torontoanalyst

The following chart indicates the production possibilities of food and drink per day in Country A and Country B.

	Units of Output Per Day
	Country A	Country B
Food	9	5
Drink	7	5

Which of the following statements is most accurate?

A) Mutual gains could be realized from trade if A specialized in drink production and B specialized in the food production.

B) Since B workers can produce more of food and drink than A workers, no gains from trade are possible.

C) Mutual gains could be realized from trade if A specialized in food production and B specialized in drink production.

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Mutual gains could be realized from trade if A specialized in food production and B specialized in drink production. The reason centers on comparative advantage. Country A must give up 7/9th unit of drink to produce one unit of food. Country B must give up 1 unit of drink to produce one unit of food. Therefore, the opportunity cost of producing food is greater for B than for A. If B produces 5 units of drink and A produces 9 units of food, total production will be greater than it would be if both countries produced both goods. By trading, both countries benefit.

torontoanalyst

The following chart indicates the production possibilities of food and drink per day in Country A and Country B.

	Units of Output Per Day
	Country A	Country B
Food	4	8
Drink	6	7

Which of the following statements about the chart is most accurate?

A) Since B workers can produce more of food and drink than A workers, no gains from trade are possible.

B) Mutual gains could be realized from trade if A specialized in food production and B specialized in drink production.

C) Mutual gains could be realized from trade if A specialized in drink production and B specialized in the food production.

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Mutual gains could be realized from trade if A specialized in drink production and B specialized in food production. The reason centers on comparative advantage. Country A must give up 1.5 units of drink to produce one unit of food. Country B must give up 0.875 units of drink to produce one unit of food. Therefore, the opportunity cost of producing food is greater for A than for B. If B produces 8 units of food and A produces 6 units of drink, total production will be greater than it would be if both countries produced both goods. By trading, both countries benefit.

torontoanalyst

Globeconotrade, AG is a European based global producer of transportation, mining and infrastructure equipment, consumer durables, and manufacturing technology. Globeconotrade has subsidiaries in 47 countries on 5 continents, producing a variety of subparts and components used in the assembly and manufacturing of the firm’s final products.
The Chief Executive Officer of Globeconotrade, Aldo Frankl, has been asked by the company’s board to make a presentation regarding international trade among the various subsidiaries of the firm. The board has become concerned that global trade restrictions are hampering Globeconotrade’s ability to source its components in the most economically efficient locations. The board is considering the potential need for Globeconotrade to hire a political lobbying firm to present its views to various national governments and work to ease trade restrictions that are of concern to Globeconotrade.
Frankl has asked the firm’s Chief Operating Officer, Victoria Dion, to provide information about both the current level of international trade among Globeconotrade’s various divisions, and the types of international trade that would be desirable if trade barriers were reduced or eliminated.
Dion understands the board’s desire to open various countries to freer trade, but she also has concerns in the opposite direction. Dion tells Frankl that there are several subsidiaries of Globeconotrade that sell final products which are locally made. These subsidiaries are suffering from competition by low-cost imports. Dion would like to see Globeconotrade lobby to impose trade barriers in these countries to protect Globeconotrade’s local subsidiaries.
Dion offers the example of Minidonia, where Globeconotrade has a locally based transportation company. Globeconotrade’s current operations in Minidonia are summarized in Table 1:
Table 1
Minidonia Trade Statistics

Minidonian peso	45/euro
Total imports	100 million
Total exports	85 million
Principal imports	transportation equipment, machinery
Principal exports	minerals, agricultural products

Dion advises Frankl, “In Minidonia, we should lobby the government for tariff protection from imported transportation equipment. We should point out to them that protecting the domestic transportation industry from foreign competition protects Minidonian jobs and will play a key role in keeping Minidonian unemployment rates low for the long term.” Frankl replies, “We could also remind them that reducing the import of transportation equipment would have a direct impact in reducing the country’s capital account deficit, since trade in goods and services is a major component of the capital account.”
To help them prepare their lobbying arguments, Frankl and Dion ask the firm’s Chief Economist, Neema Landseer, to provide background information regarding expected changes in Minidonia’s currency due to the export effect and relative differences between the Euro and Minidonia’s interest rates. She makes the following statements:

Statement 1:	"The export effect suggests that, all else being equal, if a currency falls in value, the demand for exports denominated in that currency should increase." [/td]
Statement 2:	"Interest rate parity holds when any forward premium or discount just offsets differences in interest rates so that an investor will earn the same return investing in either currency."

Frankl suggests that they should also focus on the benefits of tariffs to the national government. Frankl points out, “When a country imposes a tariff instead of a quota, gain in tariff revenue partially offsets the loss to the economy because of the trade restriction. The total deadweight loss to consumers is the same under a quota or tariff.” Landseer suggests that they need to be careful in their suggestions about how to set up the quotas because “the way in which export amounts are allocated among domestic producers will determine who gets the gain in producer surplus.”The law of comparative advantage holds that trading partners can be made better off if they:

A) specialize in production of goods for which they are the low exchange rate adjusted producer.

B) import those goods for which they have a comparative advantage.

C) specialize in production of goods for which they are the low opportunity cost producer.

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The law of comparative advantage holds that trading partners can be made better off if they specialize in production of goods for which they are the low opportunity cost producer. They should export, not import, goods for which they have a comparative advantage. Absolute and exchange rate adjusted costs are not relevant to the concept of comparative advantage.

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Which of the following arguments in favor of trade restrictions is least likely to be supported by economists?

A) Infant industries should be protected.

B) National defense industries should be protected.

C) Trade with low-wage countries depresses wage rates in high-wage countries.

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Trade with low-wage countries does not in itself depress wage rates since productivity must be considered. The other arguments all have some support among economists.

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Are Dion and Frankl correct in their assessment of the impact that restricting imports of transportation equipment would have on Minidonia’s economy?

Dion

Frankl

A) Yes No

B) No No

C) No Yes

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Dion and Frankl are both incorrect. Dion is incorrect because trade barriers do not protect jobs in the long run. The jobs protected by import restrictions will be offset by jobs lost in other industries, so that the net number of jobs in the country is not protected in the long run. Frankl is incorrect because trade in goods and services is a major component of the current, not capital, account deficit. In addition, Minidonia has a current account deficit, which implies that it would have a capital account surplus, not a capital account deficit.

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Which of the following groups in Minidonia is least likely to be helped by the imposition of tariffs on Minidonian imports of transportation equipment?

A) Automotive manufacturers.

B) Trucking companies.

C) Automotive manufacturers administrative employees.

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Tariffs on transportation equipment benefit the government in the form of tariff revenue, and benefit domestic producers and industry workers in the form of higher prices for transportation equipment. The users of transportation equipment, such as trucking companies, suffer from higher costs due to the higher prices of transportation equipment.

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Is Landseer correct in her statements regarding the Minidonian peso and:

the export effect?

interest rate parity?

A) Yes Yes

B) Yes No

C) No Yes

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Landseer is correct in both of her statements. The export effect suggests that, all else being equal, if a currency falls in value, the demand for exports denominated in that currency should increase. Interest rate parity holds when any forward premium or discount just offsets differences in interest rates so that an investor will earn the same return investing in either currency.

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Which most accurately describes the statements made by Frankl and Landseer about tariffs and quotas?

Frankl

Landseer

A) Incorrect Incorrect

B) Correct Correct

C) Correct Incorrect

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Frankl is correct that the increase in revenue to the domestic government under a tariff system partially offsets the lost gains from trade, even though there is still a deadweight loss to the economy. Landseer is incorrect because the producers who gain producer surplus are the foreign, not domestic, producers.