[CFA L2]Economics 【Reading 16】Sample 2012, possible, producing, milk

JonnyKay

This table below outlines the possible tradeoffs of producing milk and bread for Country A and Country B.

Country A		Country B
Milk	Bread	Milk	Bread
0	5	0	8
10	0	12	0

A) Neither country would gain from trade.

B) Both countries would gain if Country A traded bread for B's milk.

C) Both countries would gain if Country A traded milk for B's bread.

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Country A gives up 1 bread to produce 2 milk. Country B gives up 1 bread to produce 1.5 milk. Country A should make milk and Country B should make bread.

JonnyKay

Suppose labor in Venezuela is less productive than labor in the United States in all areas of production. Which of the following statements about trading between Venezuela and the U.S. is most accurate?

A) Venezuela will not have a comparative advantage in any good.

B) Both nations can benefit from trade.

C) Venezuela can benefit from trade but the U.S. cannot.

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Although one country may have an absolute advantage in all areas, trade is based on differences in opportunity costs, or comparative advantage. Any country will always have a comparative advantage in the production of some goods; thus, all countries can benefit from trade.

JonnyKay

The table below outlines the possible tradeoffs of producing units of cloth and corn for both Country A and Country B.

Country A		Country B
Units of Cloth	Units of Corn	Units of Cloth	Units of Corn
0	4	0	8
6	3	8	6
14	0	16	0

Which scenario best describes the effects of trade between the countries?

A) Both countries would gain if Country A traded cloth for Country B’s corn.

B) Both countries would gain if Country A traded corn for Country B’s cloth.

C) Country B would not gain from trade, because it has an absolute advantage in the production of both goods.

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If Country B devotes all of its resources to producing corn, it will make 8 units while, under the same circumstances, Country A will make 4 units. Therefore, Country B is twice as productive with respect to corn as Country A. Country B can also produce more cloth (16 units) in relation to Country A (14 units) supposing all resources are used for cloth. However, rather than being twice as productive as was the case for corn, it is only slightly more productive. Therefore, Country B has a comparative advantage in corn, and thus should specialize in its production, while Country A should specialize in the production of cloth.

JonnyKay

Calvin Gooden, an assistant economist with the World Bank, is a member of a Level I CFA study group. Most of the members of his group do not have an economics background and are frustrated with the material on comparative advantage. Gooden devises the following question to help them study. The table below gives the prices of four goods (jeans, wine, cheese, and LCD screens) in France and the United Kingdom (U.K.). Gooden tells the group to assume that the current exchange rate is 1.5 EUR/ 1.0 GBP.

Good	France (in EUR)	United Kingdom (in GBP)
Jeans	42	26
Wine	18	14
Cheese	5	3
LCD Screens	85	50

Acting to minimize costs, French consumers will purchase:

A) French wine and cheese and British jeans and LCD screens.

B) British wine and French jeans, cheese, and LCD screens.

C) French wine and British jeans, cheese, and LCD screens.

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First, convert to one currency (we will convert to EUR), then assume that consumers will purchase from the cheapest suppliers. The cheapest country appears in bold.

Good	France (in EUR)	United Kingdom (in EUR)
Jeans	42	26 × 1.5 = 39
Wine	18	14 × 1.5 = 21
Cheese	5	3 × 1.5 = 4.5
LCD Screens	85	50 × 1.5 = 75

Thus, French consumers will minimize cost by purchasing French wine and British jeans, cheese, and LCD screens.

JonnyKay

Calvin Gooden, an assistant economist with the World Bank, is a member of a Level I CFA study group. Most of the members of his group do not have an economics background and are frustrated with the material on comparative advantage. Gooden devises the following question to help them study. The table below gives the prices of four goods (jeans, wine, cheese, and LCD screens) in France and the United Kingdom (U.K.). Gooden tells the group to assume that the current exchange rate is 1.5 EUR/ 1.0 GBP.

Good	France (in EUR)	United Kingdom (in GBP)
Jeans	42	26
Wine	18	14
Cheese	5	3
LCD Screens	85	50

Acting to minimize costs, French consumers will purchase:

A) French wine and cheese and British jeans and LCD screens.

B) British wine and French jeans, cheese, and LCD screens.

C) French wine and British jeans, cheese, and LCD screens.

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First, convert to one currency (we will convert to EUR), then assume that consumers will purchase from the cheapest suppliers. The cheapest country appears in bold.

Good	France (in EUR)	United Kingdom (in EUR)
Jeans	42	26 × 1.5 = 39
Wine	18	14 × 1.5 = 21
Cheese	5	3 × 1.5 = 4.5
LCD Screens	85	50 × 1.5 = 75

Thus, French consumers will minimize cost by purchasing French wine and British jeans, cheese, and LCD screens.

JonnyKay

Mike Harris in a research paper on free trade between high-wage countries and low-wage countries concluded free trade between low-wage countries such as China, India, and Pakistan and high-wage countries such as the U.S., Japan, and Germany would depress wages in high-wage countries. His conclusion was based on the following:

Point 1: U.S., Japanese, and German workers are unable to compete with cheap foreign labor from countries such as China, India, and Pakistan.

Point 2: U.S., Japanese, and German workers are less productive than workers in China, Pakistan, and India.
Point 3: Free-trade between high-wage countries and low-wage countries will reduce the consumption possibilities of people in high-wage countries.

Are Points 1, 2, and 3, as raised by Harris correct?

Point 1

Point 2

Point 3

A) Incorrect Correct Correct

B) Incorrect Incorrect Incorrect

C) Correct Correct Incorrect

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Points 1 and 3 are incorrect because due to the law of comparative advantage which states in part that when two countries trade products in which they both have a comparative advantage both countries will be better off because they will both be able to consume outside their respective production possibility frontiers.  
Point 2 is incorrect because as labor becomes more expensive as in industrialized countries, capital (technology) is substituted for labor increasing the productivity of each worker.

JonnyKay

The law of comparative advantage explains why a nation will benefit from trade when it:

A) exports goods for which it is a low-cost producer, while importing those for which it is a high-cost producer.

B) exports more than it imports.

C) exports goods for which it is a high-cost producer, while importing those for which it is a low-cost producer.

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Comparative advantage is the ability to produce a good at a lower opportunity cost than others can produce it. When trading partners specialize in producing products for which they have a comparative advantage; costs are minimized, output is greater, and both trading partners benefit.

JonnyKay

According to the law of comparative advantage:

A) a nation will benefit from trade when it imports goods for which it is the high cost producer and exports goods for which it is the low-cost producer.

B) if a foreign government subsidizes the textile industry, the domestic government should impose a tariff.

C) Mexico is considered to have a comparative advantage in plastics if Mexico can produce plastic using fewer resources than the U.S.

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This statement is the law of comparative advantage.
The other choices are incorrect. The law of comparative advantage supports international trade. According to the law of comparative advantage, both trading partners are better off if they specialize in the production of goods for which they are the low-opportunity cost producer and trade for those goods for which they are the high-opportunity cost producer. Mexico is considered to have an absolute advantage in plastics if Mexico can produce plastic using fewer resources than the U.S.

JonnyKay

A country has a comparative advantage over another when:

A) a nation has the ability to produce a good with a lower opportunity cost than another nation.

B) a nation can produce more output with a given amount of input than another nation.

C) it can produce a product with the fewest resources.

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A nation will have a comparative advantage in the production of good A when the number of units of B, given up to produce one unit of A, is lower than that for any other country.

JonnyKay

Which type of advantage determines the pattern of trade in the world?

A) Comparative advantage.

B) Absolute advantage.

C) Advantages due to tariffs and quotas.

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Comparative advantage is the ability to produce a good at a lower opportunity cost than others can produce it. According to the law of comparative advantage, trading partners are both better off if they specialize in the production of goods for which they are the low-opportunity cost producer and trade for goods for which they are the high-opportunity cost producer.