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Prior to the beginning of the baseball season, the United States government places a tariff on imported bubble gum. Assume for this example that this tariff has a significant impact on the supply of bubble gum. Which of the following statements about the impact of this tariff is least valid? The tariff:

A) will prohibit foreign firms from dumping bubble gum on the U.S. market at below cost.

B) will protect the jobs of domestic bubble gum industry workers in the long run.

C) is not necessary to maintain the high wages of the U.S. bubble gum industry workers.

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In the long run, trade restrictions do not protect the net number of jobs in the country. The number of jobs protected by import restrictions will be offset by jobs lost in the import/export industry. Import/export firms will be unable to sell the overpriced domestic products abroad or import and sell the lower priced restricted foreign-made product.
The other statements are at least partially valid. Some reasons for trade restrictions that have some or partial validity are: national defense argument, infant industries argument, and anti-dumping argument. The assertion that trade with low-wage countries depresses wage rates in high-wage countries stems from a misunderstanding of comparative advantage. When each country produces goods for which it has a comparative advantage, both countries will benefit. High-wage countries likely have a comparative advantage in high tech manufacturing and low wage countries will have an advantage in labor-intensive goods.

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"Import quotas will create jobs, increasing the employment level of a nation." Economic analysis indicates that this statement is incorrect in:

A) the short run only.

B) the long run only.

C) both the long and short run.

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The argument that trade restrictions protect jobs is of questionable validity. First, trade restrictions prevent trading partners from developing the purchasing power needed to buy import goods from the protected country, thus depressing the country's own export industry. Second, the higher price of the protected domestic goods dampens domestic purchasing power, taking sales away from other domestic products. Third, the jobs that would have been created in the import industry are never created.

The number of jobs protected by import restrictions will be offset by jobs lost in the import/export industry.

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The anti-dumping argument in favor of trade restrictions is the argument that restrictions should be imposed to:

A) discourage foreign firms from engaging in price competition.

B) prevent foreign firms from dumping unwanted products in domestic markets.

C) prevent foreign firms from selling their product below cost.

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The anti-dumping argument is that restrictions should be used to prohibit foreign firms from increasing market share by selling products below cost.

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Which of the following is a reason why trade with low-wage countries does NOT depress wage rates in high-wage countries?

A) High hourly wage rates mean high per unit labor costs.

B) High-wage countries have an advantage in labor-intensive goods.

C) When each country produces goods for which it has a comparative advantage, both countries benefit.

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When both countries produce the goods in which they have an advantage, total output and the availability of goods will increase.

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An anti-dumping restriction on trade:

A) prohibits foreign firms from selling products below cost to gain market share.

B) keeps some highly sensitive products in the country.

C) protects infant industries.

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Firms dump their goods at a price lower than cost in order to drive out the competition. Once this is complete, they will be able to raise prices to much higher levels in order to gain abnormal profits. Of course, once prices are increased, new competitors may arise.

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Which of the items below is NOT a valid reason why nations adopt trade restrictions? To:

A) protect industries in which they have a comparative advantage.

B) prohibit foreign firms from increasing market share by selling products below cost.

C) protect industries that are highly sensitive to national security.

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If a particular country enjoys a comparative advantage in a particular industry, no protection is needed.

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Which of the following arguments for trade restrictions is least valid?

A) Trade restrictions create domestic jobs.

B) Some industries are highly sensitive to national security, and their products should therefore remain in the country.

C) Tariffs are used to prohibit foreign firms from selling products in the country at below cost in an attempt to gain market share.

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While the other explanations have some support among economists, the argument that trade restrictions create domestic jobs has very little support. Part of the popularity of trade restrictions stems from their ability to protect easily identifiable jobs and the high wage levels in these jobs. However, in the long run, trade restrictions cannot protect the net number of jobs in the country.

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David Forsythe and Linda Novak are discussing the advantages and disadvantages of import restrictions. They state the following:

Forsythe: One of the groups that benefits from import restrictions is often the government that imposes them.

Novak: Import restrictions impose costs on specific groups, such as the country’s import industries, but these costs are more than offset by the benefits to other groups and to the economy as a whole.

With respect to these statements:

A) only one is correct.

B) both are correct.

C) both are incorrect.

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Forsythe is correct. A primary reason why trade restrictions remain widespread is the revenue that governments receive from tariffs. Novak is incorrect. Trade restrictions benefit specific groups, such as workers in the protected industries, but those benefits are most often less than the costs imposed on consumers and other industries as a whole.

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David Forsythe and Linda Novak are discussing the advantages and disadvantages of import restrictions. They state the following:

Forsythe: One of the groups that benefits from import restrictions is often the government that imposes them.

Novak: Import restrictions impose costs on specific groups, such as the country’s import industries, but these costs are more than offset by the benefits to other groups and to the economy as a whole.

With respect to these statements:

A) only one is correct.

B) both are correct.

C) both are incorrect.

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Forsythe is correct. A primary reason why trade restrictions remain widespread is the revenue that governments receive from tariffs. Novak is incorrect. Trade restrictions benefit specific groups, such as workers in the protected industries, but those benefits are most often less than the costs imposed on consumers and other industries as a whole.

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David Kirk, CFA, is an analyst on the global equities desk for a large investment banking company in New York. Kirk is searching for investment opportunities in companies that operate in relatively economically undeveloped countries. He is currently researching possible investments in businesses located in Wayland, a small emerging country located in Eastern Europe. Wayland has significant coal deposits within its borders, and is a leading producer in the region. Kirk’s interest in the country stems from the fact that Wayland has recently emerged an as independent nation after centuries of rule by a larger country. Wayland is in the early stages of government formation, although many of its elected leaders are experienced, having served under the previous government.
Kirk is not a risk-averse investor, but realizes that opportunities in Wayland may have some unique features. For example, the government of Wayland is considering putting some type of trade restrictions in place to protect the country’s leading industry, the production of coal. Government officials want to ensure that the industry, which is quasi-governmental, is shielded from lower cost importers from surrounding countries. At the same time, the government wants to encourage growth and development in other industries so that in the future, the country’s economy is not dependent upon one industry. Kirk wants to explore the short- and long-term implications of any trade restrictions the government may enact.
Also, Kirk plans on performing a thorough analysis of the government of Wayland’s anticipated approach toward monetary policy. With an expected increase in international trade, the country’s central bank must more carefully manage the country’s balance of payments accounts. The current exchange rate for W$, the national currency of Wayland, is W$125/€. Exactly one year ago, the same exchange rate was W$115/€. In addition, over the same time period, real interest rates in Wayland have declined relative to comparable interest rates in the European Union. Kirk will project the expected returns on an investment in a Wayland-based company, based upon several likely interest rate and exchange rate scenarios.The government of Wayland argues that its policy of placing trade restrictions on the import of coal into the country will serve to protect the entire country by providing both job security and lower fuel prices to its citizens. Which of the following statements regarding Wayland’s policy is most accurate?

A) The effect of the trade restrictions cannot be predicted, but will encourage growth in other industries that do not have the same governmental protection.

B) The trade restrictions will protect Wayland’s core industry, which in turn will lead to growth in the country’s per capita income.

C) The trade restrictions will be to the benefit of the coal producers at the expense of the entire country’s economy and its citizens.

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In general, economists agree that trade restrictions are to the benefit of the protected industry at the expense of the rest of the general economy and the citizens. (Study Session 4, LOS 16.c)

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Assume that Wayland has a comparative advantage in the production of coal, while Country X has a comparative advantage in the production of paper goods. Which of the following statements regarding the law of comparative advantage is most accurate?

A) Wayland should impose a quota on the import of coal and Country X should impose a similar quota on the import of paper goods in order to preserve their respective comparative advantages.

B) When each country specializes in the good for which they have the comparative advantage and trades with the other, both countries will benefit from the alliance.

C) Wayland should impose a tariff on the import of coal and Country X should impose a similar tariff on the import of paper goods in order to preserve their respective comparative advantages.

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The law of comparative advantage holds that trading partners are better off if they specialize in the production of those goods for which they are the low-opportunity cost producers. In this example, Wayland and Country X should each specialize in the production of their respective specialized goods and then trade with each other, resulting in an arrangement that is beneficial to both sides. (Study Session 4, LOS 16.a)

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Recent financial information released by the government of Wayland for the year ending 2006 includes the following information (in millions of W$):

Current account	W$ 550,000
Capital account	−285,000

Calculate the official reserve account (in millions of W$) for Wayland as of the end of 2006:

A) W$−265,000.

B) W$265,000.

C) W$835,000.

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The Balance of Payments equation is:

Current account + capital account + official reserve account = 0

Therefore, solving for the official reserve account, W$550,000 + (−285,000) − 0 = W$−265,000. (Study Session 4, LOS 18.b)

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With regard to the performance of Wayland’s currency over the past year, which of the following statements is most accurate? The W$ has:

A) depreciated relative to the Euro, in part due to the decline in Wayland’s real interest rates relative to the EU.

B) appreciated relative to the Euro, in part due to the decline in Wayland’s real interest rates relative to the EU.

C) depreciated relative to the Euro, in part due to investor expectations that trade restrictions will soon be enacted by Wayland’s government.

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The real interest rates in Wayland have declined over the past year relative to rates in the EU, so investors will find Euro-denominated investments more attractive than W$-denominated investments. As a result, the W$ has depreciated in value relative to the Euro as demand for investments in the W$ currency have decreased. (Study Session 4, LOS 18.d)

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Assume that Wayland's central bank states that its goal is to maintain the long-term W$ exchange rate relative to the Euro at W$110/€. Which of the following statements regarding the possible strategies that the central bank of Wayland can pursue is most correct? The bank is signaling a:

A) crawling peg policy which will help to reduce foreign exchange risk for importers and exporters.

B) fixed rate policy that will be periodically reset to avoid having the bank either run out of reserves or accumulate too many reserves of foreign currency.

C) fixed rate policy, but the effectiveness of the policy will hinge on the adequacy of the central bank's reserves.

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The central bank is signaling a commitment to a fixed rate policy. The policy is sustainable only if the bank has sufficient foreign exchange reserves to support the value of the W$. If not, the typical scenario is that attempts to support the currency (maintain the fixed rate) will exhaust the bank's reserves, leading to a currency devaluation in the long-run. (Study Session 4, LOS 18.f)

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The current spot rate for the US dollar per Euro is US$1.42/€. Calculate the current cross rate for W$ per US$.

A) W$88.03/US$.

B) W$177.50/US$.

C) W$80.99/US$.

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In Wayland, the direct exchange rate is:

(W$125/€) / (US$1.42/€) = W$88.03/US$

(Study Session 4, LOS 17.a)