supply schedule

32. In U.S. trade law, Section 301 cases involve accusations of:
a. International dumping by U.S. companies
b. Full-cost pricing by U.S. companies
c. Unfair trade practices by foreign nations
d. Trade embargoes by foreign nations

33. Industrial policy attempts to fulfill all of the following objectives except:
a. Improving the infrastructure for an industry
b. Easing transitions for workers in declining industries
c. Supporting troubled industries if the difficulty is temporary
d. Fostering industries which offer long-run comparative disadvantage

34. Countervailing duties may be imposed:
a. In response to a foreign export subsidy
b. In response to a foreign antidumping tariff
c. To promote exports of domestic companies
d. To promote imports of domestic consumers

35. The World Trade Organization provides for all of the following except:
a. The usage of the normal-trade-relation (most-favored-nation) clause
b. Assistance in the settlement of trade disagreements
c. Multilateral tariff reductions
d. Bilateral tariff reductions

36. In U.S. trade law, which measure permits the levying of restrictions on fairly traded imports that harm or threaten to harm American manufacturers?
a. Antidumping duty
b. Countervailing duty
c. National security clause
d. Escape clause

37. Which international organization stipulates procedures for the settlement of international trade disputes?
a. World Trade Organization
b. World Bank
c. International Monetary Fund
d. Organization of Economic Development

38. The most recent round of multilateral trade negotiations is the:
a. Kennedy Round
b. Tokyo Round
c. Doha Round
d. Geneva Round

39. In 1986 the United States enacted the Comprehensive Anti-Apartheid Act which provided for all of the following except the termination of:
a. New U.S. loans to the South African government
b. New U.S. investment in South Africa
c. U.S. imports of South African gold coins
d. U.S. imports of all South African goods

Assume Boeing Inc. (of the United States) and Airbus Industrie (of Europe) rival for monopoly profits in the Canadian aircraft market. Suppose the two firms face identical cost and demand conditions, as seen in Figure 6.1.

Figure 6.1. Strategic Trade Policy: Boeing versus Airbus

40. Referring to Figure 6.1, assume that Boeing is the first to enter the Canadian market. Without a governmental subsidy, the firm maximizes profits by selling ____ aircraft at a price of $____, and realizes profits totaling $____.
a. 4, $12 million, $16 million
b. 4, $16 million, $12 million
c. 8, $12 million, $16 million
d. 8, $16 million, $12 million

41. Consider Figure 6.1. At the monopoly price as established by Boeing, Canadian consumers realize $____ of consumer surplus from the availability of aircraft.
a. $4 million
b. $8 million
c. $12 million
d. $16 million

42. Consider Figure 6.1. Suppose the European government provides Airbus a subsidy of $4 million on each aircraft manufactured, and that the subsidy convinces Boeing to exit the Canadian market. As the monopoly seller, Airbus maximizes profit by selling ____ aircraft at a price of $____, and realizes profits totaling $____.
a. 6, $10 million, $36 million
b. 6, $12 million, $24 million
c. 12, $10 million, $36 million
d. 12, $12 million, $24 million

43. Referring to Figure 6.1, the total cost of the Airbus subsidy to the European taxpayer equals:
a. $16 million
b. $20 million
c. $24 million
d. $28 million

44. Referring to Figure 6.1, the Airbus subsidy leads to a (an) increase/decrease in Canadian consumer surplus of $____, as compared to the consumer surplus that existed in the absence of a subsidy.
a. Increase of $8 million
b. Increase of $10 million
c. Decrease of $8 million
d. Decrease of $10 million

45. Consider Figure 6.1. For Europe as a whole (Airbus and European taxpayers), the subsidy leads to a (an) increase/decrease in net revenues of $____.
a. Increase of $12 million
b. Increase of $16 million
c. Decrease of $12 million
d. Decrease of $16 million

Figure 6.2 illustrates the calculator market for Mexico, assumed to be a small nation that is unable influence the South Korean (world) price. Assume the South Korean price to be $60 per calculator.

Figure 6.2. Effects of an Export Subsidy

46. Consider Figure 6.2. With free trade, Mexican consumers purchase ____ calculators, Mexican firms produce ____ calculators, and ____ calculators are imported.
a. 10, 4, 6
b. 10, 6, 4
c. 10, 8, 2
d. 10, 2, 8

47. Consider Figure 6.2. With free trade, Mexicans attain $____ of consumer surplus from the availability of calculators, while Mexican producer surplus equals $____.
a. $400, $200
b. $200, $400
c. $500, $180
d. $500, $240

48. Consider Figure 6.2. To help its firms further penetrate export markets, suppose the South Korean government provides them a production subsidy of $20 per calculator. With the subsidy, South Korean firms charge a price of $____ and export ____ calculators to Mexico.
a. $40, 8
b. $40, 10
c. $20, 8
d. $20, 10

49. Consider Figure 6.2. The South Korean subsidy helps/hurts Mexican manufacturers, since their producer surplus rises/falls by $____.
a. Helps, rises, $60
b. Helps, rises, $100
c. Hurts, falls, $60
d. Hurts, falls, $100

50. Consider Figure 6.2. As a result of the South Korean subsidy, Mexicans find their consumer surplus:
a. Rising by $160
b. Rising by $220
c. Falling by $160
d. Falling by $220

51. Consider Figure 6.2. For Mexico’s producers and consumers as a whole, the South Korean subsidy leads to a:
a. $120 welfare gain
b. $320 welfare gain
c. $120 welfare loss
d. $320 welfare loss

Figure 6.3 represents the Iraqi computer market. Assume Iraq purchases all of its computers from the United States.

Figure 6.3 Iraqi Computer Market and Economic Sanctions

52. Consider Figure 6.3. With free trade, Iraq purchases ____ computers at a price of $____, and realizes $____ of consumer surplus from the availability of computers.
a. 30, $3,000, $25,000
b. 30, $3,000, $35,000
c. 30, $3,000, $45,000
d. 30, $3,000, $55,000

53. Consider Figure 6.3. In response to Iraq’s armed invasion of neighboring countries, suppose the United States imposes a partial embargo that limits exports to Iraq to 10 computers. The export quota leads to an increase/decrease in the price of computers equal to $____, and an increase/decrease in consumer surplus equal to $____.
a. Increase, $2000, decrease, $40,000
b. Increase, $4000, decrease, $60,000
c. Decrease, $2000, increase, $40,000
d. Decrease, $4000, increase, $60,000

54. Consider Figure 6.3. Of the quota-induced change in Iraqi consumer surplus, $____ is not transferred to other sectors of Iraq’s economy and represents deadweight loss.
a. $5000
b. $10,000
c. $15,000
d. $20,000

55. Consider Figure 6.3. Of the quota-induced change in Iraqi consumer surplus, the amount of the change in Iraq’s consumer surplus that is transferred to other sectors of Iraq’s economy is captured by the United States as:
a. Tax revenue
b. Export revenue
c. Producer surplus
d. Consumer surplus

56. Consider Figure 6.3. For the United States, the export quota results in a (an):
a. Improvement in its terms of trade with Iraq
b. Increase in its export revenue
c. Increase in domestic computer prices
d. Decrease in domestic consumer surplus

57. The implicit industrial policies of the U.S. government have included:
a. Formulating industry-specific economic policies designed to promote national champions
b. Nationalizing basic industries such as steel and autos
c. Encouraging cartelization of aircraft and aluminum manufacturers
d. Improving the setting for industry such as communications and infrastructure

58. Economic sanctions are most effective in causing the target nation to modify its behavior when the:
a. Target nation had negligible economic relationships with the imposing nation prior to the sanctions
b. People of the target nation have weak cultural ties to the people of the imposing nation
c. Sanctions are levied by a large number of nations
d. Target government is supported by the majority of its people

59. In 1995 the ____ was established to administer the new global trade rules agreed in the Uruguay Round of multilateral trade negotiations.
a. World Trade Organization
b. Organization for Economic Cooperation and Development
c. General Agreement on Tariffs and Trade
d. United Nations

60. In 1995 the General Agreement on Tariffs and Trade was replaced by the ____.
a. Agency for International Development
b. Organization for Economic Cooperation and Development
c. United Nations Center for Trade and Development
d. World Trade Organization

61. The most important determinants of sanctions include
a. Cultural factors including nationalistic attitudes
b. Strength of political opposition in the targeting nation
c. The number of nations imposing sanctions
d. All of the above

62. Industrial policies
a. Require formal explicit efforts by governments
b. May be implicit
c. Have never been used by the U.S. government
d. Both a and b

63. Trade adjustment assistance policies
a. Can resolve all workers’ challenges to free trade
b. Attempt to share gains from free trade with disadvantaged workers
c. Have never been used to sustain a losing business concern
d. Are financed by state and local tax revenues

64. The United States
a. Has been a heavy user of antidumping laws to protect domestic producers
b. Has rarely used antidumping laws to protect domestic producers
c. Has targeted antidumping action against China, Japan, Canada, Italy, and Germany
d. Both a and c

TRUE/FALSE

1. The high point of U.S. protectionism occurred with the passage of the Kennedy Act in the 1960s.

2. With the passage of the Smoot-Hawley Act in 1930, U.S. average tariffs were raised to over 50 percent on protected imports.

3. Proponents of the Smoot-Hawley Act of 1930 viewed it as a means of combating domestic unemployment.

4. It is generally agreed that the Smoot-Hawley Act of 1930 led to improvements in U.S. exports and an overall increase in U.S. output and employment.

5. According to the Reciprocal Trade Agreements Act of 1934, the President could lower tariffs by up to 10 percent of the existing level without congressional approval.

6. Under the normal-trade-relations (most-favored-nation) principle, two nations agree to apply tariffs to each other at rates as low as those applied to any other nation.

7. According to the normal-trade-relations (most-favored-nation) principle, if the United States extends MFN treatment to China and then grants a low tariff on imports of shirts from South Korea, the United States is obligated to provide the identical low-tariff on imports of shirts from China.

8. U.S. tariffs on imports from countries issued normal-trade-relations (most-favored-nation) status are often three or four times as high as those on comparable imports from nations not receiving that status.

9. According to the General Agreement on Tariffs and Trade and its successor, the World Trade Organization, only bilateral trade negotiations can take place between a country and its trading partners.

10. Members of the General Agreement on Tariffs and Trade and its successor, the World trade through Trade Organization, agree to the principle of nondiscrimination in trade and the reduction of trade barriers by multilateral negotiations.

11. The Uruguay Round of trade negotiations resulted in the General Agreement on Tariffs and Trade being succeeded by the World Trade Organization.

12. The only members of the General Agreement on Tariffs and Trade and its successor, the World Trade Organization, are developing countries rather than developed countries.

13. According to the fast-track provision of U.S. trade law, once the President has completed trade negotiations, their outcome is subject to a vote (without amendment) in Congress within 90 legislative days of submission.

14. The fast-track provision of U.S. trade law has the affect of speeding up the timetable during which the President negotiates trade agreements with foreign governments.

15. The main focus of the Uruguay Round of multilateral trade negotiations was on tariff barriers rather than nontariff trade barriers.

16. Although the Uruguay Round of multilateral trade negotiations succeeded in reducing nontariff trade barriers, it could not achieve reductions in tariff trade barriers.

17. Among the codes of conduct addressed at the Tokyo Round of multilateral trade negotiations were customs valuation, product standards, subsidies and countervailing duties, government procurement policies, and import licensing procedures.

18. Under the government procurement policy of the World Trade Organization, federal-state-local governments are prevented from discriminating in favor of the products of domestic suppliers on contracts valued at $1 million and more.

19. Unlike the Tokyo Round of multilateral trade negotiations, the Uruguay Round addressed the issues of intellectual property protection, trade barriers in services, and agricultural subsidies.

20. The U.S. trade-remedy laws attempt to redress hardships for U.S. firms resulting from actions and policies of foreign firms and governments.

21. According to U.S. trade law, the escape clause provides relief to U.S. firms due to unfair foreign competition.

22. According to the escape clause, temporary trade restrictions may be imposed in industries where domestic producers are substantially being harmed by surging imports.

23. The purpose of “countervailing duties,” as levied by the domestic government, is to neutralize import tariffs imposed by foreign governments.

24. Under the provisions of the World Trade Organization, Canada would have the right to impose countervailing duties on imports of South Korean steel when the South Korean government provides export subsidies to its steelmakers.

25. Economic theory suggests that if France is a net importer of automobiles, whose production is subsidized by the Korean government, the overall welfare of France decreases because of the Korean subsidy.

26. An antidumping duty levied on imports of foreign-produced steel leads to an increase in consumer surplus in the home country.

27. U.S. antidumping duties are intended to neutralize exports to the United States at prices below average total cost or exports to the United States at prices lower than those charged in the exporter’s home market.

28. Intellectual property refers to holdings of rare books and pieces of art that are traded on the world market.

29. Copyrights, trademarks, and patents are used to protect the intellectual property of a nation from foreign imitators.

30. Under the trade adjustment assistance program, a domestic firm or worker can file for governmental assistance only if it demonstrates that it suffered economic hardship due to imports of foreign-subsidized goods.

31. Industrial policy attempts to foster the development of industries that offer long-run comparative disadvantages and which are insulated from other sectors of the economy.

32. During the post World War II era, the United States has adopted explicit industrial policies similar to those of France and Japan.

33. Industrial policies of the U.S. government have included subsidizing particular firms to promote national champions, nationalizing basic industries, and encouraging cartelization of industries.

34. The Export-Import Bank provides export-credit subsidies to U.S. producers of agricultural goods.

35. Major beneficiaries of export-credit subsidies, granted by the Export-Import Bank, have included U.S. producers of aircraft, telecommunications, and power-generating equipment.

36. The Commodity Credit Corporation makes available export credit financing for U.S. agricultural exports.

37. As a way of helping U.S. business firms trade in the world market on a more equal terms with their organized foreign competitors, the U.S. government permits them to form export trade associations and export trading companies.

38. If the U.S. government pursued a “knowledge-based growth policy,” it would subsidize particular firms to help them compete in the world economy.

39. In the post World War II era, the Japanese government formed industrial policies to encourage the development of its steel, auto, shipbuilding, and machine tool industries.

40. Unlike Japan and the United States, France has refrained from forming explicit industrial policies to enhance the competitiveness of its national champions.

41. According to the strategic- trade- policy hypothesis, governmental subsidies granted to domestic producers can help them in capturing economic profits from foreign competitors.

42. The strategic-trade-policy hypothesis assumes that domestic firms operate under increasing cost conditions as well as in perfectly competitive markets.

43. According to the strategic-trade-policy hypothesis, government can alter the terms of competition to favor domestic companies, thus increasing their profits at the expense of their rivals.

44. The classical theory of comparative advantage assumes that firms operate in imperfectly competitive markets, while the theory of strategic trade policy assumes that firms operate in perfectly competitive markets.

45. According to the strategic-trade-policy hypothesis, a subsidy granted to domestic exporters may lead to increased export profits which more than offset the cost of the subsidy to domestic taxpayers.

46. By reducing available supplies of a product, an export embargo leads to falling prices in the target nation and increasing target-nation consumer surplus.

47. Assume that the United States is the only supplier of grain to China and that it levies a partial export embargo against China. The embargo leads to increased U.S. welfare if the resulting improvement in the U.S. terms of trade with China more than offset the costs of the lower export volume to China.

48. Economic sanctions are most effective in pressuring the target country to modify its behavior when the sanctions are imposed by a small number of countries and when the target country had weak economic ties to the imposing countries before the sanctions were initiated.

49. It is widely recognized that the economic sanctions levied against Iraq in 1990 were a major factor causing Iraq to withdraw its military forces from Kuwait.

50. Assume that Russia has a comparative advantage in vodka. If the United States extends Russia the benefits of the normal-trade-relations (most favored nation)principle, U.S. consumer surplus decreases in the vodka market.

51. Assume that the United States imports chemicals from Germany. Trade theory predicts that if the German government grants an export subsidy to its chemical firms, the overall welfare of the United States will increase.

52. Concerning industrial policy, the United States has nationalized its major industries in an attempt to promote global champions.

53. The Uruguay Round of multilateral trade negotiations succeeded in establishing the World Trade Organization.

54. Established in 1995, the World Trade Organization took charge of administering the new global trade rules agreed in the Uruguay Round of multilateral trade negotiations.

55. The World Trade Organization brings into the multilateral trading system manufactured goods and agricultural products, but not trade in services, intellectual property protection, and investment.

56. The General Agreement on Tariffs and Trade was founded in 1995 as a successor to the World Trade Organization.

SHORT ANSWER

1. What is the essential idea behind strategic trade policy?

2. What is the basis for trade adjustment assistance?

ESSAY

1. Has industrial policy contributed significantly to Japan’s economic growth?

2. Explain how advocates of strategic trade policy differ from the classical free traders in their treatment of externalities?

ECO 305 Week 5 Quiz

CHAPTER 7—TRADE POLICIES FOR THE DEVELOPING NATIONS

MULTIPLE CHOICE

1. Which of the following is not a major factor that encourages developing nations to form international commodity agreements?
a. Inelastic commodity supply schedules
b. Inelastic commodity demand schedules
c. Export markets that tend to be unstable
d. Secular increases in their terms of trade

2. International commodity agreements do not:
a. Consist of consuming and producing nations who desire market stability
b. Levy export cutbacks so as to offset rising commodity prices
c. Utilize buffer stocks to generate commodity price stability
d. Increase the supply of commodities to prevent rising prices

3. Concerning the price elasticities of supply and demand for commodities, empirical estimates suggest that most commodities have:
a. Inelastic supply schedules and inelastic demand schedules
b. Inelastic supply schedules and elastic demand schedules
c. Elastic supply schedules and inelastic demand schedules
d. Elastic supply schedules and elastic demand schedules

4. If the demand schedule for bauxite is relatively inelastic to price changes, an increase in the supply schedule of bauxite will cause a:
a. Decrease in price and a decrease in sales revenue
b. Decrease in price and an increase in sales revenue
c. Increase in price and a decrease in sales revenue
d. Increase in price and an increase in sales revenue

5. A primary goal of international commodity agreements has been the:
a. Maximization of members’ revenues via export taxes
b. Nationalization of corporations operating in member nations
c. Adoption of tariff protection against industrialized nation sellers
d. Moderation of commodity price fluctuations when markets are unstable

6. Which device has the International Tin Agreement utilized as a way of stabilizing tin prices?
a. Multilateral contracts
b. Export subsidies
c. Buffer stocks
d. Export tariffs

7. Which method has not generally been used by the international commodity agreements to stabilize commodity prices?
a. Production quotas applied to the level of commodity output
b. Buffer stock arrangements among producing nations
c. Export restrictions applied to international sales of commodities
d. Measures to nationalize foreign-owned production operations

8. The OPEC nations during the 1970s manifested their market power by utilizing:
a. Export tariffs levied for revenue purposes
b. Export tariffs levied for protective purposes
c. Import tariffs levied for protective purposes
d. Import tariffs levied for revenue purposes

9. One factor that has prevented the formation of cartels for producers of commodities is that:
a. The demand for commodities tends to be price inelastic
b. Substitute products exist for many commodities
c. Commodity produces have been able to dominate world markets
d. Production of most commodities is capital intensive

10. Which device has been used by the International Wheat Agreement to stipulate the minimum prices at which importers will buy stipulated quantities from producers and the maximum prices at which producers will sell stipulated quantities to importers?
a. Buffer stocks
b. Export controls
c. Multilateral contracts
d. Production controls

11. If the bauxite exporting countries form a cartel to boost the price of bauxite so as to increase sales revenue, they believe that the demand for bauxite:
a. Is inelastic with respect to price changes
b. Is elastic with respect to price changes
c. Will increase in response to a price increase
d. Will not change in response to a price change

12. If the supply schedule for tin is relatively inelastic to price changes, a decrease in the demand schedule for tin will cause a:
a. Decrease in price and an increase in sales revenue
b. Decrease in price and a decrease in sales revenue
c. Increase in price and an increase in sales revenue
d. Increase in price and a decrease in sales revenue

13. Which of the following could partially explain why the terms of trade of developing countries might deteriorate over time?
a. Developing-country exports mainly consist of manufactured goods
b. Developing-country imports mainly consist of primary products
c. Commodity export prices are determined in highly competitive markets
d. Commodity export prices are solely determined by developing countries

14. Which terms-of-trade concept emphasizes a nation’s capacity to import?
a. Income terms of trade
b. Commodity terms of trade
c. Barter terms of trade
d. Price terms of trade

15. Which trade strategy have developing countries used to restrict imports of manufactured goods so that the domestic market is preserved for home producers, who thus can take over markets already established in the country?
a. International commodity agreement
b. Export promotion
c. Multilateral contract
d. Import substitution

16. Which trade strategy have developing countries used to replace commodity exports with exports such as processed primary products, semi-manufacturers, and manufacturers?
a. Multilateral contract
b. Buffer stock
c. Export promotion
d. Export quota

17. To help developing countries expand their industrial base, some industrial countries have reduced tariffs on designated manufactured imports from developing countries below the levels applied to imports from industrial countries. This scheme is referred to as:
a. Generalized system of preferences
b. Export-led growth
c. International commodity agreement
d. Reciprocal trade agreement

18. Which nation accounts for the largest amount of OPEC’s oil reserves and production?
a. Iran
b. Libya
c. Iraq
d. Saudi Arabia

19. Assuming identical cost and demand curves, OPEC as a cartel will, in comparison to a competitive industry:
a. Produce greater output and charge a lower price
b. Produce greater output and charge a higher price
c. Produce less output and charge a higher price
d. Produce less output and charge a lower price

20. Which of the following situations reduces the likelihood of successful operation of a cartel?
a. Cartel sales experience a rapid expansion
b. The demand for cartel output is price inelastic
c. The number of firms in the cartel is large
d. It is very difficult for new firms to enter the market

21. Which industrialization policy used by developing countries places emphasis on the comparative advantage principle as a guide to resource allocation?
a. Export promotion
b. Import substitution
c. International commodity agreements
d. Multilateral contract

22. A widely used indicator to differentiate developed countries from developing countries is:
a. International trade per capita
b. Real income per capita
c. Unemployment per capita
d. Calories per capita

23. Concerning the hypothesis that there has occurred a long-run deterioration in the developing countries’ terms of trade, empirical studies provide:
a. Mixed evidence that does not substantiate the deterioration hypothesis
b. Overwhelming support for the deterioration hypothesis
c. Overwhelming opposition to the deterioration hypothesis
d. None of the above

24. For the oil-importing countries, the increases in oil prices in 1973-1974 and 1979-1980 resulted in all of the following except:
a. Balance of trade deficits
b. Price inflation
c. Constrained economic growth
d. Improving terms of trade

25. Hong Kong and South Korea are examples of developing nations that have recently pursued industrialization policies.
a. Import substitution
b. Export promotion
c. Commercial dumping
d. Multilateral contract

26. Stabilizing commodity prices around long-term trends tends to benefit importers at the expense of exporters in markets characterized by:
a. Demand-side disturbances
b. Supply-side disturbances
c. Demand-side and supply-side disturbances
d. None of the above

27. Stabilizing commodity prices around long-term trends tends to benefit exporters at the expense of importers in markets characterized by:
a. Demand-side disturbances
b. Supply-side disturbances
c. Demand-side and supply-side disturbances
d. None of the above

28. To be considered a good candidate for an export cartel, a commodity should:
a. Be a manufactured good
b. Be a primary product
c. Have a high price elasticity of supply
d. Have a low price elasticity of demand

29. To be considered a good candidate for an export cartel, a commodity should:
a. Be a manufactured good
b. Be a primary product
c. Have a low price elasticity of supply
d. Have a high price elasticity of demand

30. To help developing nations strengthen their international competitiveness, many industrial nations have granted nonreciprocal tariff reductions to developing nations under the:
a. International commodity agreements program
b. Multilateral contract program
c. Generalized system of preferences program
d. Export-led growth program

The diagram below illustrates the international tin market. Assume that producing and consuming countries establish an international commodity agreement under which the target price of tin is $5 per pound.

Figure 7.1. Defending the Target Price in Face of Changing Demand Conditions

31. Consider Figure 7.1. Suppose the demand for tin increases from D0 to D1. Under a buffer stock system, the buffer-stock manager could maintain the target price by:
a. Selling 15 pounds of tin
b. Selling 30 pounds of tin
c. Buying 15 pounds of tin
d. Buying 30 pounds of tin

32. Consider Figure 7.1. Suppose the demand for tin decreases from D0 to D2. Under a buffer stock system, the buffer-stock manager could maintain the target price by:
a. Selling 15 pounds of tin
b. Selling 30 pounds of tin
c. Buying 15 pounds of tin
d. Buying 30 pounds of tin

33. Consider Figure 7.1. Suppose the demand for tin decreases from D0 to D2. Under a system of export quotas, the tin producers could maintain the target price by:
a. Increasing the quantity of tin supplied by 15 pounds
b. Increasing the quantity of tin supplied by 30 pounds
c. Decreasing the quantity of tin supplied by 15 pounds
d. Decreasing the quantity of tin supplied by 30 pounds

The diagram below illustrates the international tin market. Assume that the producing and consuming countries establish an international commodity agreement under which the target price of tin is $5 per pound.

Figure 7.2. Defending the Target Price in Face of Changing Supply Conditions

34. Consider Figure 7.2. Suppose the supply of tin increases from S0 to S1. Under a buffer stock system, the buffer-stock manager could maintain the target price by:
a. Purchasing 15 pounds of tin
b. Purchasing 30 pounds of tin
c. Selling 15 pounds of tin
d. Selling 30 pounds of tin

35. Consider Figure 7.2. Suppose the supply of tin decreases from S0 to S2. Under a buffer stock system, the buffer-stock manager could maintain the target price by:
a. Purchasing 15 pounds of tin
b. Purchasing 30 pounds of tin
c. Selling 15 pounds of tin
d. Selling 30 pounds of tin

36. Consider Figure 7.2. Assume there exists a cartel of several producers that is maximizing total profit. If one producer cheats on the cartel agreement by decreasing its price and increasing its output, rational action of the other producers is to:
a. Increase their price in order to regain sacrificed profits
b. Decrease their price as well
c. Keep on selling at the agreed-upon price
d. Give the product away for free

37. A reason why it is difficult for producers to maintain a cartel is that:
a. The elasticity of demand for the cartel’s output decreases over time
b. Producers in the cartel have the economic incentive to cheat
c. Economic profits discourage other producers from entering the industry
d. Producers in the cartel have the motivation to lower price but not to raise price

38. Once a cartel establishes its profit-maximizing price:
a. Entry into the industry of new competitors will not affect the cartel’s profits
b. Output changes by cartel members have no effect on the market price
c. Each cartel member is tempted to cheat on the cartel price in order to add to its profit
d. All cartel members have a strong incentive to adhere to the agreed-upon price

Figure 7.3. World Oil Market

39. Consider Figure 7.3. Under competitive conditions, the quantity of oil produced equals:
a. 40 barrels
b. 70 barrels
c. 90 barrels
d. 110 barrels

40. Consider Figure 7.3. Under competitive conditions, the price of a barrel of oil equals:
a. $7
b. $11
c. $12
d. $16

41. Consider Figure 7.3. Under competitive conditions, producer profits total:
a. $0
b. $140
c. $200
d. $280

42. Consider Figure 7.3. Under a profit-maximizing cartel, the quantity of oil produced equals:
a. 40 barrels
b. 70 barrels
c. 90 barrels
d. 110 barrels

43. Consider Figure 7.3. Under a profit-maximizing cartel, the price of a barrel of oil equals:
a. $7
b. $11
c. $16
d. $19

44. Consider Figure 7.3. Under a profit-maximizing cartel, producers realize:
a. Profits totaling $280
b. Profits totaling $360
c. Losses totaling $140
d. Losses totaling $180

45. Import substitution policies make use of:
a. Tariffs that discourage goods from entering a country
b. Quotas applied to goods that are shipped abroad
c. Production subsidies granted to industries with comparative advantages
d. Tax breaks granted to industries with comparative advantages

46. Export-led growth tends to:
a. Exploit domestic comparative advantages
b. Discourage competition in the global economy
c. Lead to unemployment among domestic workers
d. Help firms benefit from diseconomies of large-scale production

47. All of the following nations except ____ have recently utilized export-led (outward oriented) growth policies.
a. Hong Kong
b. South Korea
c. Argentina
d. Singapore

48. The characteristics that have underlaid the economic success of the “high-performing Asian Economies” have included all of the following except:
a. High rates of domestic investment
b. Diseconomies of scale occurring at low output levels
c. Large endowments of human capital
d. High levels of labor productivity

49. The development of countries like South Korea and Singapore has been underlaid by all of the following except:
a. High domestic interest rates
b. R&D and product innovation
c. Education and on-the-job training
d. High levels of saving and investment

50. For most developing countries:
a. Productivity is high among domestic workers
b. Population-growth and illiteracy rates are low
c. Saving and investment levels are high
d. Agricultural goods and raw materials constitute much of domestic output

51. East Asian economies have performed well by
a. Obtaining foreign technology
b. Remaining open to international trade
c. Investing in their people
d. All of the above

52. East Asian economies started enacting export-push strategies
a. By late 1950s and 1960s
b. Immediately after World War II
c. In the late 1980s
d. In the early 2000s

53. Prior to the formation of the Organization of Petroleum Exporting Countries, individual oil producing nations,
a. Operated like sellers in a competitive market
b. Behaved like individual sellers in a monopoly market
c. Had considerable control over the price of oil
d. Both b and c.

54. A key factor underlying the instability of primary product prices and export receipts of developing nations is the
a. Low price elasticity of the demand of primary products
b. High price elasticity of supply of primary products
c. High price elasticity of demand of primary products
d. None of the above

TRUE/FALSE

1. The developing nations are most of those in Africa, Asia, North America, and Western Europe.

2. Most developing-nation exports go to industrial nations while most developing-nation imports originate in industrial nations.

3. The majority of developing-nation exports are primary products such as agricultural goods and raw materials; of the manufactured goods exported by developing nations, most are labor-intensive goods.

4. Developing nations overwhelmingly acknowledge that they have benefited from international trade according to the principle of comparative advantage.

5. Among the economic problems facing developing countries have been low dependence on primary-product exports, unstable export markets, and worsening terms of trade.

6. For developing countries, a key factor underlying the instability of primary-product prices and export receipts is the high price elasticity of demand for products such as tin and copper.

7. Empirical research indicates that the demand and supply schedules for most primary products are relatively inelastic to changes in price.

8. If the demand for coffee is price inelastic, an increase in the supply of coffee leads to falling prices and rising sales revenues.

9. Not only do changes in demand induce relatively wide fluctuations in price when supply is inelastic, but changes in supply induce relatively wide fluctuations in price when demand is inelastic.

10. Developing countries have complained that because their commodity terms of trade has deteriorated in recent decades, they should receive preferential tariff treatment from industrialized countries.

11. To promote stability in commodity markets, International Commodity Agreements have utilized production and export controls, buffer stocks, and multilateral contracts.

12. During periods of falling demand for coffee, an International Commodity Agreement could offset downward pressure on price by implementing policies to increase the supply of coffee.

13. To prevent the market price of tin from rising above the target price, the manager of a buffer stock will purchase excess supplies of tin from the market.

14. To prevent the market price of tin from falling below the target price, the manager of a buffer stock would purchase any excess supply of tin that exists at the target price.

15. Prolonged defense of a price ceiling tends to increase the supply of a commodity held by a buffer stock manager, thus putting downward pressure on price.

16. Rather than conduct massive stabilization operations, buffer stock officials will periodically revise target prices should they move out of line with long-term price trends.

17. A multilateral contract stipulates the maximum price at which importing nations will purchase guaranteed quantities from producing nations and the minimum price at which producing nations will sell guaranteed amounts to importing nations.

18. It is widely agreed that import-substitution policies have been a main contributor to above-average growth rates in developing countries.

19. Under the Generalized System of Preferences program, the major industrial countries agree to temporarily reduce tariffs on designated imports from other industrial countries.

20. The “newly industrializing countries” of East Asia have emphasized the implementation of import-substitution policies to insulate their industries from international competition.

21. In recent decades, the East Asian “newly industrializing countries” have pursued export-led growth (outward orientation) as an industrialization strategy.

22. The purpose of a cartel is to support prices higher than would occur under more competitive conditions, thus increasing the profits of cartel members.

23. A cartel tends to be most successful in maximizing the profits of its members when there are a large number of producers in the cartel and these producers’ cost and demand conditions greatly differ from each other.

24. When cartel members agree to restrict output to increase the price of their product, a single member of the cartel has an economic incentive to violate the agreement by increasing its output so as to increase profits.

25. Developing countries have often felt that it is easier to protect their manufacturers, via import-substitution policies, against foreign competitors than to force industrial nations to reduce trade restrictions on products exported by developing countries.

26. Import-substitution policies are supported by the fact that many developing countries have small domestic markets and thus their producers enjoy the benefits of diseconomies of small-scale production.

27. Export-led growth industrialization suffers a major problem: it depends on the willingness and ability of foreign nations to absorb the goods exported by the country pursuing such a policy.

28. The so-called Four Tigers include Australia, South Korea, Taiwan, and Hong Kong.

29. By the 1990s, China had departed from a capitalistic economy and shifted to a Soviet-type economy encompassing small-scale, labor-intensive industry.

30. During the late 1980s and early 1990s, China dismantled much of its centrally-planned economy and permitted free enterprise to replace it.

31. In its transition toward capitalism, by the 1990s China permitted free enterprise as well as democracy for its people.

32. Most of China’s manufactured exports have constituted labor-intensive goods.

33. In 1999 the United States revoked the normal-trade-relations (most-favored-nation) status it provided China in retaliation for China’s suppression of human rights.

34. A multilateral contract specifies the maximum price at which exporting countries agree to sell a product and the minimum price at which importing countries agree to buy a product.

35. As a profit-maximizing cartel, the Organization of Petroleum Exporting Countries would produce a greater output and charge a lower price than what would occur in a competitive market.

36. The success of buffer stocks is limited by the fact that stockpiles of a product may be exhausted after prolonged sales, while funds may be exhausted after prolonged purchases.

37. The United Nation Conference on Trade and Development in 1964 was successful in convincing developing countries to switch from export-led industrialization to import-substitution industrialization.

38. Under the Generalized System of Preferences program, the industrialized countries agree to maintain lower tariffs on imports of natural resources and higher tariffs on imports of manufactured goods.

39. The replacement of imports of one nation with imports of another nation is known as “import substitution.”

40. During periods of weak demand, the Organization of Petroleum Countries has implemented production (export) quotas to ensure that excess oil supplies be kept off the market.

SHORT ANSWER

1. What are some major trade problems faced by developing nations?

2. Are economic downturns helpful to cartels?

ESSAY

1. What are some of the growth strategies that have been employed by the developing nations? How successful are these strategies?

2. Describe the flying-geese pattern of economic growth? What countries have pursued this strategy?

ECO 305 Week 6 Quiz

CHAPTER 8—REGIONAL TRADING ARRANGEMENTS

MULTIPLE CHOICE

1. The European Union is primarily intended to permit:
a. Countries to adopt scientific tariffs on imports
b. An agricultural commodity cartel within the group
c. The adoption of export tariffs for revenue purposes
d. Free movement of resources and products among member nations

2. Which of the following represents the stage where economic integration is most complete?
a. Economic union
b. Customs union
c. Monetary union
d. Common market

3. Which of the following represents the stage where economic integration is least complete?
a. Free trade area
b. Monetary union
c. Common market
d. Customs union

4. Customs union theory reasons that the formation of a customs union will decrease members’ real welfare when the:
a. Trade diversion effect exceeds the trade creation effect
b. Trade production effect exceeds the trade consumption effect
c. Trade consumption effect exceeds the trade production effect
d. Trade creation effect exceeds the trade diversion effect

5. Which economic integration scheme is solely intended to abolish trade restrictions among member countries, while setting up common tariffs against nonmembers?
a. Economic union
b. Common market
c. Free trade area
d. Customs union

6. By 1992 the European Union had become a full-fledged:
a. Economic union
b. Monetary union
c. Common market
d. Fiscal union

7. Which device has the European Union used to equalize farm-product import prices with politically determined European Union prices, regardless of shifts in world prices?
a. Variable levies
b. Import quotas
c. Import subsidies
d. Domestic content regulations

8. Which trade instrument has the European Union used to insulate its producers and consumers of agricultural goods from the impact of changing demand and supply conditions in the rest of the world?
a. Domestic content regulations
b. Variable import levies
c. Voluntary export quotas
d. Orderly marketing agreements

9. Assume that the formation of a customs union turns out to include the lowest-cost world producer of the product in question. Which effect could not occur for the participating countries?
a. Trade creation-production effect
b. Trade creation-consumption effect
c. Trade diversion
d. Scale economies and competition

10. Which organization of nations permits free trade among its members in industrial goods, while each member maintains freedom in its trade policies toward non-member countries?
a. European Union
b. Benelux
c. Council for Mutual Economic Assistance
d. North American Free Trade Association

11. Which of the following organizations is considered a regional trading arrangement?
a. Organization of Petroleum Exporting Countries
b. North Atlantic Treaty Organization
c. Benelux
d. International Tin Agreement

12. When products from high-cost suppliers within a customs union replace imports from a low-cost nation that is not a member of the customs union, there exist(s):
a. Dynamic welfare losses
b. Dynamic welfare gains
c. Trade creation
d. Trade diversion

13. Which form of economic integration occurs when participating countries abolish tariffs on trade among themselves, establish a common tariff on imports from nonmembers, and permit free movement of capital and labor within the organization?
a. Free trade area
b. Economic union
c. Common market
d. Monetary union

14. A static welfare effect resulting from the formation of the European Union would be:
a. Economies of scale
b. Trade diversion
c. Investment incentives
d. Increased competition

15. A dynamic welfare gain resulting from the formation of the European Union would be:
a. Trade diversion
b. Trade creation
c. Diseconomies of scale
d. Economies of scale

16. Which organization was founded in 1957 whose objective was to create an economic union among its members?
a. General Agreements on Tariffs and Trade
b. Organization of Economic Cooperation and Development
c. European Union
d. Latin American Free Trade Association

17. The common agriculture policy of the European Union has supported European farmers via:
a. Export tariffs and domestic content regulations
b. Variable levies and voluntary export agreements
c. Content regulations and export subsidies
d. Export subsidies and variable levies

18. Which nation is not a member of the North American Free Trade Association?
a. Canada
b. Greenland
c. Mexico
d. United States

19. Suppose a communist country agrees to pay for delivery of machinery with goods produced by the machinery. This arrangement refers to:
a. Countertrade
b. International commodity agreements
c. Coproduction agreements
d. Trade diversion

20. NAFTA is a:
a. Monetary union
b. Free trade area
c. Common market
d. Customs union

21. Under the European Union’s common agricultural policy, a variable import levy equals the:
a. Amount by which the EU’s support price exceeds the world price
b. Amount by which the world price exceeds the EU’s support price
c. Support price of the EU
d. World price

22. Members of the European Union find that “trade creation” is fostered when their economies are:
a. Highly competitive
b. Highly noncompetitive
c. Small in economic importance
d. Geographically distant

23. The European Union has achieved all of the following except:
a. Adopted a common fiscal policy for member nations
b. Established a common system of agricultural price supports
c. Disbanded all tariffs among its member countries
d. Levied common tariffs on products imported from nonmembers

24. When the United States, Canada, and Mexico form a free trade area, and Mexico begins importing a product from Canada rather than from the lowest cost world producer.
a. Trade diversion occurs
b. Trade creation occurs
c. World welfare rises
d. World welfare falls to zero

25. When the formation of a free trade area results in the reduction of trade with nonmember nations in favor of member countries, ____ occurs.
a. Trade devaluation
b. Trade revaluation
c. Trade destruction
d. Trade diversion

26. Which country is not a member of the European Union?
a. Spain
b. Germany
c. France
d. Iceland

27. The implementation of the European Union has:
a. Made it harder for Americans to compete against the Germans in the British market
b. Made it easier for Americans to compete against the Germans in the British market
c. Made it harder for Americans to compete against the Japanese in the British market
d. Made it easier for Americans to compete against the Japanese in the British market

28. The common agricultural policy of the European Union has:
a. Increased American farm exports to the EU
b. Decreased American farm exports to the EU
c. Lowered the price of American farm exports to the EU
d. Not affected the price of American farm exports to the EU

29. The implementation of a common market involves all of the following except:
a. Elimination of trade restrictions among member countries
b. A common tax system and monetary union
c. Prohibition of restrictions on factor movements
d. A common tariff levied in imports from nonmembers

30. Under the common agricultural policy, exports of any surplus quantities of EU produce are encouraged through the usage of:
a. Variable levies
b. Export subsidies
c. Import quotas
d. Countertrade

Figure 8.1 depicts the supply and demand schedules of calculators for Greece, a “small” country that is unable to affect the world price. Greece’s supply and demand schedules of calculators are respectively depicted by SG and DG. Assume that Greece imports calculators from either Germany or France. Suppose Germany is the world’s low-cost producer who can supply calculators to Greece at $20 per unit, while France can supply calculators at $30 per unit.

Figure 8.1. Effects of a Customs Union

31. Consider Figure 8.1. With free trade, Greece imports:
a. 3 calculators from France
b. 5 calculators from France
c. 3 calculators from Germany
d. 5 calculators from Germany

32. Consider to Figure 8.1. Assume Greece levies a per-unit tariff of $20 on imports from both Germany and France.

Greece will import:
a. 1 calculator from Germany
b. 1 calculator from France
c. 3 calculators from Germany
d. 3 calculators from France

33. Consider Figure 8.1. Assume Greece levies a per-unit tariff of $20 on imports from both Germany and France.

As a result of the $20 tariff, Greece’s consumer surplus falls by:
a. $90
b. $100
c. $110
d. $120

34. Consider Figure 8.1. Assume Greece levies a per-unit tariff of $20 on imports from both Germany and France.

The deadweight welfare loss to Greece, resulting from the $20 tariff, equals:
a. $20
b. $40
c. $60
d. $80

35. Referring to Figure 8.1, suppose Greece forms a customs union with France. Greece will import:
a. 3 calculators at a per-unit price of $30
b. 3 calculators at a per-unit price of $40
c. 6 calculators at a per-unit price of $30
d. 6 calculators at a per-unit price of $40

36. Consider Figure 8.1. The value of the trade diversion effect, resulting from the Greece/France customs union, equals:
a. $5
b. $10
c. $15
d. $20

37. Consider Figure 8.1. The value of the trade creation effect, resulting from the Greece/France customs union, equals:
a. $5
b. $10
c. $15
d. $20

38. Consider Figure 8.1. Comparing the trade creation and trade diversion effects, the impact of the Greece/France customs union on the welfare of Greece is:
a. A $5 increase in economic welfare
b. A $10 increase in economic welfare
c. A $5 decrease in economic welfare
d. No change in economic welfare

39. Consider Figure 8.1. Suppose Greece had formed a customs union with Germany, rather than France. The value of the trade diversion effect would be:
a. Zero
b. $5
c. $10
d. $15

40. According to Figure 8.1, the formation of a Greece/Germany customs union would result in:
a. $20 of trade diversion
b. $40 of trade diversion
c. $20 of trade creation
d. $40 of trade creation

41. In 1989 Canada and the United States agreed to implement a (an) ____ over a ten year period.
a. Customs union
b. Common market
c. Free trade area
d. Economic union

42. In the United States, the proposed North American Free Trade Agreement was generally supported by:
a. Labor unions
b. Electronics firms
c. Environmentalists
d. Citrus producers

43. At the Maastricht Summit of 1991, European Union negotiators called for the pursuit of a:
a. Free trade area
b. Customs union
c. Common market
d. Monetary union

44. By removing discriminatory government procurement laws within the European Union, member nations hoped to benefit from all of the following except:
a. EU governments could purchase from the cheapest foreign suppliers
b. Increased competition occurs as domestic firms compete with foreign firms previously shut out of the domestic market
c. Industries are restructured which permits surviving firms to achieve economies of scale
d. Agricultural prices fall as more farmers are allowed to produce their commodities

45. Suppose that government procurement liberalization results in the U.K. government importing automobiles from Germany, the low-cost EU manufacturer. Cost savings could result from all of the following except:
a. Competition effect
b. Scale-economy effect
c. Protective effect
d. Trade effect

46. Suppose that steel from Japan faces a 20 percent tariff in France and a 25 percent tariff in Italy, while France and Italy maintain free trade between each other. France and Italy are therefore part of a (an):
a. Free trade area
b. Customs union
c. Common market
d. Economic union

47. Suppose that Mexico and Canada form a free-trade area and Canada begins importing steel from Mexico rather than from Germany. There occurs:
a. Trade diversion
b. Trade creation
c. Trade destruction
d. Trade exhaustion

48. Suppose that Mexico and Canada form a free-trade area. Mexicans then decrease auto manufacturing and increase imports of autos from Canada, while the Canadians decrease computer production and import more computers from Mexico. This is an example of:
a. Trade diversion
b. Trade creation
c. Trade destruction
d. Trade exhaustion

49. If the United States and Canada abolish all tariffs on each other’s goods and implement a common tariff on goods imported from other countries, there occurs a (an):
a. Free-trade area
b. Customs union
c. Common market
d. Economic union

50. Suppose that the United Kingdom and Italy abolish all tariffs on each other’s goods and all restrictions on movements of factors of production between them. They also implement a common protectionist policy toward other countries. This is an example of a (an):
a. Free-trade area
b. Customs union
c. Common market
d. Economic union

51. The North American Free Trade Agreement was expected to benefit ____ the most.
a. Canada
b. Mexico
c. Greenland
d. United States

52. The North American Free-Trade Agreement was most strongly opposed by U.S.:
a. Electronics manufacturers
b. Labor unions
c. Commercial banks
d. Engineering companies

53. In the United States, which group was most likely to be hurt by the North American Free Trade Agreement?
a. Unskilled labor
b. Skilled labor
c. Owners of capital equipment
d. Owners of financial capital

54. By joining NAFTA, the United States, Canada, and Mexico would find their short-run welfare decreasing due to the:
a. Economies of scale effect
b. Business investment effect
c. Trade creation effect
d. Trade diversion effect

55. When Mexico became a part of NAFTA, along with Canada and the United States, it:
a. Eliminated tariffs against Canada and the United States but maintained them against nonmembers
b. Eliminated tariffs against Canada, the United States, and all nonmember countries
c. Increased tariffs against Canada the United States, and all nonmember countries
d. Increased tariffs against Canada and the United States, but did not change them against nonmember countries

56. In a centrally-planned economy:
a. Commercial decisions are made by independent buyers and sellers acting in their own interest
b. Market-determined prices are used for allocating scarce resources
c. Prices play a rationing role so that the availability of goods is made consistent with buyer preferences and income
d. Government controls prices and output of goods bought and sold, with minimal recognition given to considerations of efficiency

57. The failure of the centrally-planned economies was exemplified by all of the following except:
a. Interest rates that were below free-market levels
b. Consumer and producer goods of inferior quality
c. Declining rates of economic growth
d. Shortages of essential goods and services

58. The transition of the former communist countries to market economies requires:
a. Implementation of governmental price controls
b. Privatization of public property
c. Transforming competitive industries into monopolies
d. The sale of private industries to the government

59. The transition of the former communist countries to market economies would likely result in:
a. The implementation of price ceilings
b. The implementation of price floors
c. Price inflation
d. Price deflation

60. In the former Soviet Union, major manufacturing firms were typically:
a. Owned and operated by employee labor unions
b. Owned and operated by the government
c. Privately owned, but operated by the government
d. Publically owned, but operated by the private sector

61. The transition of the former communist countries to market economies requires all of the following except:
a. Removing domestic price controls
b. Opening economies to international competition
c. Establishing private property rights
d. Terminating the convertibility of their currencies

62. The former communist countries included all of the following except:
a. East Germany
b. Soviet Union
c. Austria
d. Poland

63. The regional trade block of the former communist countries, which lasted from 1949-1991, was known as the:
a. Eastern European Economic Area
b. Nordic Preferential Trade Agreement
c. Council for Mutual Economic Assistance
d. European Industrial Cooperation Union

64. The economic reforms of the early 1990s that occurred in the former Soviet Union and Eastern Europe resulted in:
a. The formation of the Council for Mutual Economic Assistance
b. Multinational firms refusing to operate in these nations
c. A movement from centrally-planned economies toward market economies
d. A movement from market economies toward centrally-planned economies

65. The transition from government-controlled prices to market-determined prices in the former communist countries would be expected to result in:
a. Price stability
b. Price deflation
c. Price inflation
d. None of the above

66. Suppose that Canada has domestic firms that could supply its entire market for radios at a price of $50, while U.S. firms could supply radios at $40 and Mexico at $30. Suppose that Canada initially has a 50 percent tariff on imports of radios and then forms a free trade area with the United States. As a result, Canada realizes:
a. Trade creation, no trade diversion, and overall welfare gains
b. Trade creation, no trade diversion, and overall welfare losses
c. Trade diversion, no trade creation, and potential overall welfare losses
d. Trade diversion, trade creation, and potential overall welfare gains

67. Suppose that Canada has domestic firms that could supply its entire market for radios at a price of $50, while U.S. firms could supply radios at $40 and Mexico at $30. Suppose that Canada initially has a 50 percent tariff on imports of radios and then forms a free trade area with Mexico. As a result, Canada realizes:
a. Trade creation, no trade diversion, and overall welfare gains
b. Trade creation, no trade diversion, and overall welfare losses
c. Trade diversion, no trade creation, and potential overall welfare losses
d. Trade diversion, trade creation, and potential overall welfare gains

68. As of 2002, members of the European Monetary Union agreed to replace their currencies with the:
a. mark
b. dollar
c. franc
d. euro

69. The formation of the European Monetary Union is expected to entail benefits for member countries which include all of the following except:
a. Greater certainty for investors within the EMU
b. Lower costs of transactions within the EMU
c. Independent monetary policies run by the central bank of each member country
d. Enhanced competition among companies in member countries

70. According to the theory of optimum currency areas, a currency area has the least chance for success when:
a. Countries of the currency area have differing business cycles
b. Workers have a high degree of mobility across borders of the currency area
c. Prices and wages can be adjusted in response to economic disturbances
d. A single monetary policy affects all member countries in the same manner

71. A main disadvantage of the European Monetary Union is that:
a. Each member country loses the use of monetary policy as to tool to combat recession
b. There is a high degree of labor mobility among the member countries
c. Prices are highly flexible in response to changing economic conditions
d. Wages are highly flexible in response to changing economic conditions

72. World welfare under a customs union
a. Increases due to a trade creation effect
b. Decreases due to a trade diversion effect
c. Depends on the relative strength of the trade creation effect and the trade diversion effect
d. All of the above

73. A common market
a. Allows the imposition of common external trade barriers against non-members
b. Represents less economic integration than a free trade area
c. Does not permit free movement of goods among member nations
d. Does not allow free movement of factors of production among nations

74. The gains from having an optimum currency include
a. Price differentiation
b. Lower competition
c. Lower transaction costs
d. Both b and c

75. For decades, the Eastern European countries have suffered from
a. Widespread price controls
b. Excessive competition
c. Lack of enforceable property rights
d. Both a and c

TRUE/FALSE

The figure below depicts the steel market for Portugal, a small nation that is unable to affect the world price. Assume that Germany and France can supply steel to Portugal at a price of $200 and $300 respectively.

Figure 8.2. Portugal’s Steel Market

1. Consider Figure 8.2. With free trade, Portugal will import 25 tons of steel from Germany at a price of $200 per ton.

2. Consider Figure 8.2. With free trade, Portugal produces 15 tons of steel, consumes 30 tons of steel, and imports 15 tons of steel.

3. Consider Figure 8.2. If Portugal levies a 100 percent nondiscriminatory tariff on its steel imports, it will purchase 5 tons of steel from France at a price of $500 per ton.

4. Consider Figure 8.2. If Portugal forms a customs union with France, the resulting trade-creation effect equals $500.

5. Consider Figure 8.2. If Portugal forms a customs union with France, the resulting trade-diversion effect equals $400.

6. Consider Figure 8.2. As a result of a customs union formed with France, Portugal’s overall welfare rises by $900.

7. Consider Figure 8.2. If Portugal had formed a customs union with Germany, Portugal’s welfare would have decreased by $500.

8. The European Union protects its agricultural producers from import competition by the use of tariff rates that vary directly with world prices.

9. Under the variable levy system of the European Union, EU farmers are protected against import competition by tariffs that vary inversely with the world price.

10. Trade creation tends to more than offset trade diversion for a home country forming a customs union with partner countries when: (1) the tariff rate in the home country is high prior to the formation of the customs union; (2) there are a large number of countries forming the customs union.

11. If Chile and Mexico form a free-trade agreement, the welfare of the two countries will necessarily increase.

12. If Chile and Mexico abolish all tariffs on each other’s products while maintaining their own tariffs against other countries, these two countries have formed a customs union.

13. With a preferential trading arrangement, a group of countries agrees to unilaterally reduce tariffs applied to imports from all countries of the world.

14. Economic integration is the process of eliminating restrictions on international trade, payments, and factor mobility.

15. When a group of countries establish a free-trade area, they achieve the highest stage of economic integration.

16. A free-trade area is an association of trading countries whose members agree to remove all trade restrictions among themselves, while each member country imposes identical trade restrictions against nonmember countries.

17. If the United Kingdom and Italy eliminate all tariffs on each other’s goods and all restrictions to factor movements between them, and implement a uniform system of import restrictions against the rest of the world, these countries have formed a common market.

18. The highest stage of economic integration is a monetary union.

19. Trade creation would occur if Canada and the United States form a free-trade area, and Canadians then import less steel from the United States while importing more steel from Japan.

20. Suppose that Mexico and Canada form a free-trade area. The Mexicans then decrease refrigerator manufacturing and increase imports of refrigerators from Canada, while the Canadians decrease auto manufacturing and import more autos from Mexico. This is an example of trade creation.

21. Trade creation and trade diversion refer to the short run (static) effects of economic integration while economies of scale, stimulus to investment, and effects on competition refer to the long run (dynamic) effects.

22. For countries forming a customs union, the trade-creation effect represents a welfare loss and the trade-diversion effect represents a welfare gain.

23. In the short run, Mexico would realize overall welfare gains from becoming a member of the North American Free Trade Agreement if the resulting diseconomies of scale effect more than offset the competition effect.

24. Trade creation occurs when imports from a low-cost supplier outside of a customs union are replaced by purchases from a higher-cost supplier within the union.

25. If a customs union includes the low-cost supplier of the world, there would be no adverse trade-diversion effect that would counteract the positive trade-creation effect.

26. The potential for trade diversion is smaller when a custom union’s external tariff is lower rather than higher.

27. If a customs union included all of the countries in the world, there could exist only trade creation, not trade diversion.

28. The larger the size and the greater the number of countries in a customs union, the greater will be the trade-diversion effect.

29. Over the long run, the formation of a customs union may yield welfare gains due to economies of scale, greater competition, and stimulus to investment.

30. By the mid-1990s, the European Union had essentially achieved the common market stage of economic integration.

31. At the Maastricht Summit of 1991, members of the European Union expressed the goal of achieving the common market stage of economic integration.

32. To protect its farmers from foreign competition, the European Union has utilized variable import levies and export subsidies.

33. To protect its farmers from imports of agricultural goods, the European Union has implemented tariff rates that vary directly with world prices.

34. As of 1992, the European Union had achieved the monetary union stage of economic integration.

35. The Maastricht Treaty of 1991 established a blueprint for economic union and monetary union for European Union members.

36. It is generally agreed that completing the common market stage of integration for the European Union contributed to overall welfare losses due to trade diversion exceeding trade creation.

37. Government procurement liberalization permits a country to realize cost savings resulting from the trade effect, competition effect, and economies-of-scale effect.

38. During the 1980s and 1990s, the United States negotiated free-trade agreements with Israel, Mexico, and Canada.

39. Forming a free-trade agreement with the United States provided Canadian producers a danger and an opportunity. The danger was that U.S. producers might be more price competitive than Canadian producers; the opportunity was that longer production runs for Canadian producers, made possible by a free-trade agreement, would result in cost reductions due to economies of scale.

40. Some trade creation was expected to occur as a result of the U.S.-Canada free-trade agreement, since Canadian exports to the United States and U.S. exports to Canada were expected to expand at the expense of imports from Germany and Japan that faced trade restrictions.

41. Negotiating the North American Free Trade Agreement was relatively easy since it involved meshing two large industrial countries with a developing country.

42. Critics of the North American Free Trade Agreement maintained that it would result in manufacturing firms fleeing Mexico’s stringent pollution-control policies and relocating in the United States and Canada.

43. U.S. labor unions argued against the North American Free Trade Agreement on the grounds that it would result in U.S. companies relocating in Mexico in order to take advantage of lower wage rates.

44. The North American Free Trade Agreement was expected to provide proportionately smaller benefits to Mexico than to the United States or Canada.

45. In the former Soviet Union, production of capital goods was determined by the free market while consumer-goods production was determined by central planning.

46. The former Soviet Union was characterized by central economic planning and public ownership of manufacturing enterprises.

47. Pricing of consumer goods in the former Soviet Union was typically regulated by price ceilings which led to shortages.

48. The transition of the former Soviet Union from a planned economy to a market economy would require the elimination of price controls, the privatization of public property, and the promotion of business competition.

49. From the 1940s to the 1980s, the former communist countries remained isolated from the world economy, primarily due to different tariff systems among the former communist countries.

50. A political dilemma facing the former communist countries in the 1990s was that the transition from a centrally-planned economy to a market economy would result in short-run costs but long-run benefits.

SHORT ANSWER

1. What is meant by economic integration?

2. What factors influence the extent of trade creation and trade diversion?

ESSAY

1. Explain the theory of optimum currency areas.

2. Concerning transition economies, what do the advocates of shock therapy propose?

ECO 305 Week 7 Quiz

CHAPTER 9—INTERNATIONAL FACTOR MOVEMENTS AND MULTINATIONAL ENTERPRISES

MULTIPLE CHOICE

1. “Risk spreading” is a motive most likely to be served when firms undergo:
a. Horizontal integration
b. Vertical integration
c. Conglomerate integration
d. None of the above

2. The source (home) location of most of the world’s leading multinational enterprises is:
a. North America and Europe
b. North America and Asia
c. Europe and South America
d. Europe and Asia

3. Which type of multinational diversification occurs when the parent firm establishes foreign subsidiaries to produce intermediate goods going into the production of finished goods?
a. Forward vertical integration
b. Backward vertical integration
c. Forward horizontal integration
d. Backward horizontal integration

4. Suppose that an American automobile manufacturer establishes foreign subsidiaries to market the automobiles. This practice is referred to as:
a. Forward vertical integration
b. Forward conglomerate integration
c. Backward vertical integration
d. Backward conglomerate integration

5. Suppose that a steel manufacturer headquartered in Japan sets up a subsidiary in Canada to produce steel. This practice is referred to as:
a. Conglomerate integration
b. Forward vertical integration
c. Backward vertical integration
d. Horizontal integration

6. During the 1970s, American oil companies acquired nonenergy companies (e.g., copper, auto components) in response to anticipated decreases in investment opportunities in oil. This type of diversification is referred to as:
a. Horizontal integration
b. Conglomerate integration
c. Forward vertical integration
d. Backward vertical integration

7. Which of the following best refers to the outright construction or purchase abroad of productive facilities, such as manufacturing plants, by domestic residents?
a. Direct investment
b. Portfolio investment
c. Short-term capital investment
d. Long-term capital investment

8. In recent years, the largest amount of U.S. direct investment abroad has occurred in:
a. Central America
b. South America
c. Europe
d. Japan

9. In recent years, most foreign direct investment in the United States has come from:
a. Western Europe
b. Central America
c. South America
d. Asia

10. Most U.S. direct investment abroad occurs in:
a. Communications
b. Petroleum
c. Finance and insurance
d. Manufacturing

11. Most foreign direct investment in the United States occurs in:
a. Public utilities
b. Communications
c. Manufacturing
d. Mining and smelting

12. Which of the following is not a significant motive for the formation of multinational enterprises?
a. Avoiding tariffs by obtaining foreign manufacturing facilities
b. Obtaining the benefits from overseas comparative advantages
c. The acquisition of natural resource supply sources
d. Subsidies granted by the home government to overseas corporations

13. Suppose General Motors charges its Mexican subsidiary $1 million for auto assembly equipment that could be purchased on the open market for $800,000. This practice is best referred to as:
a. International dumping
b. Cost-plus pricing
c. Transfer pricing
d. Technological transfer

14. Multinational enterprises may provide benefits to their source (home) countries because they may:
a. Secure raw materials for the source country
b. Shift source country technology overseas via licensing
c. Export products which reflect source-country comparative disadvantage
d. Result in lower wages for source-country workers

15. Trade analysis involving multinational enterprises differs from our conventional trade analysis in that multinational enterprise analysis emphasizes:
a. Absolute cost differentials rather than comparative cost differentials
b. The international movement of factor inputs rather than finished goods
c. Purely competitive markets rather than imperfectly competitive markets
d. Portfolio investments rather than direct foreign investments

16. Direct foreign investment has taken all of the following forms except:
a. Investors buying bonds of an existing firm overseas
b. The creation of a wholly owned business enterprise overseas
c. The takeover of an existing company overseas
d. The construction of a manufacturing plant overseas

17. Which of the following would best explain why foreign direct investment might be attracted to the United States?
a. U.S. price ceilings that hold down the price of energy
b. U.S. wage rates exceeding the productivity of U.S. labor
c. Artificially high prices being charged for the stock of U.S. firms
d. Anticipations of future reductions in U.S. tariff levels

18. Both Coca-Cola Co. and Pepsi-Cola Co. are multinational firms in that their soft drinks are bottled throughout the world. This practice illustrates:
a. Backward vertical integration
b. Forward vertical integration
c. Horizontal integration
d. Conglomerate integration

19. The market power effect of an international joint venture can lead to welfare losses for the domestic economy unless offset by cost reductions. Which type of cost reduction would not lead to offsetting welfare gains for the overall economy?
a. R&D generating improved technology
b. Development of more productive machinery
c. New work rules promoting worker efficiency
d. Lower wages extracted from workers

20. All of the following are potential advantages of an international joint venture except:
a. Sharing research and development costs among corporations
b. Forestalling protectionism against imports
c. Establishing work rules promoting higher labor productivity
d. Operating at diseconomy-of-scale output levels

21. Which term best describes the New United Motor Manufacturing Co.?
a. Multinational enterprise
b. International joint venture
c. Multilateral contract
d. International commodity agreement

22. Multinational enterprises:
a. Increase the transfer of technology between nations
b. Make it harder for nations to foster activities of comparative advantage
c. Always enjoy political harmony in nations where their subsidiaries operate
d. Require governmental subsidies in order to conduct worldwide operations

23. Firms undertake multinational operations in order to:
a. Hire low-wage workers
b. Manufacture in nations they have difficulty exporting to
c. Obtain necessary factor inputs
d. All of the above

24. Multinational enterprises face problems since they:
a. Cannot benefit from the advantages of comparative advantage
b. May raise political problems in countries where their subsidiaries operate
c. Can invest only at home, but not overseas
d. Can invest only overseas, but not at home

25. American labor unions have recently maintained that U.S. multinational enterprises have been:
a. Exporting American jobs by investing overseas
b. Exporting American jobs by keeping investment in the United States
c. Importing cheap foreign workers by shifting U.S. investment overseas
d. Importing cheap foreign workers by keeping U.S. investment at home

26. American labor unions accuse U.S. multinational firms of all of the following except: that such firms
a. Enjoy unfair advantages in taxation
b. Export jobs by shifting technology overseas
c. Export jobs by shifting investment overseas
d. Operate at output levels where scale economies occur

27. Which of the following refers to the price charged for products sold to a subsidiary of a multinational enterprise by another subsidiary in another nation?
a. Transfer pricing
b. International dumping
c. Price discrimination
d. Full-cost pricing

28. Which business device involves the creation of a new business by two or more companies, often for a limited period of time?
a. Multinational enterprise
b. International joint venture
c. Horizontal merger
d. Vertical merger

29. International joint ventures can lead to welfare losses when the newly established firm:
a. Adds to the preexistent productive capacity
b. Enters markets neither parent could have entered individually
c. Yields cost reductions unavailable to parent firms
d. Gives rise to increased amounts of market power

30. Multinational enterprises:
a. Always produce primary goods
b. Always produce manufactured goods
c. Produce primary goods or manufactured goods
d. None of the above

Figure 9.1 illustrates the market conditions facing Sony Company and American Company initially operating as competitors in the domestic ball bearing market. Each firm realizes constant long-run costs, MC0=AC0.

Figure 9.1. International Joint Venture

31. Consider Figure 9.1. With Sony Company and American Company behaving as competitors, the equilibrium price and output respectively equal:
a. $4 and 2 units
b. $4 and 4 units
c. $6 and 2 units
d. $6 and 4 units

32. Consider Figure 9.1. At the equilibrium price, domestic households attain ____ of consumer surplus:
a. $4
b. $8
c. $12
d. $16

33. Consider Figure 9.1. Suppose that Sony Company and American Company jointly form a new firm, Venture Company, whose ball bearings replace the output sold by the parents in the domestic market. Assuming that Venture Company operates as a monopoly and that its costs equal MC0=AC0, the firm’s price, output, and total profit would respectively equal:
a. $6, 2 units, $4
b. $4, 2 units, $2
c. $6, 4 units, $4
d. $4, 4 units, $2

34. Consider Figure 9.1. Compared to the market equilibrium position achieved by Sony Company and American Company as competitors, Venture Company as a monopoly leads to a deadweight loss of consumer surplus of:
a. $2
b. $4
c. $6
d. $8

35. Consider Figure 9.1. Assume Venture Company’s formation yields new cost reductions, indicated by MC1=AC1, which result from technological advances. Realizing that Venture Company results in a deadweight loss of consumer surplus, the net effect of Venture Company’s formation on the welfare of the domestic economy is:
a. No change
b. Gain of $2
c. Gain of $4
d. Loss of $2

36. Consider Figure 9.1. Assume Venture Company’s formation yields new cost reductions, indicated by MC1=AC1, which result from wage concessions accepted by Venture Company employees. The net effect of Venture Company’s formation on the welfare of the domestic economy is:
a. No change
b. Gain of $2
c. Loss of $2
d. Loss of $4

37. Consider Figure 9.1. Assume Venture Company’s formation yields new cost reductions, indicated by MC1=AC1, which result from changes in work rules by Venture Company employees that led to higher worker productivity. The net effect of Venture Company’s formation on the welfare of the domestic economy is:
a. No change
b. Gain of $2
c. Gain of $4
d. Loss of $2

Figure 9.2 represents the U.S. labor market. Assume that labor and capital are the only factors of production. Also assume the initial supply schedule of labor is denoted by S0 and consists entirely of native U.S. workers. The demand schedule of labor is denoted by D0.

Figure 9.2. U.S. Labor Market

38. Consider Figure 9.2, at labor market equilibrium, workers are hired at a wage rate of $____ per hour, while total wages equal ____.
a. 2, $12, $24
b. 2, $12, $36
c. 3, $9, $27
d. 3, $9, $36

39. Consider Figure 9.2. At labor market equilibrium, the payment to U.S. capital owners equals:
a. $3
b. $6
c. $9
d. $12

40. Consider Figure 9.2. If Mexican migration to the United States results in the labor force increasing to 3 workers, denoted by schedule S1, the:
a. Wage rate for native U.S. workers decreases and the payments to U.S. capital owners increases
b. Wage rate for native U.S. workers decreases and the payments to U.S. capital owners decreases
c. Wage rate for native U.S. workers increases and the payments to U.S. capital owners increases
d. Wage rate for native U.S. workers increases and the payments to U.S. capital owners decreases

41. Consider Figure 9.2. As the result of the Mexican migration to the United States:
a. U.S. capital owners lose
b. Native U.S. workers lose
c. U.S. capital owners and native U.S. workers lose
d. U.S. capital owners and native U.S. workers gain

42. Consider Figure 9.2. Policies that permit Mexican workers to freely migrate to the United States would likely be resisted by:
a. U.S. capital owners
b. Native U.S. workers
c. U.S. capital owners and native U.S. workers
d. Neither U.S. capital owners nor native U.S. workers

43. ____ refers to highly educated and skilled people who migrate from poor developing countries to wealthy industrial countries.
a. Direct investment
b. Portfolio investment
c. Transfer pricing
d. Brain drain

44. “Guest worker” programs generally result in temporary migration of workers from:
a. Wealthy nations to wealthy nations
b. Wealthy nations to impoverished nations
c. Impoverished nations to wealthy nations
d. Impoverished nations to impoverished nations

45. Mexico’s ____ refer to an assemblage of U.S.-owned companies that use U.S.-owned parts and Mexican assembly to manufacture goods that are exported to the United States.
a. Multinational corporations
b. International joint ventures
c. Maquiladoras
d. Transplants

46. Critics of U.S. trade and immigration policy maintain that
a. It has depressed wages for many Americans
b. It has increased the supply of less educated workers in the United States
c. It has an adverse impact on the employment opportunities of less-skilled, American workers
d. All of the above

47. American critics of U.S. multinational enterprises contend that they promote
a. Runaway jobs
b. Technology transfers abroad
c. Tax evasion
d. All of the above

48. Joint ventures may lead to
a. Welfare increases
b. Welfare decreases
c. No changes in welfare
d. All of the above

49. Foreign direct investment typically occurs when
a. The earnings of the parent company are invested in plant expansion overseas
b. The parent company transfers jobs overseas
c. The parent company closes its foreign production plants
d. The parent company purchases bonds of foreign governments

TRUE/FALSE

1. International trade in goods and services and flows of productive factors are substitutes for each other.

2. Most multinational corporations have a low ratio of foreign sales to total sales, usually 5 percent or less.

3. Vertical integration occurs if a parent multinational corporation establishes foreign subsidiaries to produce intermediate goods or inputs that go into the production of a finished good.

4. Exxon Oil Co. would undertake forward vertical integration if its retailing division acquired oil wells in the Middle East.

5. Forward vertical integration would occur if a U.S. automobile manufacturer acquired a German subsidiary.

6. Most vertical foreign investment, as implemented by multinational corporations, is “forward” in nature rather than “backward.”

7. Horizontal integration would occur if General Motors sets up a subsidiary in Mexico to produce automobiles identical to those that it produces in the United States.

8. Multinational corporations sometimes locate manufacturing subsidiaries abroad to avoid tariff barriers which would place their products at a competitive disadvantage in a foreign country.

9. Foreign direct investment would occur if Mobile Inc. of the United States acquired sufficient common stock in a foreign oil company to assume voting control.

10. Foreign direct investment would occur if Microsoft Inc. of the United States purchased securities of the French government.

11. Conglomerate integration would occur if General Motors Inc. of the United States acquired a controlling interest in a British chemical company.

12. Both economic theory and empirical studies support the notion that foreign direct investment is conducted in anticipation of future profits.

13. Multinational corporations often locate manufacturing operations abroad in order to take advantage of foreign resource endowments or wage scales.

14. If the size of the Canadian market is large enough to permit efficient production in Canada, a U.S. firm would profit by establishing a Canadian manufacturing subsidiary or licensing rights to a Canadian firm to manufacture and sell its product in Canada.

15. There is virtually universal agreement among economists that foreign direct investment in the United States has reduced the economic welfare of the average U.S. citizen.

16. Foreign-owned companies in the United States operate under more strict antitrust, environmental, and other regulations than U.S.-owned companies.

17. During the 1980s and 1990s, Japanese auto firms established manufacturing facilities in the United States known as “transplants.”

18. By establishing transplant factories in the United States, Japanese automakers were able to avoid export restrictions imposed by the Japanese government, but not import restrictions imposed by the U.S. government.

19. Mergers differ from joint ventures in that they involve the creation of a new business firm, rather than the union of two existing companies.

20. Developing countries, such as Mexico and India, often close their borders to foreign companies unless they are willing to take on partner companies in developing countries.

21. In natural-resource oriented industries, such as oil and copper, joint ventures have often been formed by several companies since the cost of resource-extraction may be prohibitively large for a particular company.

22. International joint ventures tend to yield a welfare increasing market-power effect and a welfare decreasing cost-reduction effect.

23. A joint venture leads to increases in national welfare if the cost-reduction effect is due to wage concessions and if it more than offsets the market-power effect.

24. A joint venture leads to increases in national welfare if its cost-reduction effect is due to productivity gains and if it more than offsets the market-power effect.

25. Joint ventures lead to losses in national welfare when the newly established business adds to pre-existing production capacity and fosters additional competition.

26. Joint ventures lead to national welfare gains if the newly established business yields productivity increases that would have been unavailable if each parent performed the same function separately.

27. A joint venture along two large competing companies tends to yield a market-power effect, which results in a reduction in consumer surplus, that is not offset by a corresponding gain to producers.

28. If a joint venture among competing firms is able to cut costs by extracting wage concessions from domestic workers, national welfare increases.

29. Critics of multinational corporations maintain that they often abandon domestic workers in order to take advantage of lower wage scales abroad.

30. The theory of multinational enterprise is totally inconsistent with the principle of comparative advantage.

31. Due to transfer-pricing problems, multinational corporations must shift profits away from countries with low corporate tax rates to high tax-rate countries, thus absorbing a larger tax bite.

32. Maquiladoras refer to an assemblage of U.S.-owned companies that combine Mexican parts and U.S. assembly to manufacture goods that are exported to Mexico.

33. Opposition to Mexico’s maquiladoras has come from U.S. labor unions which claim that maquiladoras have resulted in job losses for U.S. workers.

34. As workers migrate from low-wage Mexico to high-wage United States, wages tend to rise in Mexico and fall in the United States.

35. The migration of workers from Mexico to the United States tends to exert downward pressure on the wages of native U.S. workers that compete against Mexican workers for jobs.

36. The effect of workers migrating from low-wage Mexico to high-wage United States is to redistribute income from capital to labor in the United States and from labor to capital in Mexico.

37. In the United States, labor unions have generally resisted efforts to implement restrictions on the number of foreigners allowed into the country.

38. Developing countries have sometimes feared open immigration policies of developed countries on the grounds that highly educated and skilled people may emigrate to the developed countries, thus limiting the growth potential of the developing countries.

39. The United States has discouraged the “brain drain” problem by permitting the immigration of unskilled workers while restricting the immigration of skilled persons.

40. Labor migration tends to increase output and decrease wages in the country of immigration while decreasing output and increasing wages in the country of emigration.

SHORT ANSWER

1. What are the typical ways in which multinational enterprises have diversified their operations?

2. What are Mexican maquiladoras?

ESSAY

1. Are there any differences between the theory of multinational enterprises and conventional trade theory?

2. What are the disadvantages of forming joint ventures?

ECO 305 Week 8 Quiz

CHAPTER 10—THE BALANCE OF PAYMENTS

MULTIPLE CHOICE

1. On the balance-of-payments statements, merchandise imports are classified in the:
a. Current account
b. Capital account
c. Unilateral transfer account
d. Official settlements account

2. The balance of international indebtedness is a record of a country’s international:
a. Investment position over a period of time
b. Investment position at a fixed point in time
c. Trade position over a period of time
d. Trade position at a fixed point in time

3. Which balance-of-payments item does not directly enter into the calculation of the U.S. gross domestic product?
a. Merchandise imports
b. Shipping and transportation receipts
c. Direct foreign investment
d. Service exports

4. Which of the following is considered a capital inflow?
a. A sale of U.S. financial assets to a foreign buyer
b. A loan from a U.S. bank to a foreign borrower
c. A purchase of foreign financial assets by a U.S. buyer
d. A U.S. citizen’s repayment of a loan from a foreign bank

5. Which of the following would call for inpayments to the United States?
a. American imports of German steel
b. Gold flowing out of the United States
c. American unilateral transfers to less-developed countries
d. American firms selling insurance to British shipping companies

6. In a country’s balance of payments, which of the following transactions are debits?
a. Domestic bank balances owned by foreigners are decreased
b. Foreign bank balances owned by domestic residents are decreased
c. Assets owned by domestic residents are sold to nonresidents
d. Securities are sold by domestic residents to nonresidents

7. Which of the following is classified as a credit in the U.S. balance of payments?
a. U.S. exports
b. U.S. gifts to other countries
c. A flow of gold out of the U.S.
d. Foreign loans made by U.S. companies

Table 10.1 gives hypothetical figures for U.S. International Transactions.

Table 10.1. U.S. International Transactions

Amount
Transaction (billions of dollars)

Merchandise imports 110
Military transactions, net -5
Remittances, pensions, transfers -20
U.S. private assets abroad -50
Merchandise exports 115
Investment income, net 15
U.S. government grants -5
(excluding military)
Foreign private assets in the U.S. 25
Compensation of employees -5
Allocation of SDRs 5
Travel and transportation receipts, net 20

8. Referring to Table 10.1, the goods and services balance equals:
a. $5 billion
b. $15 billion
c. $20 billion
d. $25 billion

9. Referring to Table 10.1, the current account balance equals:
a. $5 billion
b. $10 billion
c. $15 billion
d. $20 billion

10. Unlike the balance of payments, the balance of international indebtedness indicates the international:
a. Investment position of a country at a given moment in time
b. Investment position of a country over a one-year period
c. Trade position of a country at a given moment in time
d. Trade position of a country over a one-year period

11. Which of the following indicates the international investment position of a country at a given moment in time?
a. The balance of payments
b. The capital account of the balance of payments
c. The current account of the balance of payments
d. The balance of international indebtedness

12. Concerning the U.S. balance of payments, which account is defined in essentially the same way as the net export of goods and services, which comprises part of the country’s gross domestic product?
a. Merchandise trade account
b. Goods and services account
c. Current account
d. Capital account

13. If an American receives dividends from the shares of stock she or he owns in Toyota, Inc., a Japanese firm, the transaction would be recorded on the U.S. balance of payments as a:
a. Capital account debit
b. Capital account credit
c. Current account debit
d. Current account credit

14. If the United States government sells military hardware to Saudi Arabia, the transaction would be recorded on the U.S. balance of payments as a:
a. Current account debit
b. Current account credit
c. Capital account debit
d. Capital account credit

15. The U.S. balance of trade is determined by:
a. Exchange rates
b. Growth of economies overseas
c. Relative prices in world markets
d. All of the above

16. U.S. military aid granted to foreign countries is entered in the:
a. Merchandise trade account
b. Capital account
c. Current account
d. Official settlements account

17. If the U.S. faces a balance-of-payments deficit on the current account, it must run a surplus on:
a. The official settlements account
b. The capital account
c. Either the official settlements account or the capital account
d. Both the official settlements account and the capital account

18. The current account of the U.S. balance of payments does not include:
a. Investment income
b. Merchandise exports and imports
c. The sale of securities to foreigners
d. Unilateral transfers

19. The U.S. has a balance of trade deficit when its:
a. Merchandise exports exceed its merchandise imports
b. Merchandise imports exceed its merchandise exports
c. Goods and services exports exceed its goods and services imports
d. Goods and services imports exceed its goods and services exports

20. The value to American residents of income earned from overseas investments shows up in which account in the U.S. balance of payments?
a. Current account
b. Trade account
c. Unilateral transfers account
d. Capital account

Table 10.2. International Investment Position of the United States

U.S. assets abroad
U.S. government assets $800 billion
U.S. private assets $200 billion

Foreign assets in the U.S.
Foreign official assets $600 billion
Foreign private assets $300 billion

21. Consider Table 10.2. The U.S. balance of international indebtedness suggests that the United States is a net:
a. Debtor
b. Creditor
c. Spender
d. Exporter

22. For the first time since World War I, in 1985 the United States became a net international:
a. Exporter
b. Importer
c. Debtor
d. Creditor

23. A country that is a net international debtor initially experiences:
a. An augmented savings pool available to finance domestic spending
b. A higher interest rate, which leads to lower domestic investment
c. A loss of funds to trading partners overseas
d. A decrease in its services exports to other countries

24. Credit (+) items in the balance of payments correspond to anything that:
a. Involves receipts from foreigners
b. Involves payments to foreigners
c. Decreases the domestic money supply
d. Increases the demand for foreign exchange

25. Debt (-) items in the balance of payments correspond to anything that:
a. Involves receipts from foreigners
b. Involves payments to foreigners
c. Increases the domestic money supply
d. Decreases the demand for foreign exchange

26. When all of the debit or credit items in the balance of payments are combined:
a. Merchandise imports equal merchandise exports
b. Capital imports equal capital exports
c. Services exports equal services imports
d. The total surplus or deficit equals zero

27. In the balance of payments, the statistical discrepancy is used to:
a. Ensure that the sum of all debits matches the sum of all credits
b. Ensure that trade imports equal the value of trade exports
c. Obtain an accurate account of a balance-of-payments deficit
d. Obtain an accurate account of a balance-of-payments surplus

28. All of the following are credit items in the balance of payments, except:
a. Investment inflows
b. Merchandise exports
c. Payments for American services to foreigners
d. Private gifts to foreign residents

29. All of the following are debit items in the balance of payments, except:
a. Capital outflows
b. Merchandise exports
c. Private gifts to foreigners
d. Foreign aid granted to other nations

30. The role of ____ is to direct one nation’s savings into another nation’s investments:
a. Merchandise trade flows
b. Services flows
c. Current account flows
d. Capital flows

31. When a country realizes a deficit on its current account:
a. Its net foreign investment position becomes positive
b. It becomes a net demander of funds from other countries
c. It realizes an excess of imports over exports on goods and services
d. It becomes a net supplier of funds to other countries

32. Reducing a current account deficit requires a country to:
a. Increase private saving relative to investment
b. Increase private consumption relative to saving
c. Increase private investment relative to consumption
d. Increase private investment relative to saving

33. Reducing a current account deficit requires a country to:
a. Increase the government’s deficit and increase private investment relative to saving
b. Increase the government’s deficit and decrease private investment relative to saving
c. Decrease the government’s deficit increase private investment relative to saving
d. Decrease the government’s deficit and decrease private investment relative to saving

34. Reducing a current account surplus requires a country to:
a. Increase the government’s deficit and increase private investment relative to saving
b. Increase the government’s deficit and decrease private investment relative to saving
c. Decrease the government’s deficit and increase private investment relative to saving
d. Decrease the government’s deficit and decrease private investment relative to saving

35. Concerning a country’s business cycle, rapid growth of production and employment is commonly associated with:
a. Large or growing trade deficits and current account deficits
b. Large or growing trade deficits and current account surpluses
c. Small or shrinking trade deficits and current account deficits
d. Small or shrinking trade deficits and current account surpluses

36. The burden of a current account deficit would be the least if a nation uses what it borrows to finance:
a. Unemployment compensation benefits
b. Social Security benefits
c. Expenditures on food and recreation
d. Investment on plant and equipment

37. Concerning a country’s business cycle, ____ is commonly associated with large or growing current account deficits:
a. Rapid growth rates of production and employment
b. Slow growth rates of production and employment
c. Falling interest rates on government securities
d. Falling interest rates on corporate securities

38. According to researchers at the Federal Reserve, the loss of jobs associated with a deficit in the current account tends to be:
a. Offset by the increase of jobs associated with a surplus in the capital account
b. Reinforced by the decrease of jobs associated with a surplus in the capital account
c. A threat to the level of employment for the economy as a whole
d. Of no long-run economic consequence for workers who lose their jobs

TRUE/FALSE

Table 10.3 shows hypothetical transactions, in billions of U.S. dollars, that took place during a year.

Table 10.3. International Transactions of the United States

Amount
(billions of dollars)
Transaction

Allocation of SDRs 10
Changes in U.S. assets abroad 100
Statistical discrepancy -15
Merchandise imports -400
Payments on foreign assets in U.S. -20
Remittances, pensions, transfers -60
Travel and transportation receipts, net 30
Military transactions, net -10
Investment income, net 100
Merchandise exports 350
U.S. government grants (excluding military) -20
Changes in foreign assets in the U.S. 190
Other services, net 80
Receipts on U.S. investments abroad 30
Compensation of employees -10

1. Refer to Table 10.3. The merchandise-trade balance registered a deficit of $50 billion.

2. Refer to Table 10.3. The services balance registered a surplus of $100 billion.

3. Refer to Table 10.3. The goods-and-services balance registered a surplus of $50 billion.

4. Refer to Table 10.3. The unilateral-transfers balance registered a deficit of $40 billion.

5. Refer to Table 10.3. The current-account balance registered a surplus of $30 billion.

6. Refer to Table 10.3. The “net exports” component of the U.S. gross domestic product registered $-110 billion.

7. Refer to Table 10.3. The payments data suggest that the United States was a “net demander” of $30 billion from the rest of the world.

8. The balance of payments refers to the stock of trade and investment transactions that exists at a particular point in time.

9. Referring to the balance-of-payments statement, an international transaction refers to the exchange of goods, services, and assets between residents of one country and those abroad.

10. The balance of payments includes international transactions of households and businesses, but not government.

11. Because the balance of payments utilizes double-entry accounting, merchandise exports will always be in balance with merchandise imports.

12. On the U.S. balance-of-payments statement, the following transactions are credits, leading to the receipt of dollars from foreigners: merchandise exports, transportation receipts, income received from investments abroad, and investments in the United States by foreign residents.

13. On the U.S. balance of payments, the following transactions are debits, leading to payments to foreigners: merchandise imports, travel expenditures, gifts to foreign residents, and overseas investments by U.S. residents.

14. The “goods and services” account of the balance of payments shows the monetary value of international flows associated with transactions in goods, services, and unilateral transfers.

15. An increase in import restrictions by the U.S. government tends to promote a merchandise-trade surplus.

16. Services transactions on Canada’s balance-of-payments statement would include Canadian ships transporting lumber to Japan, foreign tourists spending money in Canada, and Canadian engineers designing bridges in China.

17. On the balance-of-payments statement, dividend and interest income are classified as capital-account transactions.

18. A surplus on Germany’s goods-and-services balance indicates that Germany has sold more goods and services to foreigners than it has bought from them over a one-year period.

19. The merchandise-trade account on the balance-of-payments statement is defined the same way as “net exports” which constitutes part of the nation’s gross domestic product.

20. A positive balance on the goods-and-services account of the balance of payments indicates an excess of exports over imports which must be added to the nation’s gross domestic product.

21. For the United States, merchandise trade has generally constituted the largest portion of its goods-and-services account.

22. Unilateral transfers refer to two-sided transactions, reflecting the movement of goods and services in one direction with corresponding payments in the other direction.

23. Unilateral transfers consist of private-sector transfers, such as church contributions to alleviate starvation in Africa, as well as governmental transfers, such as foreign aid.

24. Current-account transactions include direct foreign investment, purchases of foreign government securities, and commercial bank loans made abroad.

25. On the U.S. balance-of-payments statement, a capital inflow would occur if a Swiss resident purchases the securities of the U.S. government.

26. If Toyota Inc. of Japan builds an automobile assembly plant in the United States, the Japanese capital account would register an outflow.

27. If Bank of America receives repayment for a loan it made to a Mexican firm, the U.S. capital account would register an inflow.

28. On the balance-of-payments statement, a capital inflow can be likened to the import of goods and services.

29. The capital account of the balance of payments includes private-sector transactions as well as official-settlements transactions of the home country’s central bank.

30. If the current account of the balance of payments registers a deficit, the capital account registers a surplus, and vice versa.

31. Concerning the balance of payments, a current-account surplus means an excess of exports over imports of goods, services, investment income, and unilateral transfers.

32. If a country realizes a current-account deficit in its balance of payments, it becomes a net supplier of funds to the rest of the world.

33. Concerning the balance of payments, a current-account deficit results in a worsening of a country’s net foreign investment position.

34. In the balance-of-payments statement, statistical discrepancy is treated as part of the merchandise trade account because merchandise transactions are generally the most frequent source of error.

35. Because a large number of international transactions fail to get recorded, statisticians insert a residual, known as statistical discrepancy, to ensure that total debits equal total credits.

36. Concerning the balance of payments, the goods-and-services balance is commonly referred to as the “trade balance” by the news media.

37. Since the 1970s, the merchandise trade account of the U.S. balance of payments has registered deficit.

38. Although the United States has realized merchandise trade deficits since the early 1970s, its goods-and-services balance has always registered surplus.

39. In the past two decades, the U.S. services balance has generally registered surplus.

40. The U.S. unilateral-transfers balance has consistently registered surplus in the past two decades.

41. Because the balance of payments is a record of the economic transactions of a country over a period of time, it is a “flow” concept.

42. The United States would be a “net creditor” if the value of U.S. assets abroad exceeded the value of foreign assets in the United States.

43. If a country consistently realizes a current-account surplus in its balance of payments, it likely will become a “net debtor” in its balance of international indebtedness.

44. By the mid-1980s, the United States had evolved from the status of a net-creditor nation to a net-debtor nation in its balance of international indebtedness.

45. The net-debtor status, that the United States achieved in its balance of international indebtedness by the mid-1980s, reflected the continuous current-account surplus that the United States attained in its balance of payments during the 1970s.

46. Although a net-debtor country may initially benefit from an inflow of savings from abroad, over the long run continued borrowing results in growing dividend payments to foreigners and a drain on the debtor-country’s economic resources.

47. The official reserve assets of the United States consist of holdings of gold and foreign corporate securities.

48. That U.S. importers purchase bananas from Brazil constitutes a debit transaction on the U.S. balance of payments.

49. That German investors collect interest income on their holdings of U.S. Treasury bills constitutes a credit transaction on the U.S. balance of payments.

50. That U.S. charities donate funds to combat starvation in Africa constitutes a debit transaction on the U.S. balance of payments.

51. To reduce a current account deficit, a country should either decrease the budget deficit of its government or reduce investment spending relative to saving.

52. Most economists belief that in the 1980s, a massive outflow of capital caused a current account deficit for the United States.

53. A current account deficit for the United States necessarily reduces the standard of living for American households.

54. Rapid growth of production and employment is commonly associated with large or growing trade surpluses and current account surpluses.

55. Often, countries realizing rapid economic growth rates possess long-run current account deficits.

56. For the United States, a consequence of its current account deficit is a growing foreign ownership of the capital stock of the United States and a rising fraction of U.S. income that must be diverted abroad in the form of interest and dividends to foreigners.

57. Most economists contend that any reduction in the current account deficit is better achieved through increased national saving than through reduced domestic investment.

SHORT ANSWER

1. What are the components of the current account of the balance of payments?

2. Concerning the balance of international indebtedness, when is a country a net creditor or a net debtor?

ESSAY

1. How do we measure the international investment position of the United States at any point in time? How did the U.S. become a net debtor nation so rapidly?

2. What does a current account deficit mean?

CHAPTER 11—FOREIGN EXCHANGE

MULTIPLE CHOICE

1. Assume you are an American exporter and expect to receive 50 pounds sterling at the end of 60 days. You can remove the risk of loss due to a devaluation of the pound sterling by:
a. Selling sterling in the forward market for 60-day delivery
b. Buying sterling now and selling it at the end of 60 days
c. Selling the dollar equivalent in the forward market for 60-day delivery
d. Keeping the sterling in Britain after it is delivered to you

2. Which of the following tends to cause the U.S. dollar to appreciate in value?
a. An increase in U.S. prices above foreign prices
b. Rapid economic growth in foreign countries
c. A fall in U.S. interest rates below foreign levels
d. An increase in the level of U.S. income

3. Concerning the covering of exchange market risks–assuming that a depreciation of the domestic currency is anticipated, one can say that there is an incentive for:
a. Exporters to rush to cover their future needs
b. Importers to rush to cover their future needs
c. Both exporters and importers to rush to cover their future needs
d. Neither exporters nor importers to rush to cover their future needs

4. When short-term interest rates become lower in Tokyo than in New York, interest arbitrage operations will most likely result in a:
a. Increase in the spot price of the yen
b. Increase in the forward price of the dollar
c. Sale of dollars in the forward market
d. Purchase of yen in the spot market

5. An appreciation in the value of the U.S. dollar against the British pound would tend to:
a. Discourage the British from buying American goods
b. Discourage Americans from buying British goods
c. Increase the number of dollars that could be bought with a pound
d. Discourage U.S. tourists from traveling to Britain

6. Concerning the foreign exchange market, one can best say that:
a. There is a spot market for virtually every currency in the world
b. The market is highly centralized like the stock exchange
c. Most foreign exchange payments are made with bank notes
d. The values of the forward and spot rates are always in agreement

7. Suppose researchers discover that Swiss beer causes cancer when given in large amounts to British mice. This finding would likely result in a (an):
a. Increase in the demand for Swiss francs
b. Decrease in the demand for Swiss francs
c. Increase in the supply of Swiss francs
d. Decrease in the supply of Swiss francs

8. Suppose that real incomes increase more rapidly in the United States than in Mexico. In the United States, this situation would likely result in a (an):
a. Increase in the demand for pesos
b. Decrease in the demand for pesos
c. Increase in the supply of pesos
d. Decrease in the supply of pesos

9. A depreciation of the dollar refers to:
a. A fall in the dollar price of foreign currency
b. An increase in the dollar price of foreign currency
c. A loss of foreign-exchange reserves for the U.S.
d. An intervention in the international money market

10. If Canadian speculators believed the Swiss franc was going to appreciate against the U.S. dollar, they would:
a. Purchase Canadian dollars
b. Purchase U.S. dollars
c. Purchase Swiss francs
d. Sell Swiss francs

11. A major difference between the spot market and the forward market is that the spot market deals with:
a. The immediate delivery of currencies
b. The merchandise trade account
c. Currencies traded for future delivery
d. Hedging of international currency risks

12. The exchange rate is kept the same in all parts of the market by:
a. Forward cover
b. Hedging
c. Exchange speculation
d. Exchange arbitrage

13. If you have a commitment to pay a friend in Britain 1,000 pounds in 30 days, you could remove the risk of loss due to the appreciation of the pound by:
a. Buying dollars in the forward market for delivery in 30 days
b. Selling dollars in the forward market for delivery in 30 days
c. Buying the pounds in the forward market for delivery in 30 days
d. Selling the pounds in the forward market for delivery in 30 days

14. An increase in the dollar price of other currencies tends to cause:
a. U.S. goods to be cheaper than foreign goods
b. U.S. goods to be more expensive than foreign goods
c. Foreign goods to be more expensive to residents of foreign nations
d. Foreign goods to be cheaper to residents of the United States

15. The balance on merchandise trade:
a. Must be negative
b. Must be positive
c. Must be zero
d. May be negative, positive, or zero

16. Which of the following would not induce the U.S. demand curve for foreign exchange to shift backward to the left?
a. Worsening American tastes for goods produced overseas
b. Increasing interest rates in the U.S. compared to those overseas
c. A fall in the level of U.S. income
d. A depreciation in the U.S. dollar against foreign currencies

17. A U.S. export company scheduled to receive 1 million pounds six months from today can hedge its foreign exchange risk by:
a. Buying today 1 million pounds in the forward market for delivery in six months
b. Buying 1 million pounds in the spot market for delivery in six months
c. Selling 1 million pounds in the spot market for delivery in six months
d. Selling today 1 million pounds in the forward market for delivery in six months

18. Over time, a depreciation in the value of a nation’s currency in the foreign exchange market will result in:
a. Exports rising and imports falling
b. Imports rising and exports falling
c. Both imports and exports rising
d. Both imports and exports falling

19. Grain shortages in countries that buy large amounts of grain from the United States would increase the demand for American grain and:
a. Reduce the demand for dollars
b. Increase the demand for dollars
c. Reduce the supply of dollars
d. Increase the supply of dollars

20. Suppose the exchange rate between the Japanese yen and the U.S. dollar is 100 yen per dollar. A Japanese stereo with a price of 60,000 yen will cost:
a. $60
b. $600
c. $6000
d. None of the above

21. The supply of foreign currency may be:
a. Upward-sloping
b. Backward-sloping
c. Vertical
d. None of the above

22. Suppose that a Swiss watch that costs 400 francs in Switzerland costs $200 in the United States. The exchange rate between the franc and the dollar is:
a. 2 francs per dollar
b. 1 franc per dollar
c. $2 per franc
d. $3 per franc

23. In the early 1980s, the Federal Reserve pursued a tight monetary policy. All else being equal, the impact of that policy was to ____ interest rates in the United States relative to those in Europe and cause the dollar to ____ against European currencies.
a. Decrease, depreciate
b. Decrease, appreciate
c. Increase, depreciate
d. Increase, appreciate

24. Under a system of floating exchange rates, the Swiss franc would depreciate in value if which of the following occurs?
a. Price inflation in France
b. An increase in U.S. real income
c. A decrease in the Swiss money supply
d. Falling interest rates in Switzerland

25. A depreciation of the dollar will have its most pronounced impact on imports if the demand for imports is:
a. Constant
b. Inelastic
c. Elastic
d. Unitary elastic

26. During the era of dollar appreciation, from 1981 to 1985, a main reason why the dollar did not fall in value was:
a. Flows of foreign investment into the United States
b. Rising price inflation in the United States
c. A substantial decrease in U.S. imports
d. A substantial increase in U.S. exports

27. Which financial instrument provides a buyer the right to purchase or sell a fixed amount of currency at a prearranged price, within a few days to a couple of years?
a. Letter of credit
b. Foreign currency option
c. Cable transfer
d. Bill of exchange

28. Given the foreign currency market for the Swiss franc, the supply of francs slopes upward, because as the dollar price of the franc rises:
a. America’s demand for Swiss merchandise rises
b. America’s demand for Swiss merchandise falls
c. Switzerland’s demand for American merchandise rises
d. Switzerland’s demand for American merchandise falls

29. In a supply-and-demand diagram for Japanese yen, with the exchange rate in dollars per yen on the vertical axis, the demand schedule for yen is drawn sloping:
a. Upward
b. Vertical
c. Downward
d. Horizontal

30. Suppose there occurs an increase in the Canadian demand for Japanese computers. This results in:
a. An increase in the demand for yen
b. A decrease in the demand for yen
c. An increase in the supply of yen to Canada
d. A decrease in the supply of yen to Canada

Table 11.1 gives the exchange rate quotations for the U.S. dollar and the British pound.

Table 11.1. Foreign Exchange Quotations

U.S. Dollar Currency Per
Equivalent U.S. Dollar

Tuesday Monday Tuesday Monday

Britain (Pound) 1.4270 1.4390 .7008 .6949
30-day Forward 1.4211 1.4333 .7037 .6977
60-day Forward 1.4090 1.4220 .7097 .7032
180-day Forward 1.3930 1.4070 .7179 .7107

31. Consider Table 11.1. If one were to buy pounds for immediate delivery, on Tuesday the dollar cost of each pound would be:
a. $0.7008
b. $0.7037
c. $1.4211
d. $1.4270

32. Consider Table 11.1. If one were to sell dollars for immediate delivery, on Tuesday the pound cost of each dollar would be:
a. .7008 pounds per dollar
b. .7037 pounds per dollar
c. 1.4270 pounds per dollar
d. 1.4211 pounds per dollar

33. Consider Table 11.1. Comparing Tuesday to the previous Monday, by Tuesday the dollar had:
a. Depreciated against the pound
b. Appreciated against the pound
c. Not changed against the pound
d. None of the above

34. Consider Table 11.1. Concerning the Tuesday quotations: compared to the cost of buying 100 pounds on the spot market, if 100 pounds were bought for future delivery in 180 days the dollar cost of the pounds would be:
a. $3.40 higher
b. $3.40 lower
c. $6.80 higher
d. $6.80 lower

35. Which method of trading currencies involves the conversion of one currency into another at one point in time with an agreement to reconvert it back to the original currency at some point in the future?
a. Forward transaction
b. Futures transaction
c. Spot transaction
d. Swap transaction

36. Most foreign exchange trading occurs between banks and:
a. National governments
b. Other banks
c. Corporations
d. Household investors

37. The most important (in terms of dollar value) type of foreign exchange transaction by U.S. banks is the:
a. Spot transaction
b. Forward transaction
c. Swap transaction
d. Option transaction

38. In the interbank market for foreign exchange, the ____ refers to the price that a bank is willing to pay for a unit of foreign currency.
a. Offer rate
b. Bid rate
c. Spread rate
d. Transaction rate

39. In the interbank market for foreign exchange, the ____ refers to the price for which a bank is willing to sell a unit of foreign currency.
a. Offer rate
b. Option rate
c. Futures rate
d. Bid rate

40. In the interbank market for foreign exchange, the ____ refers to the difference between the offer rate and the bid rate.
a. Cross rate
b. Option
c. Arbitrage
d. Spread

41. A corporation dealing in foreign exchange may desire to obtain an exchange quote between the pound and franc, whose values are both expressed relative to the dollar. ____ are used to determine such a relationship.
a. Spot exchange rates
b. Forward exchange rates
c. Cross exchange rates
d. Option exchange rates

42. Suppose the exchange value of the British pound is $2 per pound while the exchange value of the Swiss franc is 50 cents per pound. The cross exchange rate between the pound and the franc is:
a. 1 franc per pound
b. 2 francs per pound
c. 3 francs per pound
d. 4 francs per pound

Exhibit 11.1

Assume the following: (1) the interest rate on 6-month treasury bills is 8 percent per annum in the United Kingdom and 4 percent per annum in the United States; (2) today’s spot price of the pound is $1.50 while the 6-month forward price of the pound is $1.485.

43. Refer to Exhibit 11.1. By investing in U.K. treasury bills rather than U.S. treasury bills, and not covering exchange rate risk, U.S. investors earn an extra return of:
a. 4 percent per year, 1 percent for the 6 months
b. 4 percent per year, 2 percent for the 6 months
c. 2 percent per year, 0.5 percent for the 6 months
d. 2 percent per year, 1 percent for the 6 months

44. Refer to Exhibit 11.1. If U.S. investors cover their exchange rate risk, the extra return for the 6 months on the U.K. treasury bills is:
a. 1.0 percent
b. 1.5 percent
c. 2.0 percent
d. 2.5 percent

45. Refer to Exhibit 11.1. If the price of the 6-month forward pound were to ____, U.S. investors would no longer earn an extra return by shifting funds to the United Kingdom.
a. Rise to $1.52
b. Rise to $1.53
c. Fall to $1.48
d. Fall to $1.47

46. Assume that you are the Chase Manhattan Bank of the United States, and you have 1 million Swiss francs in your vault that you will need to use in 30 days. Moreover, you need 500,000 British pounds for the next 30 days. You arrange to loan your francs to Barclays Bank of London for 30 days in exchange for 500,000 pounds today, and reverse the transaction at the end of 30 days. You have just arranged a:
a. Forward contract
b. Futures contract
c. Spot contract
d. Currency swap

Figure 11.1 illustrates the supply and demand schedules for the Swiss franc. Assume that exchange rates are flexible.

Figure 11.1. Supply and Demand Schedules of Francs

47. Refer to Figure 11.1. At the equilibrium exchange rate of ____ per franc, ____ francs will be purchased at a total dollar cost of ____.
a. $.50, 5 million, $2.5 million
b. $.50, 5 million, $1.5 million
c. $.70, 3 million, $2.1 million
d. $.70, 7 million, $4.9 million

48. Refer to Figure 11.1. Suppose the exchange rate is $.70 per franc. At this exchange rate there is an ____ of francs which leads to a ____ in the dollar price of the franc, a (an) ____ in the quantity of francs supplied, and a (an) ____ in the quantity of francs demanded.
a. Excess demand, rise, increase, decrease
b. Excess demand, rise, decrease, increase
c. Excess supply, fall, decrease, increase
d. Excess supply, fall, increase, decrease

49. Refer to Figure 11.1. Suppose the exchange rate is $.30 per franc. At this exchange rate there is an ____ of francs which leads to a ____ in the dollar price of the franc, a (an) ____ in the quantity of francs supplied, and a (an) ____ in the quantity of francs demanded.
a. Excess demand, rise, increase, decrease
b. Excess demand, rise, decrease, increase
c. Excess supply, fall, decrease, increase
d. Excess supply, fall, increase, decrease

50. Refer to Figure 11.1. Suppose the exchange rate is $.70 per franc. Free-market forces would lead to a (an) ____ of the dollar against the franc and a (an) ____ in U.S. international competitiveness.
a. Depreciation, improvement
b. Depreciation, worsening
c. Appreciation, improvement
d. Appreciation, worsening

51. Refer to Figure 11.1. Suppose the exchange rate is $.30 per franc. Free-market forces would lead to a (an) ____ of the dollar against the franc and a (an) ____ in U.S. international competitiveness:
a. Depreciation, improvement
b. Depreciation, worsening
c. Appreciation, improvement
d. Appreciation, worsening

The figure below illustrates the market for Swiss francs in a world of market-determined exchange rates. Assume the equilibrium exchange rate is $0.5 per franc, given by the intersection of schedules S0 and D0.

Figure 11.2. Market for Francs

52. Refer to Figure 11.2. A shift in the demand for francs from D0 to D1 or a shift in the supply of francs from S0 to S2, would result in a (an):
a. Depreciation in the dollar against the franc
b. Appreciation in the dollar against the franc
c. Unchanged dollar/franc exchange rate
d. None of the above

53. Refer to Figure 11.2. A shift in the demand for francs from D0 to D2, or a shift in the supply of francs from S0 to S1, would result in a (an):
a. Depreciation in the dollar against the franc
b. Appreciation in the dollar against the franc
c. No change in the dollar/franc exchange rate
d. None of the above

54. A (An) ____ is an arrangement by which two parties exchange one currency for another and agree that the exchange will be reversed at a stipulated date in the future:
a. Arbitrage
b. Swap
c. Option
d. Hedge

Table 11.2. Supply and Demand of British Pounds

Quantity Dollars Quantity
of Pounds per of Pounds
Supplied Pound Demanded

1,000 2.00 200
800 1.80 400
600 1.60 600
400 1.40 800
200 1.20 1,000

55. Refer to Table 11.2. The equilibrium exchange rate equals:
a. $1.20 per pound
b. $1.40 per pound
c. $1.60 per pound
d. $1.80 per pound

56. Refer to Table 11.2. At the exchange rate of $1.40 per pound, there is an ____ for pounds. This imbalance causes ____ in the price of the pound, which leads to ____ in the quantity of pounds supplied and ____ in the quantity of pounds demanded.
a. Excess supply, a decrease, an increase, a decrease
b. Excess supply, an increase, a decrease, an increase
c. Excess demand, an increase, an increase, a decrease
d. Excess demand, an increase, a decrease, an increase

57. Refer to Table 11.2. At the exchange rate of $1.80 per pound, there is an ____ for pounds. This imbalance causes ____ in the price of the pound, which leads to ____ in the quantity of pounds supplied and ____ in the quantity of pounds demanded.
a. Excess supply, a decrease, a decrease, an increase
b. Excess supply, an increase, a decrease, an increase
c. Excess demand, an increase, an increase, a decrease
d. Excess demand, an increase, a decrease, an increase

Table 11.3. Key Currency Cross Rates

Dollar Euro Pound Swiss Franc

Canada 1.5326 1.4400 2.2362 0.9790
Japan 124.48 116.96 181.63 79.515
Mexico 9.7410 9.1526 14.213 6.2223
Switzerland 1.5655 1.4709 2.2842 ……….
U.K. .68540 .6440 ………. .4378
Euro 1.06430 ………. 1.5529 .67984
U.S. ………. .9396 1.4591 .63877

58. Referring to Table 11.3, the cross exchange rate between the euro and Swiss franc is approximately:
a. .68 euros per franc
b. .68 francs per euro
c. .64 euros per franc
d. .64 francs per euro

59. Referring to Table 11.3, the yen cost of purchasing 100 British pounds is roughly:
a. 18,000 yen
b. 19,000 yen
c. 20,000 yen
d. 21,000 yen

Table 11.4. Forward Exchange Rates

U.S. Dollar Equivalent

Wednesday Tuesday

Switzerland (Franc) .6598 .6590
30-day Forward .6592 .6585
90-day Forward .6585 .6578
180-day Forward .6577 .6572

60. Refer to Table 11.4. On Wednesday, the 30-day forward franc was selling at a:
a. 1 percent premium per annum against the dollar
b. 2 percent premium per annum against the dollar
c. 1 percent discount per annum against the dollar
d. 2 percent discount per annum against the dollar

61. Refer to Table 11.4. On Wednesday, the 90-day forward franc was selling at a:
a. 0.8 percent premium per annum against the dollar
b. 1.6 percent premium per annum against the dollar
c. 0.8 percent discount per annum against the dollar
d. 1.6 percent discount per annum against the dollar

62. Refer to Table 11.4. On Wednesday, the 180-day forward franc was selling at a:
a. 0.6 percent premium per annum against the dollar
b. 1.6 percent premium per annum against the dollar
c. 0.6 percent discount per annum against the dollar
d. 1.6 percent discount per annum against the dollar

63. Refer to Table 11.4. Comparing the franc’s forward rates against the franc’s spot rate, the exchange market’s consensus is that over the period of a forward contract, the franc’s spot rate will:
a. Depreciate against the dollar
b. Appreciate against the dollar
c. Remain constant against the dollar
d. None of the above

64. The offer rate
a. Is the price at which the bank is willing to sell a unit of foreign currency
b. Is the price that the bank is willing to pay for a unit of foreign currency
c. Is synonymous with the spread rate
d. None of the above

65. When the dollar depreciates
a. U.S. exporters tend to sell more goods in foreign markets
b. U.S. consumers travel abroad more cheaply
c. More foreign tourists can afford to visit the United States
d. both a and c

66. When the dollar gets stronger
a. U.S. firms become more competitive in international market
b. Foreign tourists travel in the U.S. at a higher cost
c. U.S. inflation increases
d. U.S. consumers face higher prices on foreign goods

TRUE/FALSE

1. Similar to stock and commodity exchanges, the foreign exchange market is an organized structure with a central meeting place and formal licensing requirements.

2. Most foreign exchange transactions are conducted between commercial banks and household customers.

3. Foreign-exchange brokers help commercial banks carry out foreign exchange trading and maintain desired balances of foreign exchange.

4. A person needing foreign exchange immediately would purchase it on the spot market.

5. Most foreign exchange trading is carried out in the forward market.

6. Swap transactions among commercial banks involve the conversion of one currency to another at one point with an agreement to reconvert it back into the original currency at some point in the future.

7. The bid rate refers to the price at which a bank is willing to sell a unit of foreign currency; the offer rate is the price at which a bank is willing to buy a unit of foreign currency.

8. A commercial bank profits from foreign-exchange trading when its bid rate exceeds its offer rate.

9. The “spread” is a bank’s profit margin on foreign exchange trading and equals the difference between the bid rate and the offer rate.

10. If Citibank quoted bid and offer rates for the Swiss franc at $.4850/$.4854, the bank would be prepared to buy, say, 1 million francs for $485,000 and sell them for $485,400.

11. If Chase Manhattan Bank quotes bid and offer rates for the Swiss franc at $.5250/$.5260, the bank would realize profits of $1,000 on the purchase and sale of 1 million francs.

12. If a Citibank dealer expects the Swiss franc to appreciate against the U.S. dollar, she will attempt to lower both bid and offer rates for the franc, attempting to persuade other dealers to buy francs from Citibank and dissuade other dealers from selling francs to Citibank.

13. If a Citibank dealer expects the Swiss franc to depreciate in the future, he will lower bid and offer rates for the franc in order to discourage other dealers from selling francs to Citibank and persuade other dealers to buy francs from Citibank.

14. If it takes $0.18544 to purchase 1 French franc, it takes 5.3926 francs to purchase $1.

15. If it takes 113.28 yen to buy $1, it takes $.009624 to buy 1 yen.

16. If it takes $1.5515 to buy 1 pound and $0.6845 to buy 1 franc, it takes 2.27 francs to buy 1 pound.

17. “Futures” currency contracts are issued by commercial banks and are tailored in size to the needs of the exporter or importer, while “forward” currency contracts are issued by the International Monetary Market in standardized round lots.

18. A foreign currency option is an agreement between a holder (corporation) and a writer (commercial bank) giving the holder the right to buy or sell a certain amount of foreign currency at any time through some specified date.

19. A “call” option gives General Motors the right to sell pounds at a specified price, while a put option gives General Motors the right to buy pounds at a specified price.

20. The demand for foreign exchange is derived from credit transactions on the balance of payments.

21. The U.S. demand for pounds is derived from U.S. exports to the United Kingdom, U.K. investments in the United States, and U.K. tourist expenditures in the United States.

22. As the dollar’s exchange value appreciates against the pound, U.S. residents tend to import more British goods and thus demand more pounds.

23. As the dollar depreciates against the peso, U.S. residents tend to import more Mexican goods and thus demand more pesos.

24. The supply of francs is derived from the desire of the Swiss to purchase German goods, make investments in Germany, repay debts to German lenders, and extend transfer payments to German residents.

25. The demand schedule for Swiss francs is always downsloping while the supply schedule of francs is always upsloping.

26. The supply schedule of yen has a positive-sloping region which corresponds to the inelastic region on the Japanese demand schedule for foreign currency.

27. The supply schedule of pesos has a negative-sloping region corresponding to the inelastic region on the Mexican demand schedule for foreign currency.

28. If the Swiss demand for dollars is elastic, a depreciation of the dollar against the franc will lead to a greater quantity of francs being supplied to the foreign exchange market to obtain dollars.

29. If the Swiss demand for dollars is inelastic, an appreciation of the dollar against the franc will lead to a greater quantity of francs being supplied to the foreign exchange market to obtain dollars.

30. If the Swiss demand for dollars is elastic, an appreciation of the dollar against the franc will lead to a greater quantity of francs being supplied to the foreign exchange market to obtain dollars.

31. If the Swiss demand for dollars is inelastic, a depreciation of the dollar against the franc will lead to a greater quantity of francs being supplied to the foreign exchange market to obtain dollars.

32. Movements along the demand schedule for pounds are caused by changes in the pound’s exchange rate.

33. Given an upward-sloping supply schedule of pounds and a downward-sloping demand schedule for pounds, an increase in the demand schedule causes an appreciation of the dollar against the pound.

34. Given an upward-sloping supply schedule of pounds and a downward-sloping demand schedule for pounds, a decrease in the demand schedule causes an appreciation of the dollar against the pound.

35. Given an upward-sloping supply schedule of pounds and a downward-sloping demand schedule for pounds, an increase in the supply schedule causes an appreciation of the dollar against the pound.

36. Given an upward-sloping supply schedule of pounds and a downward-sloping demand schedule for pounds, a decrease in the supply schedule causes an appreciation of the dollar against the pound.

37. The trade-weighted dollar is the weighted average of the exchange rates between the dollar and the most important industrial-country trading partners of the United States.

38. If the trade-weighted dollar moves from an index value to 100 to 110, the dollar depreciates by 10 percent against the trade-weighted averages of the exchange rates of the major trading partners of the United States.

39. An increase in the trade-weighted value of the dollar indicates a dollar appreciation relative to the currencies of its major trading partners and a worsening of U.S. international competitiveness.

40. With arbitrage, a trader attempts to purchase a foreign currency at a low price and, at a later date, resell the currency at a higher price in order to make a profit.

41. Arbitrage results in a riskless profit since a trader purchases a currency at a low price and simultaneously resells it at a higher price.

42. If the exchange rate is $0.01 per yen in New York and $0.015 per yen in Tokyo, an arbitrager could profit by buying yen in Tokyo and simultaneously sell them in New York.

43. Currency arbitrage tends to result in identical yen/dollar exchange rates in New York and in Tokyo.

44. In the forward market, the exchange rate is agreed on at the time of the currency contract, but payment is not made until the future delivery of the currency actually takes place.

45. If the spot price of the Swiss franc is $0.4020 and the 90-day forward franc sells for $0.4026, the franc is at a 90-day forward discount of $0.0006, or at a 0.2 percent forward discount per annum against the dollar.

46. Suppose that Sears owes 1 million yen to a Japanese electronics manufacturer in 3 months. It could hedge against the risk of a depreciation of the dollar against the yen by contracting to purchase 1 million yen in the forward market, at today’s forward rate, for delivery in 3 months.

47. Assume that Boeing anticipates receiving 20 million yen in 3 months from exports of jumbo jets to a Japanese airline. The firm could hedge against the risk of a depreciation of the dollar against the yen by contracting to sell its expected yen proceeds for dollars in the forward market at today’s forward rate.

48. A U.S. investor’s extra rate of return on an investment in France, as compared to the United States, equals the interest-rate differential adjusted for any change in the dollar/franc exchange rate.

49. A currency speculator’s goal is to buy a currency at a low price and immediately resell it at a higher price, thus realizing a riskless profit.

50. Stabilizing speculation reinforces market forces by intensifying an appreciation or a depreciation in a currency’s exchange value.

SHORT ANSWER

1. What foreign exchange transactions do banks typically engage in?

2. How is the equilibrium rate of exchange determined?

ESSAY

1. Is it possible to trade foreign exchange in the futures market? How does such trading differ from the forward market?

2. Where are foreign currency options traded?

ECO 305 Week 9 Quiz

CHAPTER 12—EXCHANGE-RATE DETERMINATION

MULTIPLE CHOICE

1. The relationship between the exchange rate and the prices of tradable goods is known as the:
a. Purchasing-power-parity theory
b. Asset-markets theory
c. Monetary theory
d. Balance-of-payments theory

2. If the exchange rate between Swiss francs and British pounds is 5 francs per pound, then the number of pounds that can be obtained for 200 francs equals:
a. 20 pounds
b. 40 pounds
c. 60 pounds
d. 80 pounds

3. Low real interest rates in the United States tend to:
a. Decrease the demand for dollars, causing the dollar to depreciate
b. Decrease the demand for dollars, causing the dollar to appreciate
c. Increase the demand for dollars, causing the dollar to depreciate
d. Increase the demand for dollars, causing the dollar to appreciate

4. High real interest rates in the United States tend to:
a. Decrease the demand for dollars, causing the dollar to depreciate
b. Decrease the demand for dollars, causing the dollar to appreciate
c. Increase the demand for dollars, causing the dollar to depreciate
d. Increase the demand for dollars, causing the dollar to appreciate

5. Assume that the United States faces an 8 percent inflation rate while no (zero) inflation exists in Japan. According to the purchasing-power parity theory, the dollar would be expected to:
a. Appreciate by 8 percent against the yen
b. Depreciate by 8 percent against the yen
c. Remain at its existing exchange rate
d. None of the above

6. In the presence of purchasing-power parity, if one dollar exchanges for 2 British pounds and if a VCR costs $400 in the United States, then in Great Britain the VCR should cost:
a. 200 pounds
b. 400 pounds
c. 600 pounds
d. 800 pounds

7. If wheat costs $4 per bushel in the United States and 2 pounds per bushel in Great Britain, then in the presence of purchasing-power parity the exchange rate should be:
a. $.50 per pound
b. $1.00 per pound
c. $2.00 per pound
d. $8.00 per pound

8. A primary reason that explains the appreciation in the value of the U.S. dollar in the 1980s is:
a. Large trade surpluses for the United States
b. Relatively high inflation rates in the United States
c. Lack of investor confidence in the U.S. monetary policy
d. Relatively high interest rates in the United States

9. The high foreign exchange value of the U.S. dollar in the early 1980s can best be explained by:
a. Additional investment funds made available from overseas
b. Lack of investor confidence in U.S. fiscal policy
c. Market expectations of rising inflation in the United States
d. American tourists overseas finding costs increasing

10. When the price of foreign currency (i.e., the exchange rate) is below the equilibrium level:
a. An excess demand for that currency exists in the foreign exchange market
b. An excess supply of that currency exists in the foreign exchange market
c. The demand for foreign exchange shifts outward to the right
d. The demand for foreign exchange shifts backward to the left

11. When the price of foreign currency (i.e., the exchange rate) is above the equilibrium level:
a. An excess supply of that currency exists in the foreign exchange market
b. An excess demand for that currency exists in the foreign exchange market
c. The supply of foreign exchange shifts outward to the right
d. The supply of foreign exchange shifts backward to the left

12. The appreciation in the value of the dollar in the early 1980s is explained by all of the following except:
a. The United States being considered a safe haven by foreign investors
b. Relatively high real interest rates in the United States
c. Confidence of foreign investors in the U.S. economy
d. Relatively high inflation rates in the United States

13. Suppose Mexico and the United States were the only two countries in the world. There exists an excess supply of pesos on the foreign exchange market. This suggests that:
a. Mexico’s current account is in surplus
b. Mexico’s current account is in deficit
c. The U.S. current account is in deficit
d. The U.S. current account is in equilibrium

14. If Canada runs a trade surplus with Mexico and exchange rates are floating:
a. The peso will depreciate relative to the dollar
b. The dollar will depreciate relative to the peso
c. The prices of all foreign goods will fall for Canadians
d. The prices of all foreign goods will rise for Canadians

15. If Mexico’s labor productivity rises relative to Europe’s labor productivity:
a. The peso tends to depreciate against the euro in the short run
b. The peso tends to appreciate against the euro in the short run
c. The peso tends to depreciate against the euro in the long run
d. The peso tends to appreciate against the euro in the long run

16. The international exchange value of the U.S. dollar is determined by:
a. The rate of inflation in the United States
b. The number of dollars printed by the U.S. government
c. The international demand and supply for dollars
d. The monetary value of gold held at Fort Knox, Kentucky

17. For the United States, suppose the annual interest rate on government securities equals 8 percent while the annual inflation rate equals 4 percent. For Japan, suppose the annual interest rate on government securities equals 10 percent while the annual inflation rate equals 7 percent. These variables would cause investment funds to flow from:
a. The United States to Japan, causing the dollar to depreciate
b. The United States to Japan, causing the dollar to appreciate
c. Japan to the United States, causing the yen to depreciate
d. Japan to the United States, causing the yen to appreciate

18. For the United States, suppose the annual interest rate on government securities equals 12 percent while the annual inflation rate equals 8 percent. For Japan, suppose the annual interest rate equals 5 percent. These variables would cause investment funds to flow from:
a. The United States to Japan, causing the dollar to depreciate
b. The United States to Japan, causing the dollar to appreciate
c. Japan to the United States, causing the yen to depreciate
d. Japan to the United States, causing the yen to appreciate

19. Given a system of floating exchange rates, stronger U.S. preferences for imports would trigger:
a. An increase in the demand for imports and an increase in the demand for foreign currency
b. An increase in the demand for imports and a decrease in the demand for foreign currency
c. A decrease in the demand for imports and an increase in the demand for foreign currency
d. A decrease in the demand for imports and a decrease in the demand for foreign currency

20. Given a system of floating exchange rates, weaker U.S. preferences for imports would trigger:
a. An increase in the demand for imports and an increase in the demand for foreign currency
b. An increase in the demand for imports and a decrease in the demand for foreign currency
c. A decrease in the demand for imports and an increase in the demand for foreign currency
d. A decrease in the demand for imports and a decrease in the demand for foreign currency

21. Under a system of floating exchange rates, relatively low productivity and high inflation rates in the United States result in:
a. An increase in the demand for foreign currency, a decrease in the supply of foreign currency, and a depreciation in the dollar
b. An increase in the demand for foreign currency, an increase in the supply of foreign currency, and an appreciation in the dollar
c. A decrease in the demand for foreign currency, a decrease in the supply of foreign currency, and a depreciation in the dollar
d. A decrease in the demand for foreign currency, an increase in the supply of foreign currency, and an appreciation in the dollar

22. Under a system of floating exchange rates, relatively high productivity and low inflation rates in the United States result in:
a. An increase in the demand for foreign currency, a decrease in the supply of foreign currency, and a depreciation in the dollar
b. An increase in the demand for foreign currency, an increase in the supply of foreign currency, and an appreciation in the dollar
c. A decrease in the demand for foreign currency, a decrease in the supply of foreign currency, and a depreciation in the dollar
d. A decrease in the demand for foreign currency, an increase in the supply of foreign currency, and an appreciation in the dollar

23. Which example of market expectations causes the dollar to appreciate against the yen–expectations that the U.S. economy will have:
a. Faster economic growth than Japan
b. Higher future interest rates than Japan
c. More rapid money supply growth than Japan
d. Higher inflation rates than Japan

24. Which example of market expectations causes the dollar to depreciate against the yen–expectations that the U.S. economy will have:
a. Faster economic growth than Japan
b. Higher future interest rates than Japan
c. Less rapid money supply growth than Japan
d. Lower inflation rates than Japan

25. For an American investor, the expected rate of return on European securities depends on all of the following factors except the:
a. Rate of return on equivalent American securities
b. The current exchange rate between the dollar and the pound
c. Exchange rate anticipated to prevail when the securities mature
d. Interest rate paid on European securities

26. Which of the following is likely to result in long-run depreciation of the U.S. dollar relative to the euro?
a. Relatively low interest rates in the United States
b. Relatively high labor productivity in the United States
c. Tariffs levied by the United States on steel imports from Europe
d. Stronger American preferences for goods produced in Europe

27. Which of the following is likely to result in long-run appreciation of the U.S. dollar relative to the peso?
a. Relatively high interest rates in Mexico
b. Relatively high labor productivity in Mexico
c. Tariffs applied by Mexico on computer imports from the United States
d. Stronger Mexican preferences for goods produced in the United States

28. Long-run determinants of the dollar’s exchange value include all of the following except:
a. Preferences of Americans for foreign produced goods
b. U.S. tariffs placed on imports of foreign produced goods
c. Productivity of the American worker
d. Interest rates in U.S. financial markets

29. Which theory of exchange-rate determination best views the foreign exchange market as being similar to a stock exchange where future expectations are important and prices are volatile?
a. Balance-of-payments approach
b. Purchasing-power-parity approach
c. Asset-markets approach
d. Monetary approach

30. According to the purchasing-power-parity theory, the U.S. dollar maintains its purchasing-power parity if it depreciates by an amount equal to the excess of:
a. U.S. interest rates over foreign interest rates
b. Foreign interest rates over U.S. interest rates
c. U.S. inflation over foreign inflation
d. Foreign inflation over U.S. inflation

31. An exchange rate is said to ____ when its short-run response to a change in market fundamentals is greater than its long-run response.
a. Overshoot
b. Undershoot
c. Depreciate
d. Appreciate

32. Concerning exchange rate forecasting, ____ is a common sense approach based on a wide array of political and economic data.
a. Econometric analysis
b. Technical analysis
c. Judgmental analysis
d. Sunspot analysis

33. Concerning exchange rate forecasting, ____ involves the use of historical exchange rate data to estimate future values, while ignoring the economic determinants of exchange rate movements.
a. Econometric analysis
b. Judgmental analysis
c. Technical analysis
d. Sunspot analysis

34. Concerning exchange rate forecasting, ____ relies on econometric models which are based on macroeconomic variables likely to affect currency values.
a. Fundamental analysis
b. Technical analysis
c. Judgmental analysis
d. Sunspot analysis

35. Concerning exchange-rate determination, “market fundamentals” include all of the following except:
a. Monetary policy and fiscal policy
b. Profitability and riskiness of investments
c. Speculative opinion about future exchange rates
d. Productivity changes affecting production costs

36. In the short run, exchange rates respond to market forces such as:
a. Inflation rates
b. Expectations of future exchange rates
c. Investment profitability
d. Government trade policy

37. Long-run exchange rate movements are governed by all of the following except:
a. National productivity levels
b. Consumer tastes and preferences
c. Rates of inflation
d. Interest rate levels

38. Exchange rate determination in the short run is underlied by which of the following assumptions:
a. Tariffs and quotas affect trade patterns only in the short run
b. Prices of goods and services affect trade patterns only in the short run
c. Expected returns on financial assets affect investment flows in the short run
d. Preferences for goods and services affect trade flows only in the short run

39. That identical goods should cost the same in all nations, assuming it is costless to ship goods between nations and there are no barriers to trade, is a reflection of the:
a. Monetary approach to exchange-rate determination
b. Law of one price
c. Fundamentalist approach to exchange-rate determination
d. Exchange-rate-overshooting principle

40. The Canadian dollar would depreciate on the foreign exchange market if:
a. Canadian consumer tastes change in favor of goods produced domestically
b. The profitability of assets in Canada rises relative to the profitability of assets abroad
c. Canada experiences a disastrous wheat-crop failure, leading to imports of more wheat
d. Canada realizes technological improvements in the production of manufactured goods, leading to relatively low costs for Canada

41. The demand in the United States for yen will increase if, other things remaining equal:
a. Labor costs rise in Japan
b. Income rises in Japan
c. Prices rise in Japan
d. Interest rates rise in Japan

42. The quantity of Canadian dollars supplied to the foreign exchange market would increase if, other things remaining equal:
a. Preferences for imports rise in Canada
b. Labor productivity increases in Canada
c. Prices of goods and services decrease in Canada
d. Import tariffs rise in Canada

43. The U.S. demand for pesos would shift to the right if there occurred a (an):
a. Change in preferences toward U.S. manufactured goods
b. Increase in the dollar/peso exchange rate
c. Decrease in the U.S. population
d. Increase in the U.S. price level

44. The supply of francs, would shift to the right for all of the following reasons except:
a. An increase in Swiss real income
b. An increase in Swiss prices
c. An increase in the Swiss population
d. An increase in Swiss interest rates

The figure below illustrates the supply and demand schedules of Swiss francs in a market of freely-floating exchange rates.

Figure 12.1 The Market for Francs

45. Refer to Figure 12.1. Should preferences for imports rise in the United States and fall in Switzerland, there would occur a (an):
a. Increase in the demand for francs–decrease in the supply of francs-depreciation of the dollar
b. Increase in the demand for francs–decrease in the supply of francs-appreciation of the dollar
c. Decrease in the demand for francs–decrease in the supply of francs-appreciation of the dollar
d. Decrease in the demand for francs–increase in the supply of francs-depreciation of the dollar

46. Refer to Figure 12.1. Should real interest rates in the United States rise relative to real interest rates in Switzerland, there would occur a (an):
a. Increase in the demand for francs–decrease in the supply of francs-depreciation of the dollar
b. Increase in the demand for francs–decrease in the supply of francs-appreciation of the dollar
c. Decrease in the demand for francs–increase in the supply of francs-appreciation of the dollar
d. Decrease in the demand for francs–decrease in the supply of francs-depreciation of the dollar

47. Refer to Figure 12.1. Should the U.S. price level rise relative to the Swiss price level, there would occur a (an):
a. Increase in the demand for francs–increase in the supply of francs-appreciation of the dollar
b. Decrease in the demand for francs–decrease in the supply of francs-depreciation of the dollar
c. Increase in the supply of francs–decrease in the demand for francs-appreciation of the dollar
d. Decrease in the supply of francs–increase in the demand for francs-depreciation of the dollar

48. Refer to Figure 12.1. Should the United States impose tariffs on imports from Switzerland, there would occur a (an):
a. Increase in the demand for francs and a depreciation of the dollar
b. Decrease in the demand for francs and an appreciation of the dollar
c. Decrease in the supply of francs and an appreciation of the dollar
d. Increase in the supply of francs and a depreciation of the dollar

49. Refer to Figure 12.1. Should Swiss labor productivity rise, leading to a decrease in Swiss manufacturing costs, there would occur a (an):
a. Increase in the supply of francs and a depreciation of the dollar
b. Increase in the supply of francs and an appreciation of the dollar
c. Decrease in the demand for francs and an appreciation of the dollar
d. Increase in the demand for francs and a depreciation of the dollar

50. Refer to Figure 12.1. If Switzerland experienced a disastrous wheat-crop failure, leading to additional wheat imports from the United States, there would occur an:
a. Increase in the supply of francs and an appreciation of the dollar
b. Increase in the supply of francs and a depreciation of the dollar
c. Increase in the demand for francs and a depreciation of the dollar
d. Increase in the demand for francs and an appreciation of the dollar

51. Given floating exchange rates, if Japan increases its demand for Canadian goods at the same time that Canada increases its demand for Japanese goods, then we would expect the yen’s exchange value to:
a. Appreciate against the dollar
b. Depreciate against the dollar
c. Remain constant against the dollar
d. Appreciate, depreciate, or remain constant against the dollar

52. Given floating exchange rates, assume that the Swiss decrease their import purchases from Italy while at the same time the Italians increase their purchases of Swiss government securities. The first action by itself would lead to a (an) ____ of the franc against the lira while the second action by itself would lead to a (an) ____ of the franc against the lira.
a. Appreciation, appreciation
b. Depreciation, depreciation
c. Appreciation, depreciation
d. Depreciation, appreciation

53. Given floating exchange rates, a simultaneous decrease in the Canadian demand for British products and increase in the British desire to invest in Canadian government securities would cause a (an):
a. Appreciation of the pound against the dollar
b. Depreciation of the pound against the dollar
c. Unchanged pound/dollar exchange rate
d. None of the above

54. Assume a system of floating exchange rates. Due to a high savings rate, suppose the level of savings in Japan is in excess of domestic investment needs. If Japanese residents invest abroad, the yen’s exchange value will ____ and the Japanese trade balance will move toward ____.
a. Appreciate, deficit
b. Appreciate, surplus
c. Depreciate, deficit
d. Depreciate, surplus

55. Given a system of floating exchange rates, assume that Boeing Inc. of the United States places a large order, payable in yen, with a Japanese contractor for jet engine parts. The immediate effect of this transaction will be a shift in the:
a. Supply curve of yen to the left which causes the dollar to appreciate against the yen
b. Supply curve of yen to the right which causes the dollar to depreciate against the yen
c. Demand curve for yen to the left which causes the dollar to appreciate against the yen
d. Demand curve for yen to the right which causes the dollar to depreciate against the yen

56. For purchasing-power parity to exist:
a. Flows of currency in the trade account must be offset by flows of currency in the capital account
b. The nominal interest rate must be equal to the real interest rate in all countries
c. Converting a sum of funds from one currency to another does not alter its purchasing power
d. A country’s trade account must always be in balance

57. Assume that interest rates in the United States and Britain are the same. If a U.S. resident anticipates that the exchange value of the dollar is going to appreciate against the pound, she should:
a. Borrow needed funds from British banks rather than U.S. banks
b. Borrow needed funds from U.S. banks rather than British banks
c. Convert U.S. dollars into British pounds
d. Any of the above

58. Given a system of floating exchange rates, if Canada’s labor productivity rises relative to the labor productivity of its trading partners:
a. Canadian imports will fall and the dollar will appreciate
b. Canadian imports will fall and the dollar will depreciate
c. Canadian imports will rise and the dollar will appreciate
d. Canadian imports will rise and the dollar will depreciate

59. Assume that labor productivity growth is slower in the United States than in its trading partners. Given a system of floating exchange rates, the impact of this growth differential for the United States will be:
a. Increased exports and an appreciation of the dollar
b. Increased exports and a depreciation of the dollar
c. Increased imports and an appreciation of the dollar
d. Increased imports and a depreciation of the dollar

60. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar. According to purchasing-power parity, if the price of traded goods rises by 10 percent in the United States and remains constant in Japan, the exchange rate will become
a. 72 yen per dollar
b. 81 yen per dollar
c. 99 yen per dollar
d. 108 yen per dollar

61. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar. According to purchasing-power parity, if the price of traded goods rises by 5 percent in the United States and 15 percent in Japan, the exchange rate will become:
a. 72 yen per dollar
b. 81 yen per dollar
c. 99 yen per dollar
d. 108 yen per dollar

62. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar. According to purchasing power parity, if the price of traded goods falls by 5 percent in the United States and rises by 5 percent in Japan, the exchange rate will become:
a. 72 yen per dollar
b. 81 yen per dollar
c. 99 yen per dollar
d. 108 yen per dollar

63. Suppose that the yen-dollar exchange rate changes from 85 yen per dollar to 80 yen per dollar. One can say that the:
a. Yen has appreciated against the dollar and the dollar has depreciated against the yen
b. Yen has depreciated against the dollar and the dollar has appreciated against the yen
c. Yen has appreciated against the dollar and the dollar has appreciated against the yen
d. Yen has depreciated against the dollar and the dollar has depreciated against the yen

64. Given a floating exchange rate system an increase in ____ would cause the dollar to appreciate against the euro.
a. U.S. labor costs
b. The U.S. money supply
c. U.S. prices of goods
d. U.S. real interest rates

65. Under a system of floating exchange rates, a Japanese trade surplus against Canada would result in a (an):
a. Rise in the dollar price of the yen
b. Fall in the dollar price of the yen
c. Rise in the yen price of the dollar
d. Unchanged dollar/yen exchange rate

66. When deciding between U.S. and British government securities, an American investor typically considers:
a. U.S. and British interest rates and anticipated changes in the exchange rate
b. Budget deficits of the U.S. government and British government
c. Shifts in the demand for U.S. goods and British goods
d. U.S. and British inflation rates and anticipated changes in the exchange rate

67. In the long run, exchange rates are primarily determined by:
a. Agreements among governments of the world’s industrial countries
b. Relative interest rates in developing countries and industrial countries
c. Economic fundamentals such as relative productivity levels
d. The rate at which country’s currencies exchange for gold

68. Increased tariffs on U.S. steel imports cause the dollar to ____ in the ____.
a. Appreciate, long run
b. Depreciate, long run
c. Appreciate, short run
d. Depreciate, short run

69. Lower tariffs on U.S. agricultural imports cause the dollar to ____ in the ____.
a. Appreciate, long run
b. Depreciate, long run
c. Appreciate, short run
d. Depreciate, short run

70. Relatively high interest rates in the United States causes the dollar to ____ in the ____.
a. Appreciate, long run
b. Depreciate, long run
c. Appreciate, short run
d. Depreciate, short run

71. The asset market theory of exchange rate determination suggests that the most important factor influencing the demand for domestic and foreign securities is:
a. Expected return on these assets relative to one another
b. Ability of these assets to easily be converted into cash
c. Riskiness of these assets relative to one another
d. Level of government restrictions on trade and investment flows

72. With floating exchange rates, easy credit and low short term interest rates lead to
a. Exchange rate depreciation in the short run
b. Exchange rate appreciation in the short run
c. Exchange rate depreciation in the long run
d. Exchange rate appreciation in the long run

73. With floating exchange rates, relatively high productivity growth for a nation leads to
a. Exchange rate depreciation in the short run
b. Exchange rate appreciation in the short run
c. Exchange rate depreciation in the long run
d. Exchange rate appreciation in the long run

74. All of the following are important long-run determinants of exchange rates except
a. Consumer tastes
b. Trade policy
c. Labor productivity
d. Interest rates

75. The purchasing-power parity theory suffers from the problem
a. Of choosing the appropriate price index
b. That it overlooks the influence of capital flows
c. That government policy may modify exchange rates
d. All of the above

TRUE/FALSE

1. In a free market, exchange rates are determined by market fundamentals and market expectations.

2. Concerning exchange-rate determination, market fundamentals include inflation rates, productivity levels, and speculative opinion about future exchange rates.

3. Market expectations include news about market fundamentals, speculative opinion about future exchange rates, and profitability and riskiness of investments.

4. In a free market, the equilibrium exchange rate occurs at the point where the quantity demanded of a foreign currency equals the quantity of that currency supplied.

5. Exchange rates are determined by the unregulated forces of supply and demand for foreign currencies as long as central banks do not intervene in the foreign exchange markets.

6. Over the long run, foreign exchange rates are determined by transfers of bank deposits that respond to differences in real interest rates and to shifting expectations of future exchange rates.

The figure below illustrates the supply and demand schedules of Swiss francs under a system of floating exchange rates.

Figure 12.2. The Market for Swiss Francs

7. Refer to Figure 12.2. If the United States decreases tariffs on imports from Switzerland, there would occur a decrease in the demand for francs and a decrease in the dollar price of the franc.

8. Refer to Figure 12.2. If Swiss manufacturing costs increase relative to those of the United States, there would occur an increase in the supply of francs and an appreciation in the dollar’s exchange value.

9. Refer to Figure 12.2. If the Federal Reserve adopts a restrictive monetary policy that leads to relatively high interest rates in the United States, the demand for francs would decrease, the supply of francs would increase, and the dollar’s exchange value would appreciate.

10. Refer to Figure 12.2. As the profitability of assets in Switzerland rises relative to the profitability of assets in the United States, U.S. residents make additional investments in Switzerland; this leads to an increased demand for francs and a depreciation of the dollar’s exchange value.

11. Refer to Figure 12.2. If the rate of inflation in the United States is higher than the rate of inflation in Switzerland, the demand for francs decreases, the supply of francs increases, and the dollar’s exchange value appreciates.

12. Under floating exchange rates, short-run exchange rates are primarily determined by national differences in real interest rates and shifting expectations of future exchange rates.

13. Day-to-day influences on foreign exchange rates always cause rates to move in the same direction as changes in long-term market fundamentals.

14. With floating exchange rates, a country experiencing faster economic growth than its trading partners find its currency’s exchange value appreciating.

15. If U.S. labor productivity growth is 2 percent per annum and Swiss labor productivity growth is 6 percent per annum, the dollar will depreciate against the franc under a system of floating exchange rates.

16. In 1985 and 1986 U.S. interest rates fell relative to interest rates in Japan. Under floating exchange rates, this would lead to the dollar’s exchange value depreciating against the yen.

17. A country having stronger preferences for imports than its trading partners have for its exports finds its demand for foreign exchange rising more rapidly than its supply of foreign exchange.

18. Economies with relatively high growth rates in labor productivity tend to find their currencies’ exchange values appreciating under a floating exchange-rate system.

19. Under floating exchange rates, relatively low domestic interest rates tend to promote depreciation of a currency’s exchange value while relatively high domestic interest rates lead to currency appreciation.

20. Suppose expansionary monetary policy in the United States leads to interest rates falling to 2 percent while tight monetary policy in Switzerland leads to interest rates rising to 8 percent. With floating exchange rates, the dollar would appreciate against the franc.

21. The purchasing-power-parity theory is used to predict exchange-rate movements in the short run.

22. According to the law of one price, identical goods should cost the same in all nations, assuming there are no shipping costs nor trade barriers.

23. The purchasing- power-parity theory predicts that if the U.S. inflation rate exceeds the Japanese inflation rate by 4 percent, the dollar’s exchange value will appreciate by 4 percent against the yen.

24. Assume the initial yen/dollar exchange rate to be 100 yen per dollar. If the U.S. inflation rate is 2 percent and the Japanese inflation rate is 7 percent, the exchange rate should move to 105 yen per dollar according to the purchasing-power-parity theory.

25. Assume the initial dollar/pound exchange rate to be $2 per pound. If the U.S. inflation rate is 8 percent and the U.K. inflation rate is 3 percent, the exchange rate should move to $2.10 per pound according to the purchasing-power-parity theory.

26. If consumer tastes in the United States change in favor of goods produced in France, the demand for francs will increase which causes an appreciation of the dollar against the franc under a floating exchange rate system.

27. As the profitability of Japanese assets rises relative to the profitability of Australian assets, Australian residents will make additional investments in Japan; this results in an increased demand for yen and a depreciation of the dollar under a system of floating exchange rates.

28. If the United States experiences an enormous wheat crop failure, it will have to import more wheat and the dollar’s exchange value will depreciate under a system of floating exchange rates.

29. If Japan realizes technological improvements in the production of automobiles, which lowers its production costs relative to foreign producers, Japanese exports will rise and the yen’s exchange value will appreciate under a system of floating exchange rates.

30. If Mexico applies tariffs to imports of manufactured goods, Mexico’s demand for foreign exchange will rise and the peso will depreciate under a system of floating exchange rates.

31. According to the “Big Mac” index, if a Big Mac costs $2.28 in the United States and 25.75 krone in Denmark (equivalent to $4.25), the Danish krone is an undervalued currency.

32. According to the “Big Mac” index, if a Big Mac costs $2.28 in the United States and 48 baht in Thailand (equivalent to $1.91), the baht is an undervalued currency.

33. Long-run determinants of exchange rate include labor productivity levels, inflation rates, consumer preferences for goods and services, and trade barriers.

34. In the short run, exchange rates are primarily determined by investor expectations of returns on assets such as government securities and bank accounts.

35. Changes in market expectations have their greatest impact on exchange-rate changes over the long run as opposed to the short run.

36. If it is widely expected that the British economy will experience more rapid inflation than the Australian economy, the pound will depreciate against the dollar under a system of floating exchange rates.

37. According to the asset-markets approach, adjustments among financial assets are a key determinant of long-run movements in exchange rates.

38. The asset-markets approach views exchange-rate determination as similar to the stock market in which prices are volatile and expectations are important.

39. According to the principle of exchange-rate overshooting, a short-run depreciation of a currency is likely to be greater than a long-run depreciation of that currency.

40. Exchange-rate overshooting is based on the notion that the supply schedule of a currency is more elastic in the short run than in the long run.

41. According to exchange-rate overshooting, an appreciation of the Australian dollar is likely to be greater over a long time period than over a short time period.

42. Concerning exchange rate forecasting, fundamental analysis involves consideration of a variety of macroeconomic variables and policies that tend to affect currency values.

43. Econometric models are best suited for forecasting long-run exchange rates rather than short-run exchange rates.

44. Concerning exchange rate forecasting, technical analysis extrapolates from past exchange-rate trends while ignoring economic and political determinants of exchange rates.

45. Given an efficient foreign exchange market, the spot rate is the rational approximation of the markets expectation of the forward rate that will exist at the end of the forward period.

46. A forward premium on the British pound serves as a rough benchmark of the expected rate of appreciation in the pound’s spot rate.

47. A forward discount on Mexico’s peso serves as a rough benchmark of the expected appreciation in the peso’s spot rate.

48. If you were considering hiring a forecasting firm to predict future spot rates of the yen, you would hope that the firm could predict better what would be implied by the yen’s forward rate.

49. Although the law of one price predicts that identical goods should cost the same in all nations, transportation costs and tariffs tend to prevent this prediction from actually occurring.

50. If real interest rates decline in the United States relative to real interest rates abroad, the dollar’s exchange value will appreciate under a floating exchange-rate system.

SHORT ANSWER

1. What is the purchasing power parity approach to exchange rate determination?

2. What is exchange rate overshooting?

ESSAY

1. In a free market, what determines exchange rates in the long run and the short run?

2. What is the asset market approach to exchange rate determination?

CHAPTER 13—BALANCE-OF-PAYMENTS ADJUSTMENTS

MULTIPLE CHOICE

1. Which of the following does not represent an automatic adjustment in balance-of-payments disequilibrium? Variations in:
a. Domestic income
b. Foreign prices
c. Domestic prices
d. Foreign par values

2. The balance-of-payments adjustment mechanism developed during the 1700s by the English economist David Hume is the:
a. Income-adjustment mechanism
b. Flexible-exchange-rate-adjustment mechanism
c. Price-adjustment mechanism
d. Rank-reserve-adjustment mechanism

3. Which chain of events would promote payments equilibrium for a surplus nation, according to the price-adjustment mechanism?
a. Increasing money supply–increasing domestic prices–rising imports–falling exports
b. Increasing money supply–falling domestic prices–rising imports–falling exports
c. Decreasing money supply–increasing domestic prices–falling imports–rising exports
d. Decreasing money supply–decreasing domestic prices–falling imports–rising exports

4. Which chain of events would promote payments equilibrium for a deficit nation, according to the price-adjustment mechanism?
a. Increasing money supply–increasing domestic prices–rising imports–falling exports
b. Increasing money supply–falling domestic prices–rising imports–falling exports
c. Decreasing money supply–increasing domestic prices–falling imports–rising exports
d. Decreasing money supply–decreasing domestic prices–falling imports–rising exports

5. During the gold standard era, central bankers agreed to react positively to international gold flows so as to reinforce the automatic adjustment mechanism. Which of the following best represents the above statement?
a. Income-adjustment mechanism
b. Price-adjustment mechanism
c. Rules of the game
d. Discretionary fiscal policy

6. During the gold standard era, the “rules of the game” suggested that:
a. Surplus countries should increase their money supplies
b. Deficit countries should increase their money supplies
c. Surplus and deficit countries should increase their money supplies
d. Surplus and deficit countries should decrease their money supplies

7. Which of the following balance-of-payments adjustment mechanisms is most closely related to the quantity theory of money?
a. Income-adjustment mechanism
b. Price-adjustment mechanism
c. Interest-rate-adjustment mechanism
d. Output-adjustment mechanism

8. Under the gold standard, a surplus nation facing a gold inflow and an increase in its money supply would also experience a:
a. Rise in its interest rate and a short-term financial inflow
b. Rise in its interest rate and a short-term financial outflow
c. Fall in its interest rate and a short-term financial inflow
d. Fall in its interest rate and a short-term financial outflow

9. Under the gold standard, a deficit nation facing a gold outflow and a decrease in its money supply would also experience a:
a. Rise in its interest rate and a short-term financial inflow
b. Rise in its interest rate and a short-term financial outflow
c. Fall in its interest rate and a short-term financial inflow
d. Fall in its interest rate and a short-term financial outflow

10. Assume that Canada initially faces payments equilibrium in its merchandise trade account as well as in its capital and financial account. Now suppose that Canadian interest rates increase to levels higher than those abroad. For Canada, this tends to promote:
a. Net financial inflows
b. Net financial outflows
c. Net merchandise exports
d. Net merchandise imports

11. Assume that Canada initially faces payments equilibrium in its merchandise trade account as well as in its capital and financial account. Now suppose that Canadian interest rates fall to levels below those abroad. For Canada, this tends to promote:
a. Net financial inflows
b. Net financial outflows
c. Net merchandise exports
d. Net merchandise imports

12. Suppose the United States levies an interest equalization tax, which taxes Americans on dividend and interest income from foreign securities. Such a tax would be intended to:
a. Encourage financial movements from the United States to overseas
b. Discourage financial movements from the United States to overseas
c. Discourage financial movements from overseas to the United States
d. None of the above

13. Assume that interest rates on comparable securities are identical in the United States and foreign countries. Now suppose that investors anticipate that in the future the U.S. dollar will appreciate against foreign currencies. Investment funds would thus be expected to:
a. Flow from the United States to foreign countries
b. Flow from foreign countries to the United States
c. Remain totally in foreign countries
d. Not be affected by the expected dollar appreciation

14. Suppose Japan increases its imports from Sweden, leading to a rise in Sweden’s exports and income level. With a higher income level, Sweden imports more goods from Japan. Thus a change in imports in Japan results in a feedback effect on its exports. This process is best referred to as the:
a. Monetary approach to balance-of-payments adjustment
b. Discretionary income adjustment process
c. Foreign repercussion effect
d. Price-specie flow mechanism

Exhibit 13.1

Assume the marginal propensity to consume for U.S. households equals 0.9, and the marginal propensity to import for the United States equals 0.1. Suppose there occurs an increase in investment of $10 billion at each level of income.

15. Refer to Exhibit 13.1. The value of the multiplier for the United States equals:
a. 2
b. 3
c. 4
d. 5

16. Refer to Exhibit 13.1. The change in the level of U.S. income resulting from the additional investment spending equals
a. $20 billion
b. $30 billion
c. $40 billion
d. $50 billion

17. Refer to Exhibit 13.1. The change in the level of U.S. imports resulting from the rise in U.S. income equals:
a. $5 billion
b. $10 billion
c. $15 billion
d. $20 billion

18. The monetary approach to balance-of-payments adjustments suggests that all payments deficits are the result of:
a. Too high interest rates in the home country
b. Too low interest rates in the home country
c. Excess money supply over money demand in the home country
d. Excess money demand over money supply in the home country

19. The monetary approach to balance-of-payments adjustments suggests that all payments surpluses are the result of:
a. Too high interest rates in the home country
b. Too low interest rates in the home country
c. Excess money supply over money demand in the home country
d. Excess money demand over money supply in the home country

20. Starting from a position where the nation’s money demand equals the money supply, and its balance of payments is in equilibrium, economic theory suggests that the nation’s balance of payments would move into a deficit position if there occurred in the nation a:
a. Decrease in the money supply
b. Increase in the money demand
c. Decrease in the money demand
d. None of the above

21. Which approach to balance-of-payments adjustment suggests that balance-of-payments surpluses are the result of excess money demand in the home country?
a. Absorption approach
b. Elasticities approach
c. Monetary approach
d. Purchasing-power-parity approach

22. According to the “rules of the game” of the gold standard era, a country’s central bank agreed to react to international gold flows so as to:
a. Officially devalue a currency during eras of payments surpluses
b. Officially revalue a currency during eras of payments deficits
c. Offset the automatic-adjustment mechanism (e.g., prices)
d. Reinforce the automatic-adjustment mechanism

23. According to the quantity theory of money, a change in the domestic money supply will bring about:
a. Inverse and proportionate changes in the price level
b. Inverse and less-than-proportionate changes in the price level
c. Direct and proportionate changes in the price level
d. Direct and less-than-proportionate changes in the price level

24. The formulation of the so-called income adjustment mechanism is associated with:
a. Adam Smith
b. David Ricardo
c. David Hume
d. John Maynard Keynes

25. The value of the foreign trade multiplier equals the reciprocal of the sum of the marginal propensities to:
a. Save plus import
b. Import plus invest
c. Consume plus export
d. Save plus import

26. Starting from a position where the nation’s money demand equals the money supply and its balance of payments is in equilibrium, economic theory suggests that the nation’s balance of payments would move into a deficit position if there occurred in the nation:
a. An increase in the money supply
b. A decrease in the money supply
c. An increase in money demand
d. None of the above

27. Starting from a position where the nation’s money demand equals the money supply and its balance of payments is in equilibrium, economic theory suggests that the nation’s balance of payments would move into a surplus position if there occurred in the nation:
a. A decrease in the money supply
b. An increase in the money supply
c. A decrease in the money demand
d. None of the above

28. Starting from a position where the nation’s money demand equals the money supply and its balance of payments is in equilibrium, economic theory suggests that the nation’s balance of payments would move into a surplus position if there occurred in the nation:
a. An increase in the money demand
b. A decrease in the money demand
c. An increase in the money supply
d. None of the above

29. Assume identical interest rates on comparable securities in the United States and foreign countries. Suppose investors anticipate that in the future the U.S. dollar will depreciate against foreign currencies. Investment funds would tend to:
a. Flow from the United States to foreign countries
b. Flow from foreign countries to the United States
c. Remain totally in foreign countries
d. Remain totally in the United States

30. Suppose that rising U.S. income leads to higher sales and profits in the United States. This would likely result in:
a. Increasing portfolio investment into the United States
b. Decreasing portfolio investment into the United States
c. Increasing direct investment into the United States
d. Decreasing direct investment into the United States

Figure 13.1. U.S. Capital and Financial Account

31. Refer to Figure 13.1. Upward movements along U.S. capital and financial account schedule CA0 would be caused by:
a. U.S. interest rates rising relative to foreign interest rates
b. U.S. interest rates falling relative to foreign interest rates
c. Taxes placed on income earned by U.S. residents from their foreign investments
d. Taxes placed on income earned by foreign residents from their U.S. investments

32. Refer to Figure 13.1. Downward movements along U.S. capital and financial account schedule CA0 would be caused by:
a. U.S. interest rates rising relative to foreign interest rates
b. U.S. interest rates falling relative to foreign interest rates
c. Taxes placed on income earned by U.S. residents from their foreign investments
d. Taxes placed on income earned by foreign residents from their U.S. investments

33. Refer to Figure 13.1. The U.S. capital and financial account schedule would shift upward from CA0 to CA1 if:
a. U.S. interest rates exceeded foreign interest rates
b. Foreign interest rates exceeded U.S. interest rates
c. Taxes were placed on income earned by U.S. residents from their foreign investments
d. Taxes were placed on income earned by foreign residents from their U.S. investments

34. Refer to Figure 13.1. The U.S. capital and financial account schedule would shift upward from CA0 to CA1 if:
a. U.S. residents receive subsidies to invest in foreign nations
b. U.S. interest rates rise relative to foreign interest rates
c. Taxes are reduced on income earned by U.S. residents from their foreign investments
d. Expected profits decline on U.S. investments in foreign manufacturing

35. Refer to Figure 13.1. The U.S. capital and financial account schedule would shift upward from CA0 to CA1 for all of the following reasons except:
a. U.S. political stability improves relative to foreign political stability
b. U.S. interest rates fall relative to foreign interest rates
c. Taxes are placed on income earned by U.S. residents from foreign investments
d. Restrictions are imposed on foreign loans granted by U.S. banks

36. Refer to Figure 13.1. U.S. capital and financial account schedule CA0 would shift upwards, or downwards, for all of the following reasons except:
a. U.S. residents being taxed on income earned from foreign investments
b. U.S. banks being restricted on loans that can be made abroad
c. U.S. political stability changing relative to foreign political stability
d. U.S. interest rates changing relative to foreign interest rates

Table 13.1. Canada’s Saving, Investment, Import, and Export Functions (in billions of dollars) Under a System of Fixed Exchange Rates

Export Function X = 3000
Investment Function I = 1000
Saving Function S = -1000 + 0.2Y
Import Function M = 500 + 0.25Y

37. Referring to Table 13.1, if Canada’s income rises by $200 billion, saving would rise by:
a. $10 billion
b. $20 billion
c. $30 billion
d. $40 billion

38. Referring to Table 13.1, if Canada’s income rises by $200 billion, imports would rise by:
a. $50 billion
b. $75 billion
c. $100 billion
d. $125 billion

39. Referring to Table 13.1, Canada’s foreign trade multiplier equals:
a. 1.75
b. 2.05
c. 2.22
d. 2.64

40. Referring to Table 13.1, Canada’s equilibrium level of income is:
a. $8000 billion
b. $9000 billion
c. $10,000 billion
d. $11,000 billion

41. Refer to Table 13.1. If improved business optimism leads to increases in Canada’s planned investment spending from $1000 billion to $1200 billion, Canada’s equilibrium income rises by approximately:
a. $444 billion
b. $555 billion
c. $666 billion
d. $777 billion

42. Refer to Table 13.1. If weak economic conditions abroad result in Canada’s exports falling from $3000 billion to $2500 billion, Canada’s equilibrium income falls by approximately:
a. $888 billion
b. $990 billion
c. $1110 billion
d. $1220 billion

Figure 13.2. Australian Economy Under a Fixed Exchange Rate System

43. Refer to Figure 13.2. The slope of the (X-M) schedule and (S-I) schedule indicates that Australia’s foreign trade multiplier is:
a. 0.5
b. 1.0
c. 1.5
d. 2.0

44. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that improving economic conditions abroad lead to an autonomous increase in Australian exports of $5 billion. Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a. Rises to $60 billion, surplus of $2.5 billion
b. Rises to $60 billion, surplus of $5 billion
c. Falls to $40 billion, deficit of $2.5 billion
d. Falls to $40 billion, deficit of $5 billion

45. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S- I)0 intersects (X-M)0, suppose that worsening economic conditions abroad lead to an autonomous decrease in Australian exports of $5 billion. Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a. Rises to $60 billion, surplus of $2.5 billion
b. Rises to $60 billion, surplus of $5 billion
c. Falls to $40 billion, deficit of $2.5 billion
d. Falls to $40 billion, deficit of $5 billion

46. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that improving profit expectations lead to an autonomous increase in Australian investment of $5 billion. Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a. Rises to $60 billion, deficit of $2.5 billion
b. Rises to $60 billion, deficit of $5 billion
c. Falls to $40 billion, surplus of $2.5 billion
d. Falls to $40 billion, surplus of $5 billion

47. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that worsening profit expectations lead to an autonomous decrease in Australian investment of $5 billion. Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a. Rises to $60 billion, deficit of $2.5 billion
b. Rises to $60 billion, deficit of $5 billion
c. Falls to $40 billion, surplus of $2.5 billion
d. Falls to $40 billion, surplus of $5 billion

48. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that increased thriftiness leads to an autonomous increase in Australian saving of $5 billion. Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a. Rises to $60 billion, deficit of $2.5 billion
b. Rises to $60 billion, deficit of $5 billion
c. Falls to $40 billion, surplus of $2.5 billion
d. Falls to $40 billion, surplus of $5 billion

49. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that dwindling thriftiness leads to an autonomous decrease in Australian saving to $5 billion. Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a. Rises to $60 billion, deficit of $2.5 billion
b. Rises to $60 billion, deficit of $5 billion
c. Falls to $40 billion, surplus of $2.5 billion
d. Falls to $40 billion, surplus of $5 billion

50. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that changing preferences lead to an autonomous increase in Australian imports of $5 billion. Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a. Rises to $60 billion, surplus of $2.5 billion
b. Rises to $60 billion, surplus of $5 billion
c. Falls to $40 billion, deficit of $2.5 billion
d. Falls to $40 billion, deficit of $5 billion

51. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that changing preferences lead to an autonomous decrease in Australian imports of $5 billion. Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a. Rises to $60 billion, surplus of $2.5 billion
b. Rises to $60 billion, surplus of $5 billion
c. Falls to $40 billion, deficit of $2.5 billion
d. Falls to $40 billion, deficit of $5 billion

52. In explaining balance-of-payments adjustments, the classical economists
a. Focused on interest rates exclusively
b. Remained aware of the role of interest rates
c. Only focused their attention on short-term interest rates
d. Paid exclusive attention to long-tem interest rates

53. J. M. Keynes suggested that a trade deficit nation
a. Would experience a fall in income
b. Would experience a decline in imports
c. Would require active intervention by the government
d. Both a and b

54. The classical gold standard
a. Existed from early 1800’s to early 1900’s
b. Did not allow for imports and exports of gold
c. Led to the outflow of gold from surplus nations
d. Led to the inflow of gold to deficit nations

55. The classical economists assumed
a. That the volume of final output is fixed at the full-employment level in the long-run
b. The velocity of money is constant
c. The velocity of money depends on physical, structural, and institutional factors
d. All of the above

TRUE/FALSE

1. Under a fixed exchange rate system, adjustment mechanisms work for the automatic return to current-account balance after the initial balance has been disrupted.

2. When a country’s current account moves into disequilibrium, automatic adjustments in tariffs and quotas occur which move the current account back into equilibrium.

3. Prices, interest rates, and income are the automatic adjustment variables that help restore current-account equilibrium under a system of fixed exchange rates.

4. That the balance of payments could be adjusted by prices and interest rates, under a fixed exchange rate system, originated with Keynesian theory during the 1930s.

5. David Hume’s price-adjustment mechanism supported the mercantilist view that a nation could maintain a trade surplus indefinitely.

6. Under the price-adjustment mechanism, a government’s efforts to maintain a current-account surplus is self defeating over the long run because a nation’s current account automatically moves toward equilibrium.

7. Under the gold standard of the 1800s, exchange rates were allowed to float freely in the currency markets.

8. Under the gold standard, each participating nation defined the mint price of gold in terms of its national currency was prepared to buy and sell gold at that price.

9. Under the gold standard, a nation with a current-account surplus would realize gold outflows, a decrease in its money supply, and a fall in its domestic price level.

10. The essence of the classical price-adjustment mechanism is embodied in the quantity theory of money.

11. According to the equation of exchange, the total expenditures on final goods equals the monetary value of the final goods sold.

12. Regarding the equation of exchange, the classical economists assumed that final output was below its maximum level while the velocity of money was volatile.

13. According to the quantity theory of money, a change in the money supply will induce an inverse and less-than-proportionate change in the price level.

14. Under the price-adjustment mechanism, a trade-surplus nation would realize gold inflows, an increase in its money supply, and a loss of international competitiveness.

15. The price-adjustment mechanism’s relevance to the real world has been questioned on the grounds that national output is generally not at the full-employment level and that the velocity of money is not always constant.

16. According to the price-adjustment mechanism, trade deficits can occur only in the long run rather than in the short run.

17. Under the price-adjustment mechanism, trade-deficit nations realize price inflation and a loss of competitiveness while trade surplus nations realize price deflation and an improvement in competitiveness.

18. Under the classical gold standard, adjustments in domestic prices and short-term interest rates automatically promoted balance-of-payments equilibrium over the long run.

19. Under the classical gold standard, a trade surplus nation would realize gold inflows, an increase in its money supply, rising interest rates, and net investment inflows.

20. The gold standard’s “rules of the game” required central bankers in a surplus country to initiate contractionary monetary policies which lead to higher interest rates and net investment inflows.

21. The gold standard’s “rules of the game” required central bankers in a trade deficit nation to expand the money supply, leading to falling interest rates and net investment outflows.

22. The “rules of the game” served to reinforce and speed up the interest-rate-adjustment mechanism under a system of fixed exchange rates.

Figure 13.3. U.S. Capital and Financial Account Under a Fixed Exchange Rate System

23. Refer to Figure 13.3. As U.S. interest rates rise relative to foreign interest rates, the U.S. slides upward along schedule CA0, thus moving towards capital and financial account surplus.

24. Refer to Figure 13.3. Decreases in U.S. interest rates relative to foreign interest rates would shift U.S. capital and financial account schedule CA0 downward toward CA1, resulting in net financial outflows from the United States.

25. Refer to Figure 13.3. Falling investment profitability in the United States, relative to investment profitability abroad, would shift the U.S. capital and financial account schedule downward from CA0 to CA1, resulting in net financial outflows from the United States.

26. Refer to Figure 13.3. As the U.S. government decreases taxes on income earned by U.S. residents from foreign investments, the U.S. capital and financial account schedule shifts downward from CA0 to CA1 and the United States realizes net financial outflows.

27. Refer to Figure 13.3. If the political and economic stability of foreign countries worsens relative to that of the United States, the U.S. capital and financial account schedule would shift downward from CA0 to CA1, resulting in net financial outflows from the United States.

28. According to the Keynesian income-adjustment mechanism, income differentials among nations guarantee current-account equilibrium in a world of fixed exchange rates.

29. Keynesian theory asserts that, under a system of fixed exchange rates, the influence of income changes in surplus and deficit countries will automatically promote current-account equilibrium.

30. The Keynesian income-adjustment mechanism contends that a trade-surplus nation tends to realize falling income and falling imports, thus accentuating the trade surplus.

31. The foreign-trade multiplier equals the sum of the marginal propensity to import and the marginal propensity to save.

32. If the marginal propensity to save equals 0.2 and the marginal propensity to import equals 0.3, the foreign-trade multiplier equal 2.0.

33. For an open economy subject to international trade, equilibrium income occurs where saving plus investment equals imports plus exports.

34. If the marginal propensity to save equals 0.1 and the marginal propensity to import equals 0.3, an autonomous increase in exports of $1,000 would expand domestic income by $2,500 which leads to an increase in imports of $750.

35. If the marginal propensity to save equals 0.2 and the marginal propensity to import equals 0.3, an autonomous decrease in investment spending of $1 million leads to a $2 million decrease in domestic income and a $600,000 decrease in imports.

36. For the income adjustment mechanism to reverse a trade deficit, economic policymakers must be willing to permit domestic income to increase which leads to rising imports.

37. Reliance on an automatic adjustment process tends to be unacceptable in trade-deficit nations since it requires them to accept price deflation and/or falling income as a cost of reducing imports.

38. An “automatic” adjustment mechanism would require a trade-surplus nation to accept price deflation and/or falling income as the cost of increasing imports.

Figure 13.4. Canadian Economy Under a Fixed Exchange Rate System

39. Referring to Figure 13.4, Canada’s marginal propensity to save equals 0.25 and marginal propensity to import equal 0.5.

40. Referring to Figure 13.4, Canada’s foreign-trade multiplier equals 2.0.

41. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S – I)0 intersects (X – M)0, an autonomous decrease in Canadian imports of $10 billion leads to a $20 billion decrease in income and a trade deficit of $5 billion.

42. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S – I)0 intersects (X – M)0, an autonomous increase in Canadian investment of $10 billion leads to a $20 billion increase in income and no change in the country’s trade account.

43. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S – I)0 intersects (X – M)0, an autonomous decrease in saving of $10 billion leads to a $20 billion increase in income and a trade deficit of $5 billion.

44. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S – I)0 intersects (X – M)0, an autonomous decrease in Canadian exports of $10 billion leads to a $20 decrease in income and a trade deficit of $5 billion.

45. According to the monetary approach, balance-of-payments disequilibriums are the result of imbalances in a country’s money supply and money demand.

46. The monetary approach contends that, under a fixed exchange rate system, an excess supply of money leads to a trade surplus.

47. The monetary approach contends that, under a fixed exchange rate system, an excess demand for money leads to a trade deficit.

48. The monetary approach contends that, under a fixed exchange rate system, policies that increase the supply of money relative to the demand for money lead to a trade surplus.

SHORT ANSWER

1. Compared to classical economists, how did Keynesian economics change the discussion of trade adjustment?

2. What is the foreign repercussion effect?

ESSAY

1. Explain David Hume’s theory of automatic adjustment for balance of payments disequilibria.

2. Is the monetary approach to the balance-of-payments part of the traditional adjustment theories?

ECO 305 Week 10 Quiz

CHAPTER 14—EXCHANGE-RATE ADJUSTMENTS AND THE BALANCE OF PAYMENTS

MULTIPLE CHOICE

1. According to the absorption approach, the economic circumstances that best warrant a currency devaluation is where the domestic economy faces:
a. Unemployment coupled with a payments deficit
b. Unemployment coupled with a payments surplus
c. Full employment coupled with a payments deficit
d. Full employment coupled with a payments surplus

2. According to the J-curve effect, when the exchange value of a country’s currency appreciates, the country’s trade balance:
a. First moves toward deficit, then later toward surplus
b. First moves toward surplus, then later toward deficit
c. Moves into deficit and stays there
d. Moves into surplus and stays there

3. Assume that Brazil has a constant money supply and that it devalues its currency. The monetary approach to devaluation reasons that one of the following tends to occur for Brazil:
a. Domestic prices rise–purchasing power of money falls–consumption falls
b. Domestic prices rise–purchasing power of money rises–consumption rises
c. Domestic prices fall–purchasing power of money rises–consumption falls
d. Domestic prices fall–purchasing power of money rises–consumption rises

4. According to the Marshall-Lerner approach, a currency depreciation will best lead to an improvement on the home country’s trade balance when the:
a. Home demand for imports is inelastic–foreign export demand is inelastic
b. Home demand for imports is inelastic–foreign export demand is elastic
c. Home demand for imports is elastic–foreign export demand is inelastic
d. Home demand for imports is elastic–foreign export demand is elastic

5. Assume an economy operates at full employment and faces a trade deficit. According to the absorption approach, currency devaluation will improve the trade balance if domestic:
a. Interest rates rise, thus encouraging investment spending
b. Income rises, thus stimulating consumption
c. Output falls to a lower level
d. Spending is cut, thus freeing resources to produce exports

6. An appreciation of the U.S. dollar tends to:
a. Discourage foreigners from making investments in the United States
b. Discourage Americans from purchasing foreign goods and services
c. Increase the number of dollars that could be bought with foreign currencies
d. Discourage Americans from traveling overseas

7. The Marshall-Lerner condition deals with the impact of currency depreciation on:
a. Domestic income
b. Domestic absorption
c. Purchasing power of money balances
d. Relative prices

8. According to the J-curve concept, which of the following is false–that the effects of a currency depreciation on the balance of payments are:
a. Transmitted primarily via the income adjusted mechanism
b. Likely to be adverse or negative in the short run
c. In the long run positive, given favorable elasticity conditions
d. Influenced by offsetting devaluations made by other countries

9. Which of the following is true for the J-curve effect? It:
a. Applies to the interest rate effects of currency depreciation
b. Applies to the income effects of currency depreciation
c. Suggests that demand tends to be most elastic over the long run
d. Suggests that demand tends to be least elastic over the long run

10. American citizens planning a vacation abroad would welcome:
a. Appreciation of the dollar
b. Depreciation of the dollar
c. Higher wages extended to foreign workers
d. Lower wages extended to foreign workers

11. Assume the Canadian demand elasticity for imports equals 0.2, while the foreign demand elasticity for Canadian exports equals 0.3. Responding to a trade deficit, suppose the Canadian dollar depreciates by 20 percent. For Canada, the depreciation would lead to a:
a. Worsening trade balance–a larger deficit
b. Improving trade balance–a smaller deficit
c. Unchanged trade balance
d. None of the above

12. Assume the Canadian demand elasticity for imports equals 1.2, while the foreign demand elasticity for Canadian exports equals 1.8. Responding to a trade deficit, suppose the Canadian dollar depreciates by 10 percent. For Canada, the depreciation would lead to a(n):
a. Worsening trade balance–a larger deficit
b. Improving trade balance–a smaller deficit
c. Unchanged trade balance
d. None of the above

13. From 1985 to 1988 the U.S. dollar depreciated over 50 percent against the yen, yet Japanese export prices to Americans did not come down the full extent of the dollar depreciation. This is best explained by:
a. Partial currency pass-through
b. Complete currency pass-through
c. Partial J-curve effect
d. Complete J-curve effect

14. Because of the J-curve effect and partial currency pass-through, a depreciation of the domestic currency tends to increase the size of a:
a. Trade surplus in the short run
b. Trade surplus in the long run
c. Trade deficit in the short run
d. Trade deficit in the long run

15. According to the Marshall-Lerner condition, a currency depreciation is least likely to lead to an improvement in the home country’s trade balance when:
a. Home demand for imports is inelastic and foreign export demand is inelastic
b. Home demand for imports is elastic and foreign export demand is inelastic
c. Home demand for imports is inelastic and foreign export demand is elastic
d. Home demand for imports is elastic and foreign export demand is elastic

16. If foreign manufacturers cut manufacturing costs and profit margins in response to a depreciation in the U.S. dollar, the effect of these actions is to:
a. Shorten the amount of time in which the depreciation leads to a smaller trade deficit
b. Shorten the amount of time in which the depreciation leads to a smaller trade surplus
c. Lengthen the amount of time in which the depreciation leads to a smaller trade deficit
d. Lengthen the amount of time in which the depreciation leads to a smaller trade surplus

17. The shift in focus toward imperfectly competitive markets in domestic and international trade questions the concept of:
a. Official exchange rates
b. Complete currency pass-through
c. Exchange arbitrage
d. Trade-adjustment assistance

18. The extent to which a change in the exchange rate leads to changes in import and export prices is known as:
a. The J-curve effect
b. The Marshall-Lerner effect
c. The absorption effect
d. Pass-through effect

19. Complete currency pass-through arises when a 10 percent depreciation in the value of the dollar causes U.S.:
a. Import prices to fall by 10 percent
b. Import prices to rise by 10 percent
c. Export prices to rise by 10 percent
d. Export prices to rise by 20 percent

20. Which approach predicts that if an economy operates at full employment and faces a trade deficit, currency devaluation (depreciation) will improve the trade balance only if domestic spending is cut, thus freeing resources to produce exports?
a. The absorption approach
b. The Marshall-Lerner approach
c. The monetary approach
d. The elasticities approach

21. Which approach analyzes a nation’s balance of payments in terms of money demand and money supply?
a. Expenditures approach
b. Absorption approach
c. Elasticities approach
d. Monetary approach

22. The ____ effect suggests that following a currency depreciation a country’s trade balance worsens for a period before it improves.
a. Marshall-Lerner
b. J-curve
c. Absorption
d. Pass-through

23. The J-curve effect implies that following a currency appreciation, a country’s trade balance:
a. Worsens before it improves
b. Continually worsens
c. Improves before it worsens
d. Continually improves

24. Which analysis considers the extent by which foreign and domestic prices adjust to a change in the exchange rate in the short run:
a. Monetary analysis
b. Absorption analysis
c. Expenditures analysis
d. Pass-through analysis

25. The longer the currency pass-through period, the ____ required for currency depreciation to have the intended effect on the trade balance.
a. Shorter the time period
b. Longer the time period
c. Larger the spending cut
d. Smaller the spending cut

26. The shorter the currency pass-through period, the ____ required for currency depreciation to have the intended effect on the trade balance.
a. Shorter the time period
b. Longer the time period
c. Larger the spending cut
d. Smaller the spending cut

27. Assume that Ford Motor Company obtains all of its inputs in the United States and all of its costs are denominated in dollars. A depreciation of the dollar’s exchange value:
a. Enhances its international competitiveness
b. Worsens its international competitiveness
c. Does not affect its international competitiveness
d. None of the above

28. Assume that Ford Motor Company obtains all of its inputs in the United States and all of its costs are denominated in dollars. An appreciation of the dollar’s exchange value:
a. Enhances its international competitiveness
b. Worsens its international competitiveness
c. Does not affect its international competitiveness
d. None of the above

29. Assume that Ford Motor Company obtains some of its inputs in Mexico (foreign sourcing). As the peso becomes a larger portion of Ford’s total costs, a dollar appreciation leads to a ____ in the peso cost of a Ford vehicle and a ____ in the dollar cost of a Ford compared to the cost changes that occur when all input costs are dollar denominated.
a. Smaller increase, larger decrease
b. Smaller increase, smaller decrease
c. Larger increase, smaller decrease
d. Larger increase, larger decrease

30. Assume that Ford Motor Company obtains some of its inputs in Mexico (foreign sourcing). As the peso becomes a larger portion of Ford’s total costs, a dollar depreciation leads to a (an) ____ in the peso cost of a Ford vehicle and a (an) ____ in the dollar cost of a Ford compared to the cost changes that occur when all input costs are dollar denominated.
a. Decrease, increase
b. Increase, decrease
c. Decrease, decrease
d. Increase, increase

31. Given favorable elasticity conditions, an appreciation of the yen results in
a. A smaller Japanese trade deficit
b. A larger Japanese trade surplus
c. Decreased prices for imported products for Japan
d. Increased prices for imported products for Japan

32. Given favorable elasticity conditions, a depreciation of the lira tends to result in:
a. Lower prices of imported products for Italy
b. Higher prices of imported products for Italy
c. A larger trade deficit for Italy
d. A smaller trade surplus for Italy

33. According to the J-curve effect, a depreciation of the pound’s exchange value has:
a. No impact on a U.K. balance-of-trade deficit in the short run
b. No impact on a U.K. balance-of-trade deficit in the long run
c. An immediate negative effect on the U.K. balance of trade
d. An immediate positive effect on the U.K. balance of trade

34. According to the J-curve effect, an appreciation of the yens exchange value has:
a. No impact on the Japanese trade balance in the short run
b. No impact on the Japanese trade balance in the long run
c. An immediate negative effect on the Japanese trade balance
d. An immediate positive effect on the Japanese trade balance

35. According to the Marshall-Lerner condition, currency depreciation has no effect on a country’s trade balance if the elasticity of demand for its exports plus the elasticity of demand for its imports equals:
a. 0.1
b. 0.5
c. 1.0
d. 2.0

36. According to the Marshall-Lerner condition, currency depreciation would have a positive effect on a country’s trade balance if the elasticity of demand for its exports plus the elasticity of demand for its imports equals:
a. 0.2
b. 0.5
c. 1.0
d. 2.0

37. According to the Marshall-Lerner condition, currency depreciation would have a negative effect on a country’s trade balance if the elasticity of demand for its exports plus the elasticity of demand for its imports equals:
a. 0.5
b. 1.0
c. 1.5
d. 2.0

38. The absorption approach suggests that one of the following causes a trade deficit to decrease following currency depreciation:
a. A decline in domestic interest rates
b. A rise in domestic imports
c. A rise in government spending
d. A decline in domestic absorption

39. The absorption approach to currency depreciation is represented by one of the following equations:
a. B = Y – A
b. Y = C + I + G + (X-M)
c. I + X = S + M
d. S – I = X – M

40. The time period that it takes for companies to form new business connections and place new orders in response to currency depreciation is known as the:
a. Recognition lag
b. Replacement lag
c. Decision lag
d. Production lag

41. The time period that it takes for companies to increase output of commodities for which demand has increased due to currency depreciation is known as the:
a. Recognition lag
b. Decision lag
c. Replacement lag
d. Production lag

42. According to the J-curve effect, currency appreciation:
a. Decreases a trade surplus
b. Increases a trade surplus
c. Decreases a trade surplus before increasing a trade surplus
d. Increases a trade surplus before decreasing a trade surplus

43. According to the J-curve effect, currency depreciation:
a. Decreases a trade deficit
b. Increases a trade deficit
c. Decreases a trade deficit before increasing a trade deficit
d. Increases a trade deficit before decreasing a trade deficit

44. The analysis of the effects of currency depreciation include all of the following except the:
a. Absorption approach
b. Elasticity approach
c. Fiscal approach
d. Monetary approach

45. According to the absorption approach (B = Y – A), currency devaluation improves a nation’s trade balance if:
a. Y increases and A increases
b. Y decreases and A decreases
c. Y increases and/or A decreases
d. Y decreases and/or A increases

46. The effect of currency depreciation on the purchasing power of money balances and the resulting impact on domestic expenditures is emphasized by the:
a. Absorption approach
b. Monetary approach
c. Fiscal approach
d. Elasticity approach

47. The Marshall-Lerner condition suggests that depreciation of the franc leads to a worsening of France’s trade account if the:
a. Elasticity of demand for French exports is 0.4 while the French elasticity of demand for imports is 0.2
b. Elasticity of demand for French exports is 0.6 while the French elasticity of demand for imports is 0.4
c. Elasticity of demand for French exports is 0.5 while the French elasticity of demand for imports is 0.7
d. Elasticity of demand for French exports is 0.6 while the French elasticity of demand for imports is 0.7

Table 14.1. Hypothetical Costs of Producing an Automobile for Toyota Inc. of Japan

Cost Component Yen Cost Dollar-Equivalent Cost

Labor 1,200,000
Materials
Steel 800,000
Other materials 1,600,000
Total material costs 2,400,000
Other costs 400,000
Total costs 4,000,000

48. Refer to Table 14.1. Assuming that Toyota obtains all inputs from Japanese suppliers and that the yen/dollar exchange rate is 200 yen per dollar. The dollar-equivalent cost of a Toyota automobile equals:
a. $5000
b. $10,000
c. $15,000
d. $20,000

49. Refer to Table 14.1. Assume that Toyota Inc. obtains all of its automobile inputs from Japanese suppliers. If the yen’s exchange value appreciates from 200 yen = $1 to 100 yen = $1, the yen cost of a Toyota automobile equals:
a. 4,000,000 yen
b. 6,000,000 yen
c. 8,000,000 yen
d. 10,000,000 yen

50. Refer to Table 14.1. Assume that Toyota Inc. obtains all of its automobile inputs from Japanese suppliers. If the yen’s exchange value appreciates from 200 yen = $1 to 100 yen = $1, the dollar-equivalent cost of a Toyota automobile equals:
a. $10,000
b. $20,000
c. $30,000
d. $40,000

51. Refer to Table 14.1. Assume that Toyota Inc. imports steel from U.S. suppliers, whose costs are denominated in dollars, while all other inputs are obtained from Japanese suppliers whose costs are denominated in yen. If the yen’s exchange value appreciates from 200 yen = $1 to 100 yen = $1, the yen cost of a Toyota automobile equals:
a. 2,400,000 yen
b. 3,000,000 yen
c. 3,600,000 yen
d. 4,200,000 yen

52. Refer to Table 14.1. Assume that Toyota Inc. imports steel from U.S. suppliers, whose costs are denominated in dollars, while all other inputs are obtained from Japanese suppliers whose costs are denominated in yen. If the yen’s exchange value appreciates from 200 yen = $1 to 100 yen = $1, the dollar-equivalent cost of a Toyota automobile equals:
a. $24,000
b. $30,000
c. $36,000
d. $42,000

53. The lag that occurs between changes in relative prices and the quantities of goods traded is the
a. Recognition lag
b. Recovery lag
c. Implementation lag
d. Legislative lag

54. The Marshall-Lerner condition illustrates
a. The price effects of a nation’s currency depreciation on its trade deficit
b. The price effects of a nation’s currency appreciation on its trade deficit
c. The effect of fixed exchange rate systems on the trade balance
d. None of the above

55. The absorption approach to currency depreciation focuses on the
a. Purchasing power of money
b. Relative price effects
c. Income effects
d. Price elasticity of demand

56. Reversing balance of payments disequilibria may came at the expense of
a. Economic relations with our trading partners
b. Domestic recession
c. Price inflation
d. All of the above

TRUE/FALSE

1. Currency devaluation is initiated by governmental policy rather than the free-market forces of supply and demand.

2. If a currency’s exchange rate is overvalued, a government would likely initiate actions to revalue the currency.

3. If a currency’s exchange rate is undervalued, a government would likely initiate actions to devalue the currency.

4. The purpose of currency devaluation is to cause a depreciation in a currency’s exchange value.

5. The purpose of currency revaluation is to cause an appreciation in a currency’s exchange value.

6. Assume that General Motors employs labor and materials, whose costs are denominated in dollars, in the production of automobiles. If the dollar’s exchange value depreciates by 10 percent against the yen, the yen-denominated cost of a GM vehicle rises by 10 percent.

7. Assume that General Motors employs labor and materials, whose costs are denominated in dollars, in the production of automobiles. If the dollar’s exchange value appreciates by 10 percent against the yen, the yen-denominated cost of a GM vehicle falls by 10 percent.

8. Appreciation of the dollar’s exchange value worsens the international competitiveness of Boeing Inc., whereas a dollar depreciation improves its international competitiveness.

9. When manufacturing automobiles, suppose that General Motors uses labor and materials whose costs are denominated in dollars and pounds respectively. If the dollar’s exchange value appreciates by 15 percent against the pound, the pound-denominated cost of a GM vehicle rises by 15 percent.

10. According to the absorption approach, currency devaluation best improves a country’s trade balance when its economy is at maximum capacity.

11. When manufacturing computer software, suppose that Microsoft Inc. uses labor and materials whose costs are denominated in dollars and francs respectively. If the dollar’s exchange value depreciates 10 percent against the franc, the franc-denominated cost of the firm’s software falls by 10 percent.

12. When producing jetliners, suppose that Boeing employs labor and materials whose costs are denominated in dollars and marks respectively. If the dollar’s exchange value depreciates 20 percent against the mark, the mark-denominated cost of a Boeing jetliner falls by an amount less than 20 percent.

13. As yen-denominated costs become a larger portion of Ford’s total costs, a dollar appreciation results in a smaller increase in the yen-denominated cost of a Ford auto than occurs when all input costs are dollar denominated.

14. A depreciation of the dollar results in Whirlpool dishwashers becoming less competitive in Europe.

15. By decreasing the relative production costs of U.S. companies, a dollar appreciation tends to lower U.S. export prices in foreign-currency terms, which induces an increase in the amount of U.S. goods exported abroad.

16. By increasing relative U.S. production costs, a dollar depreciation tends to increase U.S. export prices in foreign-currency terms, which results in an increase in the quantity of U.S. goods exported abroad.

17. Suppose the exchange value of the franc rises against the currencies of Switzerland’s major trading partners. To protect themselves from decreases in foreign sales caused by the mark’s appreciation, Swiss companies could shift production to countries whose currencies had depreciated against the mark.

18. In the early 1990s, the yen sharply appreciated against the dollar. To protect themselves from export reductions caused by the yen’s appreciation, Japanese auto companies transferred increasing amounts of auto production from the United States to Japan.

19. The elasticity approach to currency depreciation emphasizes the income effects of depreciation.

20. The elasticity approach to currency depreciation emphasizes the relative price effects of depreciation and suggests that depreciation best improves a country’s trade balance when the elasticities of demand for the country’s imports and exports are high.

21. The absorption approach to currency devaluation deals with the income effects of devaluation while the elasticity approach to devaluation deals with the price effects of devaluation.

22. According to the absorption approach, an increase in domestic expenditures must occur for currency devaluation to promote balance of trade equilibrium.

23. The monetary approach emphasizes the effects of currency depreciation on the purchasing power of money, and the resulting impact on domestic expenditure levels.

24. According to the Marshall-Lerner condition, currency depreciation will worsen a country’s balance of trade if the country’s elasticity of demand for imports plus the foreign demand elasticity for the country’s exports exceeds 1.0.

25. The Marshall-Lerner condition asserts that if the sum of a country’s elasticity of demand for imports and the foreign elasticity of demand for the country’s exports equals 1.0, a depreciation of the country’s currency will not affect its balance of trade.

26. Suppose the U.S. price elasticity of demand for imports equals 0.4 and the foreign demand elasticity for the U.S. exports equals 0.2. According to the Marshall-Lerner condition, a depreciation of the dollar’s exchange value will improve the U.S. balance of trade.

27. The Marshall-Lerner condition suggests that if the sum of a country’s elasticity of demand for imports and the foreign elasticity of demand for the country’s exports exceeds 1.0, an appreciation of the country’s exchange rate will worsen its balance of trade.

28. Suppose the U.S. price elasticity of demand for imports equals 1.2 and the foreign elasticity of demand for U.S. exports equals 1.5. According to the Marshall-Lerner condition, an appreciation of the dollar’s exchange value would worsen the U.S. balance of trade.

29. Empirical research suggests that most countries’ price elasticities of demand for imports and exports are very inelastic, suggesting that currency depreciation would result in a worsening of a country’s balance of trade.

30. The J-curve effect implies that in the short run a currency depreciation will result in a balance of trade surplus for the home country. As time passes, however, the home country’s balance of trade will move toward deficit.

31. Suppose the dollar appreciates 10 percent against the Swiss franc. According to the J-curve effect, the U.S. balance of trade will initially worsen, but then improve as time passes.

32. The J-curve effect implies that the price elasticity of demand for imports and exports is more elastic in the short run than in the long run.

33. The extent to which changing currency values result in changing prices of imports and exports is known as the J-curve effect.

34. Complete currency pass through suggests that if the dollar’s exchange value depreciates by 10 percent, imports will become 10 percent more expensive to Americans while U.S. exports will become 10 percent cheaper to foreigners.

35. Partial currency pass-through implies that if the dollar’s exchange value appreciates by 10 percent, imports would become, say, 6 percent more expensive to Americans while U.S. exports would become, say, 8 percent cheaper to foreigners.

36. Suppose the U.S. economy is operating at full capacity and the dollar’s exchange value depreciates. According to the absorption approach, the United States would have to accept reductions in domestic spending if the U.S. trade balance is to improve as a result of the depreciation.

SHORT ANSWER

1. How do demand elasticities influence a country’s trade position when exchange rates change?

2. How is the absorption approach used for analyzing the effects of currency devaluation?

ESSAY

1. What is a pass-through relationship?

2. How do movements in exchange rates affect domestic costs, in the presence of foreign sourcing?

CHAPTER 15—EXCHANGE-RATE SYSTEMS AND CURRENCY CRISES

MULTIPLE CHOICE

1. The exchange-rate system that best characterizes the present international monetary arrangement used by industrialized countries is:
a. Freely fluctuating exchange rates
b. Adjustable pegged exchange rates
c. Managed floating exchange rates
d. Pegged or fixed exchange rates

2. Which exchange-rate mechanism is intended to insulate the balance of payments from short-term capital movements while providing exchange rate stability for commercial transactions?
a. Dual exchange rates
b. Managed floating exchange rates
c. Adjustable pegged exchange rates
d. Crawling pegged exchange rates

3. Which exchange-rate mechanism calls for frequent redefining of the par value by small amounts to remove a payments disequilibrium?
a. Dual exchange rates
b. Adjustable pegged exchange rates
c. Managed floating exchange rates
d. Crawling pegged exchange rates

4. Under managed floating exchange rates, if the rate of inflation in the United States is less than the rate of inflation of its trading partners, the dollar will likely:
a. Appreciate against foreign currencies
b. Depreciate against foreign currencies
c. Be officially revalued by the government
d. Be officially devalued by the government

5. Under adjustable pegged exchange rates, if the rate of inflation in the United States exceeds the rate of inflation of its trading partners:
a. U.S. exports tend to rise and imports tend to fall
b. U.S. imports tend to rise and exports tend to fall
c. U.S. foreign exchange reserves tend to rise
d. U.S. foreign exchange reserves remain constant

6. Under a pegged exchange-rate system, which does not explain why a country would have a balance-of-payments deficit?
a. Very high rates of inflation occur domestically
b. Foreigners discriminate against domestic products
c. Technological advance is superior abroad
d. The domestic currency is undervalued relative to other currencies

7. Which exchange-rate system does not require monetary reserves for official exchange-rate intervention?
a. Floating exchange rates
b. Pegged exchange rates
c. Managed floating exchange rates
d. Dual exchange rates

8. A primary objective of dual exchange rates is to allow a country the ability to insulate its balance of payments from net:
a. Current account transactions
b. Unilateral transfers
c. Merchandise trade transactions
d. Capital account transactions

9. During the 1970s, the European Union, in its quest for monetary union, adopted what came to be referred to as the “Community Snake.” This device was a:
a. Adjustable pegged exchange rate system
b. Dual exchange rate system
c. Jointly floating exchange rate system
d. Freely floating exchange rate system

10. Under the historic adjustable pegged exchange-rate system, member countries were permitted to correct persistent and sizable payment deficits (i.e., fundamental disequilibrium) by:
a. Officially revaluing their currencies
b. Officially devaluing their currencies
c. Allowing their currencies to depreciate in the free market
d. Allowing their currencies to appreciate in the free market

11. Which exchange-rate system involves a “leaning against the wind” strategy in which short-term fluctuations in exchange rates are reduced without adhering to any particular exchange rate over the long run?
a. Pegged or fixed exchange rates
b. Adjustable pegged exchange rates
c. Managed floating exchange rates
d. Freely floating exchange rates

12. In 1973, the reform of the international monetary system resulted in the change from:
a. Adjustable pegged rates to managed floating rates
b. Managed floating rates to adjustable pegged rates
c. Crawling pegged rates to freely floating rates
d. Freely floating rates to crawling pegged rates

13. The Bretton Woods Agreement of 1944 established a monetary system based on:
a. Gold and managed floating exchange rates
b. Gold and adjustable pegged exchange rates
c. Special Drawing Rights and managed floating exchange rates
d. Special Drawing Rights and adjustable pegged exchange rates

14. Rather than constructing their own currency baskets, many nations peg the value of their currencies to a currency basket defined by the International Monetary Fund. Which of the following illustrates this basket?
a. IMF tranche
b. Special Drawing Rights
c. Primary reserve asset
d. Swap facility

15. Small nations (e.g., the Ivory Coast) whose trade and financial relationships are mainly with a single partner tend to utilize:
a. Pegged exchange rates
b. Freely floating exchange rates
c. Managed floating exchange rates
d. Crawling pegged exchange rates

16. Small nations (e.g., Tanzania) with more than one major trading partner tend to peg the value of their currencies to:
a. Gold
b. Silver
c. A single currency
d. A basket of currencies

17. Under a floating exchange-rate system, if American exports increase and American imports fall, the value of the dollar will:
a. Appreciate
b. Depreciate
c. Be officially revalued
d. Be officially devalued

18. Under a floating exchange-rate system, if American exports decrease and American imports rise, the value of the dollar will:
a. Appreciate
b. Depreciate
c. Be officially revalued
d. Be officially devalued

19. Under a floating exchange rate system, an increase in U.S. imports of Japanese goods will cause the demand schedule for Japanese yen to:
a. Increase, inducing a depreciation in the yen
b. Decrease, inducing a depreciation in the yen
c. Increase, inducing an appreciation in the yen
d. Decrease, inducing an appreciation in the yen

20. Given an initial equilibrium in the money market and foreign exchange market, suppose the Federal Reserve increases the money supply of the United States. Under a floating exchange-rate system, the dollar would:
a. Appreciate in value relative to other currencies
b. Depreciate in value relative to other currencies
c. Be officially devalued by the government
d. Be officially revalued by the government

21. Given an initial equilibrium in the money market and foreign exchange market, suppose the Federal Reserve decreases the money supply of the United States. Under a floating exchange rate system, the dollar would:
a. Appreciate in value relative to other currencies
b. Depreciate in value relative to other currencies
c. Be officially devalued by the government
d. Be officially revalued by the government

22. Under a floating exchange-rate system, if the U.S. dollar depreciates against the Swiss franc:
a. American exports to Switzerland will be cheaper in francs
b. American exports to Switzerland will be more expensive in francs
c. American imports from Switzerland will be cheaper in dollars
d. None of the above

23. If the Japanese yen depreciates against other currencies in the exchange markets, this will:
a. Have no effect on the Japanese balance of trade
b. Tend to worsen the Japanese balance of trade
c. Tend to improve the Japanese balance of trade
d. None of the above

24. If the Japanese yen appreciates against other currencies in the exchange markets, this will:
a. Have no effect on the Japanese balance of trade
b. Tend to improve the Japanese balance of trade
c. Tend to worsen the Japanese balance of trade
d. None of the above

25. Suppose Sweden’s inflation rate is less than that of its trading partner. Under a floating exchange rate system, Sweden would experience a:
a. Appreciation in its currency
b. Depreciation in its currency
c. Fall in the level of its exports
d. Rise in the level of its imports

26. Assume that interest rates in London rise relative to those in Switzerland. Under a floating exchange-rate system, one would expect the pound (relative to the franc) to:
a. Depreciate due to the increased demand for pounds
b. Depreciate due to the increased demand for francs
c. Appreciate due to the increased demand for francs
d. Appreciate due to the increased demand for pounds

27. Under a floating exchange-rate system, which of the following best leads to a depreciation in the value of the Canadian dollar?
a. A decrease in the Canadian money supply
b. A fall in the Canadian interest rate
c. An increase in national income overseas
d. Rising inflation overseas

28. A market-determined increase in the dollar price of the pound is associated with:
a. Revaluation of the dollar
b. Devaluation of the dollar
c. Appreciation of the dollar
d. Depreciation of the dollar

29. A market-determined decrease in the dollar price of the pound is associated with:
a. Revaluation of the dollar
b. Devaluation of the dollar
c. Appreciation of the dollar
d. Depreciation of the dollar

30. Which of the following is not a potential disadvantage of freely floating exchange rates?
a. They require larger amounts of international reserves than other exchange systems
b. Demand schedules for imports and exports may be price speculation
c. There may occur large amounts of destabilizing speculation
d. Capital movements among nations may be hindered via exchange rate fluctuations

31. Proponents of freely floating exchange rates maintain that:
a. Central banks can easily modify fluctuations in exchange rates
b. The system allows policy makers freedom in pursuing domestic economic goals
c. Inelastic demand schedules prevent large fluctuations in exchange rates
d. Inelastic supply schedules prevent large fluctuations in exchange rates

32. A potential disadvantage of freely floating exchange rates is that there would:
a. Exist excessive amounts of hedging in the foreign exchange markets
b. Be a lack of incentive to initiate exchange arbitrage
c. Be excessive amounts of destabilizing speculation
d. Exist a devaluation bias in the exchange markets

33. Under a floating exchange rate system, if there occurs a fall in the dollar price of the franc:
a. American exports to France will be cheaper in francs
b. American exports to France will be more expensive in francs
c. American imports from France will be more expensive in dollars
d. None of the above

34. Under a system of floating exchange rates, a U.S. trade deficit with Japan will cause:
a. A flow of gold from the United States to Japan
b. The U.S. government to ration yen to U.S. importers
c. An increase in the dollar price of yen
d. A decrease in the dollar price of yen

35. A potential limitation of freely floating exchange rates is that:
a. Countries require a larger amount of international reserves than otherwise
b. Countries are unable to initiate economic policies to combat unemployment
c. Exchange rates may experience wide and frequent fluctuations
d. Demand tends to be highly sensitive to price movements

36. To temporarily offset an appreciation in the dollar’s exchange value, the Federal Reserve could ____ the U.S. money supply which would promote a (an) ____ in U.S. interest rates and a ____ in investment flows to the United States.
a. Increase, decrease, decrease
b. Increase, increase, decrease
c. Decrease, decrease, decrease
d. Decrease, increase, decrease

37. To temporarily offset a depreciation in the dollar’s exchange value, the Federal Reserve could ____ the U.S. money supply which would promote a (an) ____ in U.S. interest rates and a (an) ____ in investment flows to the United States.
a. Increase, decrease, decrease
b. Increase, increase, increase
c. Decrease, decrease, increase
d. Decrease, increase, increase

38. In a managed floating exchange-rate system, temporary stabilization of the dollar’s exchange value requires the Federal Reserve to adopt a (an) ____ monetary policy when the dollar is appreciating and a (an) ____ policy when the dollar is depreciating.
a. Expansionary, expansionary
b. Expansionary, contractionary
c. Contractionary, expansionary
d. Contractionary, contractionary

39. The central bank of the United Kingdom could prevent the pound from appreciating by:
a. Selling pounds on the foreign exchange market
b. Buying pounds on the foreign exchange market
c. Reducing its inflation rate relative to its trading partners
d. Promoting domestic investment and technological development

40. A surplus nation can reduce its payments imbalance by:
a. Applying tariffs and trade restrictions on imports
b. Revaluing its national currency
c. Increasing its labor productivity
d. Setting higher interest rates than its trading partners

41. A main purpose of exchange stabilization funds is to:
a. Permit a country to overvalue its currency in the exchange markets
b. Permit a country to undervalue its currency in the exchange markets
c. Increase the supply of foreign currency when imports exceed exports
d. Decrease the supply of foreign currency when imports exceed exports

42. As a policy instrument, currency devaluation may be controversial since it:
a. Imposes hardships on the exporters of foreign countries
b. Imposes hardships on exporters of the devaluing country
c. Is generally followed by unemployment in the devaluing country
d. Is generally followed by price deflation in the devaluing country

43. Given a two-country world, assume Canada and Sweden devalue their currencies by 20 percent. This would result in:
a. An appreciation in the Canadian currency
b. An appreciation in the Swedish currency
c. An appreciation in both currencies
d. An appreciation in neither currency

44. Suppose that Japan maintains a pegged exchange rate that overvalues the yen. This would likely result in:
a. Japanese exports becoming cheaper in world markets
b. Imports becoming expensive in the Japanese market
c. Unemployment for Japanese workers
d. Full employment for Japanese workers

45. To defend a pegged exchange rate that overvalues its currency, a country could:
a. Discourage commodity exports
b. Encourage commodity imports
c. Purchase its own currency in international markets
d. Sell its own currency in international markets

46. Given a two-country world, suppose Japan devalues the yen by 20 percent and South Korea devalues the won by 15 percent. This results in:
a. An appreciation in the value of both currencies
b. A depreciation in the value of both currencies
c. An appreciation in the value of the yen against the won
d. A depreciation in the value of the yen against the won

47. Given a two-country world, suppose Japan revalues the yen by 15 percent and South Korea revalues the won by 12 percent. This results in:
a. An appreciation in the value of both currencies
b. A depreciation in the value of both currencies
c. An appreciation in the value of the yen against the won
d. A depreciation in the value of the yen against the won

Figure 15.1 shows the market for the Swiss franc. In the figure, the initial demand for marks and supply of marks are depicted by D0 and S0 respectively.

Figure 15.1. The Market for the Swiss Franc

48. Refer to Figure 15.1. With a system of floating exchange rates, the equilibrium exchange rate is:
a. $0.40 per franc
b. $0.50 per franc
c. $0.60 per franc
d. $0.70 per franc

49. Refer to Figure 15.1. Suppose that the United States increases its imports from Switzerland, resulting in a rise in the demand for francs from D0 to D1. Under a floating exchange rate system, the new equilibrium exchange rate would be:
a. $0.40 per franc
b. $0.50 per franc
c. $0.60 per franc
d. $0.70 per franc

50. Refer to Figure 15.1. Suppose the United States decreases investment spending in Switzerland, thus reducing the demand for francs from D0 to D2. Under a floating exchange rate system, the new equilibrium exchange rate would be:
a. $0.40 per franc
b. $0.50 per franc
c. $0.60 per franc
d. $0.70 per franc

51. Refer to Figure 15.1. Suppose the demand for francs increases from D0 to D1. Under a fixed exchange rate system, the U.S. exchange stabilization fund could maintain a fixed exchange rate of $0.50 per franc by:
a. Selling francs for dollars on the foreign exchange market
b. Selling dollars for francs on the foreign exchange market
c. Decreasing U.S. exports, thus decreasing the supply of francs
d. Stimulating U.S. imports, thus increasing the demand for francs

Table 15.1. The Market for Francs

Quantity of Dollar price Quantity of
francs demanded of francs francs supplied

600 $0.05 0
500 0.10 100
400 0.15 200
300 0.20 300
200 0.25 400
100 0.30 500
0 0.35 600

52. Refer to Table 15.1. Under a system of floating exchange rates, the equilibrium exchange rate equals:
a. $0.15 per franc
b. $0.20 per franc
c. $0.25 per franc
d. $0.30 per franc

53. Refer to Table 15.1. If monetary authorities fix the exchange rate at $0.10 per franc, there would be a:
a. Shortage of 200 francs
b. Shortage of 400 francs
c. Surplus of 200 francs
d. Surplus of 400 francs

54. Refer to Table 15.1. If monetary authorities fix the exchange rate at $0.30 per franc, there will be a:
a. Shortage of 200 francs
b. Shortage of 400 francs
c. Surplus of 200 francs
d. Surplus of 400 francs

55. Under managed floating exchange rates, the Federal Reserve could offset an appreciation of the dollar against the yen by:
a. Increasing the money supply which promotes falling interest rates and net investment outflows
b. Increasing the money supply which promotes rising interest rates and net investment inflows
c. Decreasing the money supply which promotes falling interest rates and net investment outflows
d. Decreasing the money supply which promotes rising interest rates and net investment inflows

56. Under managed floating exchange rates, a central bank would initiate:
a. Contractionary monetary policy to offset a depreciation of its currency
b. Contractionary monetary policy to offset an appreciation of its currency
c. Expansionary monetary policy to offset a depreciation of its currency
d. None of the above

57. To offset an appreciation of the dollar against the yen, the Federal Reserve would:
a. Sell dollars on the foreign exchange market and lower domestic interest rates
b. Sell dollars on the foreign exchange market and raise domestic interest rates
c. Buy dollars on the foreign exchange market and lower domestic interest rates
d. Buy dollars on the foreign exchange market and raise domestic interest rates

58. To help insulate their economies from inflation, currency depreciation, and capital flight, developing countries have implemented:
a. Regional trading blocs
b. Currency boards
c. Central banks
d. Regional fiscal policies

59. If Mexico dollarizes its economy, it essentially
a. Allows the Federal Reserve to be its lender of last resort
b. Accepts the monetary policy of the Federal Reserve
c. Ensures that its business cycle was identical to that of the U.S.
d. Abandons its ability to run governmental balanced budgets

60. If Mexico fully dollarizes its economy, it agrees to
a. Print pesos only to finance deficits of its national government
b. Use the U.S. dollar alongside its peso to finance transactions
c. Have the U.S. Treasury be in charge of its tax collections
d. Replace pesos with U.S. dollars in its economy

61. An objective of the dollarization of the Mexican economy would be to:
a. Shield its economy from hyperinflation, currency depreciation, and capital flight
b. Allow the Federal Reserve to be its lender of last resort
c. Ensure that its monetary policy is independent of the Federal Reserve
d. Permit it to benefit from tariffs and subsidies imposed by the U.S. government

62. In order to stabilize a currency, the central bank will need to adopt
a. An expansionary monetary policy to offset currency depreciation
b. An expansionary monetary policy to offset currency appreciation
c. A contractionary policy to offset currency appreciation
d. Both b and c

63. The crawling peg is a
a. Fixed exchange rate system
b. Floating exchange rate system
c. Compromise between fixed and floating exchange rates
d. Exchange rate system used by nations experiencing no inflation

64. Exchange rate controls
a. Achieved prominence during the economic crises of the late 1930’s
b. Were popular immediately after World War II
c. Are widely used by the developing nations
d. All of the above

65. The flexibility of floating rates may generate the problem of
a. Inflationary bias
b. Deflationary bias
c. Continuous depreciation
d. Both a and c

TRUE/FALSE

1. By the early 1970s, gold had been phased out of the international monetary system.

2. Since 1974, the major industrial countries have operated under a system of fixed exchange rates based on the gold standard.

3. Today, fixed exchange rates are used primarily by small, developing countries that tie their currencies to a key currency such as the U.S. dollar.

4. Smaller nations with relatively undiversified economies and large trade sectors tend to peg their currencies to one of the world’s key currencies.

5. Large industrial nations with diversified economies and small trade sectors have generally pegged their currencies to one of the world’s key currencies.

6. Small nations, such as Angola and Barbados, peg their currencies to the U.S. dollar since the prices of many of their traded goods are determined in markets in which the dollar is the key currency.

7. Many developing nations with low inflation rates have pegged their currencies to the U.S. dollar as a way of allowing modest increases in domestic inflation rates.

8. Pegging to a single currency is generally done by developing nations whose trade and financial relationships are mainly with a single industrial-country partner.

9. Developing countries with more than one major trading partner often peg their currencies to a group or basket of those trading partner currencies.

10. Most developing countries have chosen to allow their currencies to float independently in the foreign exchange market.

11. Today, special drawing rights (SDRs) represent the most important currency basket against which developing countries maintain pegged exchange rates.

12. The special drawing right is a currency basket of five major industrial country currencies.

13. The Australian dollar is currently regarded is the key currency of the international monetary system.

14. A “key currency” is one that is widely traded on world money markets, has demonstrated relative stable values over time, and has widely been accepted as a means of international settlement.

15. The U.S. dollar is generally regarded as the major “key currency” of the international monetary system.

16. Most nations currently allow their currencies’ exchange values to be determined solely by the forces of supply and demand in a free market.

17. Under the gold standard, the official exchange rate would be $2.80 per pound as long as the United States bought and sold gold at a fixed price of $35 per ounce and Britain bought and sold gold at 12.5 pounds per ounce.

18. The par values of most developing-country currencies are currently defined in terms of gold.

19. The purpose of an exchange stabilization fund is to ensure that the market exchange rate does not deviate beyond unacceptable levels from the official exchange rate.

20. To keep the pound’s exchange value from depreciating against the franc, the British exchange stabilization fund would sell pounds for francs on the foreign exchange market.

21. To keep the yen’s exchange value from appreciating against the dollar, Japan’s exchange stabilization fund would buy yen for dollars on the foreign exchange market.

22. The purpose of currency devaluation is to cause the home country’s exchange value to appreciate, thus reducing a balance of trade surplus.

23. If Uganda devalues its shilling by 10 percent and Burundi devalues its franc by 5 percent, the shilling’s exchange value appreciates 10 percent against the franc.

24. If Uganda sets its par value at 400 shillings per SDR and Burundi sets its par value at 200 francs per SDR, the official exchange rate is 1 franc = o.5 shillings.

25. If Uganda revalues its shilling by 20 percent and Burundi devalues its franc by 5 percent, the shillings exchange value will appreciate by 25 percent against the franc.

26. Unlike floating exchange rates, fixed exchange rates are not characterized by par values and central bank intervention in the foreign exchange market.

27. Because there is no exchange stabilization fund under floating exchange rates, any holdings of international reserves serve as working balances rather than to maintain a given exchange rate for any currency.

28. Under an adjustable-pegged system, market exchange rates are intended to be maintained within a narrow band around a currency’s official exchange rate. In the case of fundamental disequilibrium, the currency can be devalued or revalued to promote current-account equilibrium.

29. In 1973 the major industrial countries terminated managed-floating exchange rates and adopted an adjustable-pegged exchange rates.

30. A “dirty float” occurs when a nation used central bank intervention in the foreign exchange market to promote a depreciation of its currency’s exchange value, thus gaining a competitive advantage compared to its trading partners.

31. Under managed-floating exchange rates, market forces are allowed to determine exchange rates in the short run while central bank intervention is used to stabilize exchange rates in the long run.

32. Under managed floating exchange rates, central bank intervention is used to offset temporary fluctuations in exchange rates that contribute to uncertainty in carrying out transactions in international trade and finance.

33. To offset an appreciation in the dollar’s exchange value, the Federal Reserve can nudge interest rates down in the United States which results in net investment outflows.

34. When pursued over the long run, a policy of increasing the domestic money supply to offset an appreciation of the home country’s currency results in inflation and a decrease in home-country competitiveness in key industries.

35. At the Maastricht Treaty of 1991, members of the European Community established a blueprint for an Economic and Monetary Union with a single currency and a European central bank overseeing a single monetary policy.

36. It is universally recognized that Europe fulfills the conditions of an optimum currency area.

SHORT ANSWER

1. Which nations use multiple exchange rates the most and why?

2. What is an SDR?

ESSAY

1. What is the difference between the crawling peg and adjustable pegged exchange rates?

2. How can currency boards and dollarization prevent currency crises?

ECO 305 Week 11 Quiz

CHAPTER 16—MACROECONOMIC POLICY IN AN OPEN ECONOMY

MULTIPLE CHOICE

1. A nation experiences internal balance if it achieves:
a. Full employment
b. Price stability
c. Full employment and price stability
d. Unemployment and price instability

2. A nation experiences external balance if it achieves:
a. No net changes in its international gold stocks
b. Productivity levels equal to those of its trading partners
c. An increase in its money supply equal to increases overseas
d. Equilibrium in its balance of payments

3. A nation experiences overall balance if it achieves:
a. Balance-of-payments equilibrium, full employment, and price stability
b. Balance-of-payments equilibrium, maximum productivity, and price stability
c. Full employment, price stability and no change in its money supply
d. Full employment, price stability, and maximum productivity

4. Most industrial countries generally considered ____ as the most important economic goal.
a. External balance
b. Internal balance
c. Maximum efficiency for business
d. Maximum efficiency for labor

5. Which policies are expenditure-changing policies?
a. Currency devaluation and revaluation
b. Import quotas and tariffs
c. Monetary and fiscal policy
d. Wage and price controls

6. Which policy is an expenditure-switching policy?
a. Increase in the money supply
b. Decrease in government expenditures
c. Increase in business and household taxes
d. Decrease in import tariffs

7. An expenditure-increasing policy would consist of an increase in:
a. Import tariffs
b. Import quotas
c. Governmental taxes
d. The money supply

8. An expenditure-reducing policy would consist of a decrease in:
a. The par value of a currency
b. Government expenditures
c. Import duties
d. Business or household taxes

9. Given fixed exchange rates, assume Mexico initiates expansionary monetary and fiscal policies to combat recession. These policies will also:
a. Increase both imports and exports
b. Increase exports and reduce imports
c. Reduce a balance-of-payments surplus
d. Reduce a balance-of-payments deficit

10. Given fixed exchange rates, assume Mexico initiates contractionary monetary and fiscal policies to combat inflation. These policies will also:
a. Reduce a balance-of-payments surplus
b. Reduce a balance-of-payments deficit
c. Increases both imports and exports
d. Decrease both imports and exports

11. The appropriate expenditure-switching policy to correct a current account surplus is:
a. Currency revaluation
b. Currency devaluation
c. Expansionary monetary policy
d. Contractionary fiscal policy

12. The appropriate expenditure-switching policy to correct a current account deficit is:
a. Contractionary monetary policy
b. Expansionary fiscal policy
c. Currency devaluation
d. Currency revaluation

13. Suppose the United States faces domestic recession and a current account deficit. Should the United States devalue the dollar, one would expect the:
a. Recession to become less severe–deficit to become less severe
b. Recession to become more severe–deficit to become less severe
c. Recession to become less severe–deficit to become more severe
d. Recession to become more severe–deficit to become more severe

14. Suppose the United States faces domestic inflation and a current account surplus. Should the United States revalue the dollar, one would expect the:
a. Inflation to become more severe–surplus to become less severe
b. Inflation to become less severe–surplus to become less severe
c. Inflation to become less severe–surplus to become more severe
d. Inflation to become more severe–surplus to become more severe

15. Suppose Brazil faces domestic recession and a current account surplus. Should Brazil revalue its currency, one would expect the:
a. Recession to become less severe–surplus to become less severe
b. Recession to become more severe–surplus to become more severe
c. Recession to become more severe–surplus to become less severe
d. Recession to become less severe–surplus to become more severe

16. Suppose that Brazil faces domestic inflation and a current account deficit. Should Brazil devalue its currency, one would expect the:
a. Inflation to become more severe–deficit to become less severe
b. Inflation to become more severe–deficit to become more severe
c. Inflation to become less severe–deficit to become less severe
d. Inflation to become less severe–deficit to become more severe

17. In a closed economy, which of the following will cause the economy’s aggregate demand curve to shift to the right?
a. decreases and wages and salaries paid to employees
b. increases in the prices of oil and natural gas
c. decreases in income taxes for households
d. decreases in the productivity of labor

18. Given an open economy with high capital mobility and floating exchange rates, suppose an expansionary monetary policy is implemented to combat recession. The initial and secondary effects of the policy
a. cause aggregate demand to increase, thus strengthening the policy’s expansionary effect on real output
b. cause aggregate demand to decrease, thus eliminating the policy’s expansionary effect on real output
c. have conflicting effects on aggregate demand, thus weakening the policy’s expansionary effect on real output
d. have conflicting effects on aggregate demand, thus strengthening the policy’s expansionary effect on real output

19. A problem that economic policy makers confront when attempting to promote both internal and external balance for the nation is that monetary or fiscal policies aimed at the domestic sector also have impacts on:
a. Trade flows only
b. Capital flows only
c. both trade flows and capital flows
d. Neither trade flows nor capital flows

20. Given an open economy with high capital mobility and floating exchange rates, suppose an expansionary fiscal policy is implemented to combat recession. The initial and secondary effects of the policy
a. cause aggregate demand to increase, thus strengthening the policy’s expansionary effect on real output
b. cause aggregate demand to decrease, thus eliminating the policy’s expansionary effect on real output
c. have conflicting effects on aggregate demand, thus weakening the policy’s expansionary effect on real output
d. have conflicting effects on aggregate demand, thus strengthening the policy’s expansionary effect on real output

21. A system of fixed exchange rates and high capital mobility strengthens which policy in combating a recession:
a. Expansionary fiscal policy
b. Expansionary monetary policy
c. Contractionary fiscal policy
d. Contractionary monetary policy

22. A system of floating exchange rates and high capital mobility strengthens which policy in combating a recession:
a. Expansionary fiscal policy
b. Expansionary monetary policy
c. Contractionary fiscal policy
d. Contractionary monetary policy

23. Given an open economy with high capital mobility, all of the following statements are true except:
a. fiscal policy is strengthened under fixed exchange rates
b. monetary policy is weakened under fixed exchange rates
c. monetary policy is strengthened under floating exchange rates
d. fiscal policy is strengthened under floating exchange rates

24. Under a system of managed-floating exchange rates with heavy exchange rate intervention:
a. Fiscal policy is successful in promoting internal balance, while monetary policy is unsuccessful
b. Monetary policy is successful in promoting internal balance, while fiscal policy is unsuccessful
c. Both fiscal policy and monetary policy are successful in promoting internal balance
d. Neither fiscal policy nor monetary policy are successful in promoting internal balance

25. Given a system of floating exchange rates, an expansionary monetary policy by the Federal Reserve will cause
a. the dollar to appreciate and will decrease U.S. net exports
b. the dollar to appreciate and will increase U.S. net exports
c. the dollar to depreciate and will increase U.S. net exports
d. the dollar to depreciate and will decrease U.S. net exports

26. Given a system of floating exchange rates, a contractionary monetary policy by the Federal Reserve will cause
a. the dollar to appreciate and will decrease U.S. net exports
b. the dollar to appreciate and will increase U.S. net exports
c. the dollar to depreciate and will increase U.S. net exports
d. the dollar to depreciate and will decrease U.S. net exports

27. All of the following are obstacles to international economic policy coordination except:
a. Different national objectives and institutions
b. Different national political climates
c. Different phases in the business cycle
d. Different national currencies

28. Suppose a central bank prevents a depreciation of its currency by intervening in the foreign exchange market and buying its currency with foreign currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a rise in aggregate demand

29. At the ____, the Group-of-Five nations agreed to intervene in the currency markets to promote a depreciation in the U.S. dollar’s exchange value.
a. Plaza Agreement of 1985
b. Louvre Accord of 1987
c. Bonn Summit of 1978
d. Tokyo Summit of 1962

30. The Plaza Agreement of 1985 and Louvre Accord of 1987 are examples of:
a. Tariff trade barrier formation
b. Nontariff trade barrier formation
c. International economic policy coordination
d. Beggar-thy-neighbor policies

Exhibit 16.1

At the Plaza Accord of 1985, the Group-of-Five nations agreed to drive the value of the dollar downward (i.e., depreciation) so as to help reduce the U.S. trade deficit. Answer the following question(s) on the basis of this information.

31. Refer to Exhibit 16.1. To help drive the dollar’s exchange value downward, the Federal Reserve would:
a. Reduce taxes
b. Increase taxes
c. Decrease the money supply
d. Increase the money supply

32. Refer to Exhibit 16.1. The Federal Reserve might refuse to support the accord on the grounds that when helping to drive the dollar’s exchange value downward, it promotes an increase in the U.S.:
a. Rate of inflation
b. Budget deficit
c. Unemployment level
d. Economic growth rate

33. Under a fixed exchange-rate system and high capital mobility, an expansion in the domestic money supply leads to:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit

34. Under a fixed exchange-rate system and high capital mobility, a contraction in the domestic money supply leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit

35. Under a fixed exchange-rate system and high capital mobility, an expansionary fiscal policy leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit

36. Under a fixed exchange-rate system and high capital mobility, a contractionary fiscal policy leads to a:
a. Trade-account deficit and a capital-account surplus
b. Trade-account deficit and a capital-account deficit
c. Trade-account surplus and a capital-account surplus
d. Trade-account surplus and a capital-account deficit

37. Suppose a central bank prevents a depreciation of its currency by intervening in the foreign exchange market and buying its currency with foreign currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a fall in aggregate demand

38. Suppose a central bank prevents an appreciation of its currency by intervening in the foreign exchange market and selling its currency for foreign currency. This causes the
a. domestic money supply to decrease and a decline in aggregate demand
b. domestic money supply to increase and a decline in aggregate demand
c. domestic money supply to decrease and a rise in aggregate demand
d. domestic money supply to increase and a fall in aggregate demand

39. Assume a system of floating exchange rates. In response to relatively high interest rates abroad, suppose domestic investors place their funds in foreign capital markets. The result would be
a. a depreciation of the domestic currency and a rise in net exports
b. a depreciation of the domestic currency and a fall in net exports
c. an appreciation of the domestic currency and a rise in net exports
d. an appreciation of the domestic currency and a fall in net exports

40. Assume a system of floating exchange rates. In response to relatively high domestic interest rates, suppose that foreign investors place their funds in domestic capital markets. The result would be
a. a depreciation of the domestic currency and a rise in net exports
b. a depreciation of the domestic currency and a fall in net exports
c. an appreciation of the domestic currency and a rise in net exports
d. an appreciation of the domestic currency and a fall in net exports

41. When a nation realizes external balance
a. it can have a current account deficit
b. it can have a current account surplus
c. it has neither a current account deficit nor a current account surplus
d. Both a and b

42. Direct controls may take the form of
a. Tariffs
b. Export subsidies
c. Export quotas
d. All of the above

43. With a fixed exchange rate system, internal balance is most effectively achieved by using
a. Expansionary monetary policy to combat recession
b. Expansionary fiscal policy to combat inflation
c. Contractionary monetary policy to combat recession
d. Contractionary fiscal policy to combat recession

44. Policy coordination is complicated by
a. Different economic objectives
b. Different national institutions
c. Different phases in the business cycle
d. All of the above

TRUE/FALSE

1. A nation realizes internal balance if economy achieves full employment and price stability.

2. Nations have typically placed greater importance to the goal of internal balance than to the goal of external balance.

3. A nation realizes external balance when its current account is in equilibrium.

4. A nation realizes overall balance when it achieves full employment and current account equilibrium.

5. Expenditure-changing policies modify the direction of aggregate demand, shifting it between domestic output and imports.

6. Expenditure-switching policies include fiscal policy and monetary policy.

7. Economic policymakers have typically adopted expenditure-increasing policies to combat inflation and expenditure-reducing policies to combat recession.

8. Expenditure-switching policies alter the level of total spending (aggregate demand) for goods and services produced domestically and those imported.

9. Currency devaluation and revaluation are considered to be expenditure-changing policies since they alter a country’s aggregate demand for goods and services.

10. Expenditure-switching policies include currency revaluation, currency devaluation, and direct controls such as tariffs, quotas, and subsidies.

11. Given an open economy with high capital mobility and floating exchange rates, suppose an expansionary monetary policy is implemented to combat recession. The initial and secondary effects of the policy have conflicting effects on aggregate demand, thus weakening the policy’s expansionary effect.

12. Given an open economy with high capital mobility and fixed exchange rates, suppose an expansionary fiscal policy is implemented to combat recession. The initial and secondary effects of the policy cause aggregate demand to increase, thus strengthening the policy’s expansionary effect.

13. When the economy is in deep recession or depression, it is operating on that portion of its aggregate supply curve that is horizontal.

14. Changes in a country’s net exports, investment spending, or government spending will cause its aggregate demand curve to shift.

15. Given an open economy with high capital mobility, fiscal policy is strengthened under fixed exchange rates.

16. Given an open economy with high capital mobility, monetary policy is strengthened under fixed exchange rates.

17. Under floating exchange rates and high capital mobility, an expansionary monetary policy would help a country resolve a recession and a current account deficit.

18. Exchange rate management policies require international policy coordination because a depreciation of one nation’s currency implies an appreciation of its trading partner’s currency.

19. Currency devaluation and revaluation primarily affect the economy’s current account and have secondary effects on domestic employment and inflation.

20. Fiscal and monetary policies are generally used to combat domestic recession and inflation and have secondary effects on the balance of payments.

21. The Group of five (G-5) nations include Japan, Germany, China, and Australia.

22. The Bonn Summit of 1978 and Plaza Accord of 1985 are examples of international policy coordination.

23. International policy coordination is plagued by differing national economic objectives, institutions, political climates, and phases in the business cycle.

24. The goals of the Plaza Agreement of 1985 were to combat protectionism in the U.S. Congress, promote world economic expansion by stimulating demand in Germany and Japan, and to ease the burden of the U.S. debt service.

SHORT ANSWER

1. What policy instrument should be used when demand-pull inflation exists?

2. What happens to the balance of payments under a fixed exchange rate system, when expansionary or contractionary monetary policy is used?

ESSAY

1. Was the Plaza Agreement of 1985 a success?

2. What is international economic policy coordination?

CHAPTER 17—INTERNATIONAL BANKING: RESERVES, DEBT, AND RISK

MULTIPLE CHOICE

1. Which of the following assets makes use of the basket valuation technique?
a. Swap agreements
b. Oil facility
c. Buffer stock facility
d. Special drawing rights

2. Swap agreements are generally conducted by the:
a. Federal Reserve with foreign central banks
b. Federal Reserve with foreign commercial banks
c. U.S. Treasury with foreign central banks
d. U.S. Treasury with foreign commercial banks

3. Which of the following is a main central bank function of the International Monetary Fund?
a. The conduct of open market operations
b. The issuance of gold certificates
c. The provision of monetary policy for member nations
d. The granting of loans to member nations

4. The Federal Reserve’s swap network represents:
a. Efforts to stabilize only the value of the dollar
b. Efforts to stabilize only the value of foreign currencies
c. Long-term borrowing among countries
d. Short-term borrowing among countries

5. International trade and investment are most frequently financed by the U.S. dollar and the:
a. Japanese yen
b. British pound
c. Australian dollar
d. Swiss franc

6. The purpose of international reserves is to finance:
a. Short-term surpluses in the balance of payments
b. Long-term surpluses in the balance of payments
c. Short-term deficits in the balance of payments
d. Long-term deficits in the balance of payments

7. The currencies generally referred to as “reserve currencies” are the:
a. Japanese yen and U.S. dollar
b. Swiss franc and Japanese yen
c. British pound and U.S. dollar
d. Swiss franc and British pound

8. Which of the following does not represent a form of international liquidity?
a. IMF reserve positions
b. General arrangements to borrow
c. U.S. government securities
d. Reciprocal currency arrangements

9. Which of the following is not considered an “owned” reserve?
a. National currencies
b. Gold
c. Special drawing rights
d. Oil facility

10. Which of the following is not considered a “borrowed” reserve?
a. Special drawing rights
b. Oil facility
c. IMF drawings
d. Reciprocal currency arrangement

11. Eurodollars are:
a. Dollar-denominated deposits in overseas banks
b. European currencies used to finance transactions in the United States
c. Dollars that U.S. residents spend in Europe
d. European currencies used to finance imports from the United States

12. Which of the following is not a characteristic of the Eurodollar market? It:
a. Is mainly located in the United Kingdom and continental Europe
b. Operates as a financial intermediary, bringing together lenders and borrowers
c. Deals in interest-bearing time deposits and loans to governments
d. Grew in response to the deregulation of interest rate ceilings on U.S. savings accounts

13. Which of the following assets was (were) created in 1970 to provide additional international liquidity, in the belief that increasing world trade requires more liquidity for larger expected payments imbalances?
a. Eurodollar market
b. Special drawing rights
c. Reciprocal currency arrangements
d. General arrangements to borrow

14. Which of the following constitute(s) the largest component of the world’s international reserves?
a. Gold
b. Special drawing rights
c. IMF drawings
d. Foreign currencies

15. With an international gold standard, if a country ended up with a deficit from the balances on its current and capital accounts, it would:
a. Import gold to settle the balance
b. Export gold to settle the balance
c. Officially decrease the price of gold
d. Officially increase the price of gold

16. Which of the following is not a condition of the international gold standard? That a nation must:
a. Convert gold into paper currency, and vice versa, at a stipulated rate
b. Permit gold to be freely imported and exported
c. Tolerate wide fluctuations in its exchange rate
d. Define its monetary unit in terms of a stipulated amount of gold

17. All of the following exchange-rate systems require international reserves to finance balance-of-payments disequilibriums except:
a. Pegged or fixed exchange rates
b. Managed floating exchange rates
c. Adjustable pegged exchange rates
d. Freely floating exchange rates

18. A dollar shortage would indicate that the dollar is:
a. Undervalued in international markets
b. Overvalued in international markets
c. Overvalued in terms of gold
d. Overvalued in terms of special drawing rights

19. The U.S. gold outflow that began in the late 1940s and continued through the 1960s was due in part to:
a. Crawling pegged exchange rates
b. Freely floating exchange rates
c. An undervalued dollar
d. An overvalued dollar

20. The U.S. dollar glut of the 1960s was due in part to:
a. An undervalued dollar
b. An overvalued dollar
c. Freely floating exchange rates
d. Crawling pegged exchange rates

21. For developing countries such as Mexico and Brazil, severe economic problems in the 1980s were caused by:
a. A fall in the world demand for products produced by developing countries
b. High prices of basic raw materials and other commodities
c. Low real interest rates in the United States
d. High levels of income and imports for the United States

22. In response to the international debt problem, the United States set up a special fund in 1986 to help make up for lost oil revenues. Under the plan, the United States would make more money available as world oil prices fell. This plan was designed to help:
a. Argentina
b. Saudi Arabia
c. Mexico
d. Brazil

23. Which indicator of international debt burden schedules interest and principal payments on long-term debt as a percent of export earnings?
a. Debt service ratio
b. Debt-to-export ratio
c. Ratio of external debt to gross domestic product
d. Ratio of external debt to gross national product

24. Which term best describes the process in which the International Monetary Fund provides loans to countries facing balance-of-payments difficulties provided that they initiate programs holding promise of correcting these difficulties?
a. Conditionality
b. Debt service
c. Reciprocal currency arrangement
d. Swap agreement

25. All of the following are major goals of the International Monetary Fund except:
a. Promoting international cooperation among member countries
b. Fostering a multilateral system of international payments
c. Making long-term development and reconstruction loans
d. Promoting exchange-rate stability and the elimination of exchange restrictions

26. Which international reserve asset was officially phased out of the international monetary system by the United States in the early 1970s?
a. Special drawing rights
b. Swap agreements
c. General arrangements to borrow
d. Gold

27. Bilateral agreements between central banks, which provide for an exchange of currencies to help finance temporary balance-of-payments disequilibriums, are referred to as:
a. IMF drawings
b. Special drawing rights
c. Buffer stock facility
d. Swap agreements

28. Which organization is largely intended to make long-term reconstruction loans to developing nations?
a. Export-Import Bank
b. World Bank
c. International Monetary Fund
d. United Nations

29. “Owned” international reserves consist of:
a. Special drawing rights
b. Oil facility
c. IMF drawings
d. Reciprocal currency arrangements

30. “Borrowed” international reserves consist of:
a. IMF drawings
b. Foreign currencies
c. Gold
d. Special drawing rights

31. Concerning international lending risk of commercial banks, ____ refers to the probability that part/all of the interest/principal of a loan will not be repaid.
a. Country risk
b. Credit risk
c. Currency risk
d. Presidential risk

32. Concerning international lending risk of commercial banks, ____ is closely related to political developments in a borrowing country, especially the government’s views concerning international investments and loans.
a. Economic risk
b. Credit risk
c. Country risk
d. Currency risk

33. Concerning international lending risk of commercial banks, ____ is associated with possible changes in the exchange value of a nation’s currency.
a. Political risk
b. Country risk
c. Credit risk
d. Currency risk

34. To reduce their exposure to developing country debt, lending commercial banks have practiced all of the following except:
a. Making outright loan sales to other commercial banks
b. Reducing their capital base as a cushion against losses
c. Dealing in debt-for-debt swaps with foreign governments
d. Dealing in debt/equity swaps with foreign governments

35. To reduce losses on developing country loans, commercial banks sometimes sell their loans, at a discount, to a developing country government for local currency which is then used to finance purchases of ownership shares in developing country industries. This practice is known as:
a. Debt forgiveness
b. Debt buyback
c. Debt-for-debt swap
d. Debt/equity swap

36. Concerning international debt, ____ refers to a negotiated reduction in the contractual obligations of the debtor country and includes schemes such as markdowns and write-offs of debt.
a. Debt/equity swap
b. Debt-for-debt swap
c. Debt forgiveness
d. Debt sales

37. The exchange of borrowing country debt for an ownership position in the borrowing country is known as:
a. Debt forgiveness
b. Debt-for-debt swap
c. Debt reduction
d. Debt/equity swap

38. “Country risk” analysis is concerned with all of the following except:
a. Depreciation of the borrowing country’s currency
b. Political instability in the borrowing country
c. Economic growth in the borrowing country
d. External debt of the borrowing country

39. Debt reduction
a. Refers to any voluntary scheme that lessens the burden on the debtor nation
b. May be accomplished through debt rescheduling
c. May be achieved through debt/equity swaps
d. All of the above

40. Most analysts feel that the financial difficulties in East Asia were triggered by
a. Misallocation of investment
b. Unavailability of cheap foreign labor
c. Lack of alignment of the exchange rate with the dollar
d. Surpluses in the trade accounts of the Asian countries

41. A nation may experience debt-servicing problems because of
a. Pursuit of improper macroeconomic policies
b. Inadequate borrowing
c. Adverse economic events
d. Both a and c

42. Swap arrangements
a. Are agreements between governments
b. Require repayment within a stipulated period
c. Are usually multilateral agreements
d. Are never initiated by telephone

TRUE/FALSE

1. Under a system of fixed exchange rates, international reserves are needed to bridge the gap between monetary receipts and monetary payments.

2. International reserves allow a country to finance disequilibria in its balance-of-payments position.

3. An advantage of international reserves is that they allow countries to sustain temporary balance-of-payments deficits until acceptable adjustment measures can operate to correct the disequilibrium.

4. With floating exchange rates, countries require sizable amounts of international reserves for the stabilization of exchange rates.

5. When exchange rates are fixed by central bankers, the need for international reserves disappears.

6. When exchange rates are fixed by central bankers, international reserves are necessary for financing payments imbalances and the stabilization of exchange rates.

7. There exists a direct relationship between the degree of exchange rate flexibility and the need for international reserves.

8. With floating exchange rates, payments imbalances tend to be corrected by market-induced fluctuations in the exchange rate, and the need for exchange-rate stabilization and international reserves disappears.

The diagram below represents the exchange market position of the United States in trade with the United Kingdom. Starting at the equilibrium exchange rate of $3 per pound, suppose the demand for pounds rises from D0 to D1.

Figure 17.1 Foreign Exchange Market

9. Refer to Figure 17.1. Under a fixed exchange rate system, U.S. monetary authorities would have to supply 8 million pounds in exchange for dollars to keep the exchange rate at $3 per pound.

10. Refer to Figure 17.1. If the exchange rate was allowed to rise to $4 per pound, U.S. monetary authorities would have to supply 6 million pounds to the foreign exchange market in exchange for dollars to maintain this rate.

11. Refer to Figure 17.1. Under a floating exchange rate system, the exchange rate would rise to $4 and U.S. monetary authorities would have to supply 4 million pounds to the foreign exchange market in exchange for dollars to maintain this rate.

12. To the extent that adjustments in prices, interest rates, and income levels promote balance-of-payments equilibrium, the demand for international reserves decreases.

13. The greater a nation’s propensity to apply tariffs and quotas to key sectors, the greater will be the need for international reserves.

14. The demand for international reserves is negatively related to the level of world prices and income.

15. The demand for international reserves tend to increase with the level of world income and trade activity.

16. If a nation with a balance-of-payments deficit is willing and able to initiate quick actions to increase export receipts and decrease import payments, the amount of international reserves needed will be relatively large.

17. The supply of international reserves consists of owned reserves and borrowed reserves.

18. Foreign currencies constitute the smallest component of the world’s international reserves.

19. Gold constitutes the largest component of the world’s international reserves.

20. The U.S. dollar has been considered a reserve (key) currency because trading nations have been willing to hold it as an international reserve asset.

21. The U.S. dollar, Japanese yen, British pound, and Mexican peso are the major reserve currencies of the international monetary system.

22. By the 1990s, the British pound had replaced the U.S. dollar as the world’s key currency.

23. A goal of the International Monetary Fund is to make short-term loans to member nations so as to allow them to correct balance of payments disequilibriums without resorting to measures that would destroy national prosperity.

24. When granting loans to financially troubled nations, the International Monetary Fund requires some degree of conditionality, meaning that the borrowing nation must agree to implement economic policies as mandated by the IMF.

25. The International Monetary Fund has sometimes demanded that financially-troubled nations, that borrow from the IMF, undergo austerity programs including slashing of public spending and private consumption.

26. The main purpose of the International Monetary Fund is to grant long-term loans to developing nations to help them finance the development of infrastructure such as roads, dams, and bridges.

27. Gold is currently the most widely used asset in the international monetary system.

28. In 1974 the United States revoked a 41-year ban on U.S. citizen’s ownership of gold.

29. In 1975 the official price of gold was abolished as the unit of account for the international monetary system. As a result, gold was demonetized as an international reserve asset.

30. In the 1970s, the major industrial countries abandoned the managed-floating exchange rate system and adopted a system of fixed exchange rates tied to the price of gold.

31. Created by the International Monetary Fund, special drawing rights (SDRs) are unconditional rights to draw currencies of other nations, thus enabling countries to finance their current-account deficits.

32. The value of the SDR is tied to a currency basket consisting of the U.S. dollar, German mark, Japanese yen, French franc, and British pound.

33. The SDR has replaced the dollar, yen, and mark as the key asset of the international financial system.

34. Because the value of the SDR is tied directly to the value of the U.S. dollar, a 10 percent dollar depreciation would result in a 10 percent decrease in the SDR’s value.

35. A main purpose of the International Monetary Fund is to make loans of foreign currencies to member countries which are experiencing current-account surpluses.

36. When a deficit nation borrows from the International Monetary Fund, it purchases with its currency the foreign currency required to help finance the payments deficit.

37. The so-called General Arrangements to Borrow provide a permanent increase in the supply of international reserves.

38. Swap arrangements are bilateral agreements between central banks to allow countries to temporarily borrow funds to ease current-account deficits and discourage speculative capital flows.

39. IMF drawings, swap arrangements, buffer stock facility, and compensatory financing for exports are classified as owned reserves rather than borrowed reserves.

40. Concerning international lending risk, credit risk refers to the probability that part or all of the interest rate or principal of a loan will not be repaid.

41. Concerning international lending risk, country risk refers to the risk that part or all of the interest or principal of a loan will not be repaid.

42. Concerning international lending risk, currency risk is the risk of asset losses due to changing currency values.

43. A country with a high debt/export ratio and a high debt service/export ratio would likely be considered as an attractive place in which to invest by foreign residents.

44. A debt buyback is a debt-reduction technique in which a government of a debtor nation buys loans from commercial banks at a discount.

45. Under a debt-for-debt swap, a commercial bank sells its loans at a discount to a developing country government for local currency which it then uses to finance an equity investment in the debtor country.

46. A debt-equity swap results in a trade surplus nation forgiving the loans made to a trade-deficit nation.

47. Eurocurrencies are deposits, denominated and payable in dollars and other foreign currencies, in banks outside the United States, primarily in London, the market’s center.

SHORT ANSWER

1. Why do countries hold international reserves?

2. How can a bank reduce its exposure to the debt of developing nations?

ESSAY

1. Describe the eurocurrency market.

2. Are international reserve needs different for different exchange rate regimes?