Chapter 06 International Trade Theory Answer Key

True / False Questions

1. The theories of Smith and Ricardo show that countries should not engage in international trade for
products that it is able to produce for itself. 
 
FALSE

The theories of Smith, Ricardo, and Heckscher-Ohlin show why it is beneficial for a country to
engage in international trade even for products it is able to produce for itself.

2. Porter's theory of national competitive advantage recommends unrestricted free trade between
countries. 
 
FALSE
Porter's theory of national competitive advantage can be interpreted as justifying some limited
government intervention to support the development of certain export-oriented industries.
3. Heckscher-Ohlin theory supports the case for unrestricted free trade between nations. 
 
TRUE
The theories of Smith, Ricardo, and Heckscher-Ohlin support the case for unrestricted free trade.
4. Mercantilist doctrine advocates unrestricted free trade between countries. 
 
FALSE
Mercantilist doctrine advocated government intervention to achieve a surplus in the balance of
trade.
5. A country has an absolute advantage in the production of a product when it is more efficient than
any other country in producing it. 
 
TRUE
A country has an absolute advantage in the production of a product when it is more efficient than
any other country in producing it.
6. According to Ricardo's theory of comparative advantage, countries shall not produce a good, even
if they have an absolute advantage in its production, if they do not produce it efficiently. 
 
TRUE
According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize
in the production of those goods that it produces most efficiently and to buy the goods that it
produces less efficiently from other countries even if the country has an absolute advantage over
its production.
 
 
8. Resources always move easily from one economic activity to another. 
 
FALSE

Resources do not always move easily from one economic activity to another.
 
9. The production possibility frontier will be parabolic if constant return to specialization is
observed. 
 
FALSE

Constant returns to specialization mean that the units of resources required to produce a good are
assumed to remain constant no matter where one is on a country's production possibility frontier.
Thus the production possibility frontier will be a straight line.
 
10. Diminishing returns show that it is feasible for a country to specialize to the degree suggested by
the simple Ricardian model. 
 
FALSE

Diminishing returns show that it is not feasible for a country to specialize to the degree suggested
by the simple Ricardian model.
 
11. According to Paul Samuelson's critique, a poor country will rapidly improve its productivity if a
rich country enters into a free trade agreement with it. 
 
TRUE

Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a
poor country, there will be a dynamic gain in the efficiency with which resources are used in the
poor country. The poor country's productivity will improve rapidly.
 
12. A rich country improves its productivity by engaging in free trade with a poor country. This
situation supports Paul Samuelson's critique. 
 
FALSE

Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a
poor country, only the poor country benefits from the relationship.
 
13. Factor endowments refer to the extent to which a country is gifted with such resources as land,
labor, and capital. 
 
TRUE

Factor endowments refer to the extent to which a country is endowed with such resources as land,
labor, and capital.
14. Heckscher-Ohlin theory stresses that comparative advantage arises from differences in
productivity. 
 
FALSE

Unlike Ricardo's theory, however, the Heckscher-Ohlin theory argues that the pattern of
international trade is determined by differences in factor endowments, rather than differences in
productivity.
 
15. Ricardo's theory makes fewer simplifying assumptions compared to Heckscher-Ohlin theory. 
 
FALSE

Most economists prefer the Heckscher-Ohlin theory to Ricardo's theory because it makes fewer
simplifying assumptions.
 
16. A key assumption in the Heckscher-Ohlin theory is that technologies are the same across
countries. 
 
TRUE

A key assumption in the Heckscher-Ohlin theory is that technologies are the same across
countries.

 
17. The product life-cycle theory argues that the developing nations will not produce a product if the
product is highly standardized. 
 
FALSE

The product life-cycle theory argues that the developing nations will produce a product only when
the product becomes highly standardized.

 
18. Some of the arguments made by the product life-cycle theory seem ethnocentric and increasingly
dated when viewed from an Asian or European perspective. 
 
TRUE

Viewed from an Asian or European perspective, the theory's argument that most new products are
developed and introduced in the United States seems ethnocentric and increasingly dated.
 
19. Companies that trade small volumes of product can benefit from economies of scale. 
 
FALSE

Economies of scale are unit cost reductions associated with a large scale of output. This means
that companies that trade in large volumes benefit from the economies of scale.

20. First-mover advantages are the economic and strategic advantages that accrue to early entrants
into an industry. 
 
TRUE

First mover advantages are the economic and strategic advantages that accrue to early entrants into
an industry.

 
21. According to the new trade theory, firms that establish a first-mover advantage with regard to the
production of a particular new product may subsequently dominate global trade in that product. 
 
TRUE

According to the new trade theory, firms that establish a first-mover advantage with regard to the
production of a particular new product may subsequently dominate global trade in that product.

 
22. New trade theorists stress the role of luck in giving a firm first-mover advantages. 
 
TRUE

New trade theorists stress the role of luck, entrepreneurship, and innovation in giving a first-mover
advantages.

 
23. From a profit perspective, it makes sense for firms to disperse their productive activities to those
countries where they can be performed most efficiently. 
 
TRUE

Underlying most trade theories is the notion that different countries have particular advantages in
different productive activities. Thus, from a profit perspective, it makes sense for a firm to
disperse its productive activities to those countries where, according to the theory of international
trade, they can be performed most efficiently.

  

Multiple Choice Questions

 
24. _____ refers to a situation where a government does not attempt to influence through quotas or
duties what its citizens can buy from another country. 
 

A.  Fair trade

B.  Trade theory
C.  Free trade
D.  Mercantilism

Free trade refers to a situation where a government does not attempt to influence through quotas or
duties what its citizens can buy from another country, or what they can produce and sell to another
country.

25. David Ricardo's theory of comparative advantage explains: 

 

A.  domestic trade in terms of international differences in political environments.

B.  international trade in terms of international differences in political environments.

C.  domestic trade in terms of international differences in labor productivity.

D.  international trade in terms of international differences in labor productivity.

David Ricardo's theory of comparative advantage explains international trade in terms of
international differences in labor productivity.
26. _____ stresses that in some cases countries specialize in the production and export of particular
products because the world market can support only a limited number of firms. 
 

A.  New trade theory

B.  Absolute advantage

C.  The world market theory

D.  Mercantilism
New trade theory stresses that in some cases countries specialize in the production and export of
particular products not because of underlying differences in factor endowments, but because in
certain industries the world market can support only a limited number of firms.
 
 
 
27. _____ supports the idea that countries should export more than what they import. 
 

A.  Absolute advantage

B.  Mercantilism
C.  The world market theory
D.  New trade theory

The main tenet of mercantilism was that it is in a country's best interests to maintain a trade
surplus, to export more than it imported.
 
28. The principle of mercantilism views trade as a(n) _____ game. 
 

A.  advantage
B.  positive-sum
C.  zero-sum
D.  negative-sum

The flaw with mercantilism was that it viewed trade as a zero-sum game.
 
29. _____ argued that countries should specialize in the production of goods for which they have an
absolute advantage. 
 

A.  Paul Krugman

B.  David Hume
C.  David Ricardo
D.  Adam Smith

According to Smith, countries should specialize in the production of goods for which they have an
absolute advantage and then trade these for goods produced by other countries.
30. According to Ricardo's theory of comparative advantage, countries should: 
 

A.  specialize in the production of those goods that it produces most efficiently.
B.  specialize in the production of those goods that their competitors in the world market currently
have monopolies on.
C.  produce all the products for which they have an absolute advantage.
D.  produce only the products for which they have an absolute advantage.

According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize
in the production of those goods that it produces most efficiently and to buy the goods that it
produces less efficiently from other countries.
 
31. The theory of comparative advantage suggests that trade is a _____ game in which all countries
that participate realize economic gains. 
 

A.  net-sum
B.  positive-sum
C.  zero-sum
D.  negative-sum

The theory of comparative advantage suggests that trade is a positive-sum game in which all
countries that participate realize economic gains.
 
32. The production possibility frontier will be _____ if constant return to specialization is observed. 
 

A.  convex
B.  parabolic
C.  a straight line
D.  logarithmic

Constant returns to specialization means that the units of resources required to produce a good
(cocoa or rice) are assumed to remain constant no matter where one is on a country's production
possibility frontier (PPF). In this case, the PPF will be a straight line.
 
33. The simple comparative advantage model assumed that trade: 
 

A.  changes efficiency with which a country utilizes resources.

B.  changes a country's stock of resources.
C.  allows for dynamic changes in the marketplace.
D.  does not change a country's stock of resources.

The simple comparative advantage model assumed that trade does not change a country's stock of
resources or the efficiency with which it utilizes those resources.
 
34. Paul Samuelson's critique argues that: 
 

A.  when a rich country enters into a free trade agreement with a poor country, only the poor
country benefits from the relationship.
B.  trade is a positive-sum game in which all countries that participate realize economic gains.
C.  when a rich country enters into a free trade agreement with a poor country, only the rich
country benefits from the relationship.
D.  trade is a net-sum game in which all countries that participate realize economic gains.

Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a
poor country, only the poor country benefits from the relationship.
 
35. The Heckscher-Ohlin theory predicts that countries will: 
 

A.  export those goods that make intensive use of factors that are locally scarce.
B.  export those goods that make intensive use of factors that are locally abundant.
C.  import those goods that make intensive use of factors that are locally abundant.
D.  import those goods that make intensive use of factors that are available world-wide.

The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive
use of factors that are locally abundant, while importing goods that make intensive use of factors
that are locally scarce.
 
36. The _____ theory argues that the pattern of international trade is determined by differences in
factor endowments. 
 

A.  comparative advantage

B.  Leontief Paradox
C.  Heckscher-Ohlin
D.  absolute advantage

The Heckscher-Ohlin theory argues that the pattern of international trade is determined by
differences in factor endowments.
 
37. A capital intensive country exports products that are capital intensive. Which theory is this an
example of? 
 

A.  New trade

B.  Leontief Paradox
C.  Porter Diamond Model
D.  Heckscher-Ohlin

The given situation follows the Heckscher-Ohlin theory.

 
38. The _____ argues that a large proportion of the world's new products had been developed by U.S.
firms. 
 

A.  product life-cycle theory

B.  Porter Diamond Model
C.  new trade theory
D.  Leontief Paradox

The product life-cycle theory argues that a large proportion of the world's new products had been
developed by U.S. firms.
 
39. _____ are unit cost reductions associated with a large scale of output. 
 

A.  Current account deficits

B.  Economies of scale
C.  Current account surpluses
D.  Factor endowments

Economies of scale are unit cost reductions associated with a large scale of output.
 
40. The variety of goods that a country can produce is limited by the size of the market in industries
where _____ are important. 
 

A.  factor endowments

B.  current account deficits
C.  economies of scale
D.  current account surpluses

In industries where economies of scale are important, both the variety of goods that a country can
produce and the scale of production are limited by the size of the market.
 
41. New trade theory suggests that nations: 
 

A.  increase their commitment to research and development.

B.  adopt policies that promote strong competition within domestic markets.
C.  cannot benefit from trade when they do not differ in resource endowments or technology.
D.  may benefit from trade even when they do not differ in resource endowments or technology.

New trade theory suggests that nations may benefit from trade even when they do not differ in
resource endowments or technology.
 
42. The theories of international trade claim that promoting free trade is generally in the best interests
of: 
 

A.  a country, although it may not always be in the best interest of an individual firm.
B.  all multinational corporations.
C.  an individual firm, although it may not always be in the best interest of a country.
D.  the World Trade Organization.

The theories of international trade claim that promoting free trade is generally in the best interests
of a country, although it may not always be in the best interest of an individual firm.
 
43. Porter contends that government: 
 

A.  can influence the domestic demand conditions and the domestic rivalry components of the
diamond, but not the other two components.
B.  can influence each of the four components of the diamond either positively or negatively.
C.  can influence the factor endowments and the related and supporting industries components of
the diamond, but not the other two components.
D.  has little or no effect on the four components that shape the environment in which firms
compete.

Porter contends that government can influence each of the four components of the diamond—
factor endowments, domestic demand conditions, related and supporting industries, and domestic
rivalry—either positively or negatively.
 
44. Which of the following refers to a situation where a government does not attempt to influence
through quotas or duties what its citizens can buy from another country? 
 

A.  Economic patriotism

B.  Protectionism
C.  Free trade
D.  Offshoring

Free trade refers to a situation where a government does not attempt to influence through quotas or
duties what its citizens can buy from another country, or what they can produce and sell to another
country.
 
45. Which of the following is a major benefit of engaging in free trade? 
 

A.  It helps to reduce the financial volatility in global markets.

B.  It helps the countries protect the jobs that are available to their citizens.
C.  It gives countries access to products that they cannot produce.
D.  It allows the governments to exert more control on businesses.

Countries can benefit from exchanging goods that they can produce efficiently to obtain products
that they cannot produce.
 
46. David Ricardo's theory of comparative advantage explains global trade in terms of the: 
 

A.  first mover advantage that certain countries and firms enjoy.
B.  geographical differences between various countries.
C.  international differences in labor productivity.
D.  late mover advantage that certain countries and firms possess.

David Ricardo's theory of comparative advantage offers an explanation in terms of international

differences in labor productivity.
 
47. Which of the following theories emphasizes the interplay between the proportions in which the
factors of production are available in different countries and the proportions in which they are
needed for producing particular goods? 
 

A.  Porter's theory

B.  Smith's theory
C.  Ricardo's theory
D.  Heckscher-Ohlin theory

The Heckscher-Ohlin theory emphasizes the interplay between the proportions in which the
factors of production (such as land, labor, and capital) are available in different countries and the
proportions in which they are needed for producing particular goods.
 
48. Identify the theory that supports the view that, in some cases, countries export for the reason that
the world market can support only a limited number of firms. 
 

A.  Heckscher-Ohlin theory

B.  Smith's theory
C.  Ricardo's theory
D.  New trade theory

New trade theory stresses that in some cases countries specialize in the production and export of
particular products not because of underlying differences in factor endowments, but because in
certain industries the world market can support only a limited number of firms.
 
49. Country A exports electronic goods from Country B although there are no underlying differences
in factor endowments between the two countries. Which of the following theories explains this
anomaly? 
 

A.  Comparative advantage theory

B.  New trade theory
C.  Ricardo's theory
D.  Smith's theory

New trade theory stresses that in some cases countries specialize in the production and export of
particular products not because of underlying differences in factor endowments, but because in
certain industries the world market can support only a limited number of firms.
 
50. Which of the following observations is consistent with Michael Porter's theory of national
competitive advantage? 
 

A.  Factors such as domestic demand and domestic rivalry determine nations' dominance on
production.
B.  Countries should produce only those goods for which they have a comparative advantage.
C.  Interplay between the factors of production cause international marketing decisions.
D.  International differences in labor productivity determine nations' supremacy in production.

Michael Porter's theory of national competitive advantage attempts to explain why particular
nations achieve international success in particular industries. In addition to factor endowments,
Porter points out the importance of country factors such as domestic demand and domestic rivalry
in explaining a nation's dominance in the production and export of particular products.
 
51. Which of the following is a theory that can be used to justify limited government intervention to
support the development of certain export-oriented industries? 
 

A.  Comparative advantage theory

B.  Ricardo's theory
C.  New trade theory
D.  Heckscher-Ohlin theory

Both the new trade theory and Porter's theory of national competitive advantage can be interpreted
as justifying some limited government intervention to support the development of certain export-
oriented industries.
 
52. Which of the following is the main principle of mercantilism? 
 

A.  Protection of domestic industries is not essential for a nation's welfare.

B.  Government intervention is not required in global trade.
C.  Countries should encourage absolute free trade.
D.  It is in a country's best interests to maintain a trade surplus.

The main tenet of mercantilism was that it was in a country's best interests to maintain a trade
surplus, to export more than it imported. By doing so, a country would accumulate gold and silver
and, consequently, increase its national wealth, prestige, and power.
 
53. Which of the following is a major flaw associated with mercantilism? 
 

A.  Mercantilists do not support government intervention in trade.

B.  Mercantilists view trade as a zero-sum game.
C.  Mercantilists recommend policies to maximize imports.
D.  Mercantilists recommend countries to maintain a negative trade balance.

The flaw with mercantilism was that it viewed trade as a zero-sum game. A zero-sum game is one
in which a gain by one country results in a loss by another.
 
54. A country has an absolute advantage in the production of a product when it: 
 

A.  has the capability to produce the product within its boundaries.
B.  is more efficient than any other country in producing it.
C.  has the largest domestic demand for the product.
D.  has access to the raw materials needed to produce the product.

A country has an absolute advantage in the production of a product when it is more efficient than
any other country in producing it.
 
55. According to Adam Smith, a country should specialize in the production of a good when it has: 
 

A.  an absolute advantage in the production of the good.

B.  a strong domestic demand for the good.
C.  the ability to help country increase its national output.
D.  the necessary raw materials for production.

According to Smith, countries should specialize in the production of goods for which they have an
absolute advantage and then trade these for goods produced by other countries.
56. Country A can produce product X, but it can also buy it at a cheap rate from Country B. Which of
the following courses of action is suitable in this situation according to Adam Smith's theory of
absolute advantage? 
 

A.  Country A should import product X from country B and it should not attempt to produce it at
home.
B.  Country A should partly import the product and produce it domestically.
C.  Country A should produce more of product X and should attempt to obtain an absolute
advantage for the product.
D.  Country A should subsidize the production of product X to obtain an absolute advantage over
country B.

Smith's basic argument is that a country should never produce goods at home that it can buy at a
lower cost from other countries.
 
57. According to Ricardo's theory of comparative advantage, a country should produce goods: 
 

A.  for which it has access to raw materials.

B.  that it produces most efficiently.
C.  that have the highest domestic demand.
D.  for which it has an absolute advantage.

According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize
in the production of those goods that it produces most efficiently and to buy the goods that it
produces less efficiently from other countries, even if this means buying goods from other
countries that it could produce more efficiently itself.
 
58. Which of the following is a statement that supports the theory of comparative advantage? 
 

A.  International trade is a zero-sum gain where one nation's gain is another's loss.
B.  Domestic industries are at risk when a country engages in free trade.
C.  A country should maintain trade surplus to succeed in global trade.
D.  Global production is greater with free trade than it is with restricted trade.

The basic message of the theory of comparative advantage is that potential world production is
greater with unrestricted free trade than it is with restricted trade.
 
59. The theory of comparative advantage provides strong rationale for supporting the idea of _____. 
 

A.  business nationalism

B.  free trade
C.  protectionism
D.  governmental intervention in trade

The theory of comparative advantage suggests that trade is a positive-sum game in which all
countries that participate realize economic gains. As such, this theory provides a strong rationale
for encouraging free trade.
 
60. Diminishing returns to specialization occurs when: 
 

A.  each additional unit is produced with lesser number of laborers.

B.  a nation's gross domestic product declines for a few years.
C.  production possibility frontier appears as a rectangle.
D.  more units of resources are required to produce each additional unit.

Diminishing returns to specialization occurs when more units of resources are required to produce
each additional unit.
 
61. Which of the following is a major limitation of the simple Ricardian model of comparative
advantage? 
 

A.  The model ignores the principle of diminishing marginal returns.

B.  The model recommends excessive governmental intervention in trade.
C.  The outcome of the model suggested by Ricardo is a zero-sum game.
D.  The model is against the idea of engaging in free trade with nations.

Diminishing returns show that it is not feasible for a country to specialize to a great extent.
Ricardian model ignores this principle of diminishing returns.
 
62. What will happen, according to Paul Samuelson's critique, if a rich country enters into a free trade
agreement with a poor country? 
 

A.  Both the countries will incur losses due to the exchanges between them.
B.  The productivity of the poor country will decline rapidly.
C.  The poor country will rapidly improve its productivity.
D.  Both the countries will garner benefits from the exchanges between them.

Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a
poor country, there will be a dynamic gain in the efficiency with which resources are used in the
poor country. The poor country's productivity will improve rapidly.
 
63. Which of the following arguments supports the Paul Samuelson's critique? 
 

A.  A rich country cannot produce net gains by engaging in free trade with a poor country.
B.  Governmental intervention will reduce the likeliness of countries' economic success.
C.  Countries should attempt to specialize in the production of goods and services.
D.  Trade is a positive-sum game in which all countries that participate realize economic gains.

Paul Samuelson's critique argues that when a rich country enters into a free trade agreement with a
poor country, only the poor country benefits from the relationship.
 
64. Which of the following terms refers to the extent to which a country is gifted with such resources
as land, labor, and capital? 
 

A.  Current accounts

B.  Factor endowments
C.  National balance
D.  National accounts

Factor endowments refer to the extent to which a country is endowed with such resources as land,
labor, and capital.
 
65. Identify the theory that predicts that countries will export those goods that make intensive use of
factors that are locally abundant. 
 

A.  Theory of comparative advantage

B.  Ricardo theory
C.  New trade theory
D.  Heckscher-Ohlin theory

The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive
use of factors that are locally abundant, while importing goods that make intensive use of factors
that are locally scarce.
 
66. Which of the following is the reason why most economists prefer Heckscher-Ohlin theory to
Ricardo's theory? 
 

A.  Heckscher-Ohlin stresses on the differences in productivity between nations.

B.  Ricardo's theory considers factor endowments to describe national competitiveness.
C.  Heckscher-Ohlin theory makes fewer simplifying assumptions.
D.  Ricardo's theory considers the law of marginal returns.

Most economists prefer the Heckscher-Ohlin theory to Ricardo's theory because it makes fewer
simplifying assumptions.
 
67. Which of the following statements is true of the Leontief Paradox? 
 

A.  It shows an anomaly that occurs when a nation has high domestic demand for a product.
B.  It explains the relationship between domestic demand and comparative advantage.
C.  It disproved Ricardo's theory of comparative advantage.
D.  It raised questions about the validity of the Heckscher-Ohlin theory.

Leontief Paradox raised questions about the validity of the Heckscher-Ohlin theory.
 
68. Identify the theory that argues that advanced nations have an incentive to develop a new offering
and hence such nations always tend to create a good or service for the first time. 
 

A.  Absolute advantage

B.  Ricardo
C.  Product life-cycle
D.  Heckscher-Ohlin

The theory argues that the wealth of such advanced countries as the United States gives them an
incentive to develop new consumer goods. Such nations always develop new products.
 
69. Country X, a poor country, invents a revolutionary electronic product. The country markets this
new product in other poor countries to garner large profits. This occurrence is against the idea of
____. 
 

A.  product life-cycle theory

B.  Ricardo's theory
C.  theory of absolute advantage
D.  theory of comparative advantage

The theory argues that the wealth of such advanced countries as the United States gives them an
incentive to develop new consumer goods. The theory also argues that new products are always
introduced in developed nations.
 
70. Which of the following is a major disadvantage of the product life-cycle theory introduced by
Vernon? 
 

A.  The theory's arguments seem ethnocentric and increasingly dated.

B.  The theory failed to explain the dominance of developed nations.
C.  The theory applies only when a poor nation invents a new product.
D.  The theory cannot be used to explain the production of luxury products.

Vernon's argument that most new products are developed and introduced in the United States
seems ethnocentric and increasingly dated.
 
71. Which of the following terms refers to the unit cost reductions associated with large sized
outputs? 
 

A.  Absolute advantage of production

B.  Economies of scale
C.  Constant marginal returns
D.  Diminishing marginal returns

Economies of scale are unit cost reductions associated with a large scale of output.
 
72. Wal-Mart makes bulk purchases from its vendors and hence it is able to get better deals than its
competitors. This allows Wal-Mart to offer greater discounts to its customers. In this case, Wal-
Mart benefits from _____. 
 

A.  first-mover advantage

B.  constant marginal returns
C.  economies of scale
D.  absolute advantage of production

Economies of scale are unit cost reductions associated with a large scale of output. Here, Wal-
Mart is benefiting from the economies of scale.
 
73. Company A entered the production of office software before its competitors. Because of this, the
company's products are more familiar among and favored by customers. This situation exemplifies
the _____. 
 

A.  first-mover advantage

B.  diminishing marginal returns
C.  economies of scale
D.  constant marginal returns

First mover advantages are the economic and strategic advantages that accrue to early entrants into
an industry.
 
74. Which of the following theories suggests that first mover advantage is significant in the export of
a good? 
 

A.  Product life-cycle theory

B.  Ricardo's theory
C.  New trade theory
D.  Theory of comparative advantage

New trade theory suggests that a country may predominate in the export of a good simply because
it was lucky enough to have one or more firms among the first to produce that good. Because they
are able to gain economies of scale, the first movers in an industry may get a lock on the world
market that discourages subsequent entry.
 
75. Which of the following theories stress the role of luck, entrepreneurship, and innovation in the
production and export of a good or service by the firms in a country? 
 

A.  Product life-cycle theory

B.  Ricardo's theory
C.  Theory of comparative advantage
D.  New trade theory

New trade theory suggests that a country may predominate in the export of a good simply because
it was lucky enough to have one or more firms among the first to produce that good. New trade
theorists stress the role of luck, entrepreneurship, and innovation in giving a firm first mover
advantages.
 
76. Which of the following is one of the four attributes present in Porter's diamond? 
 

A.  Economies of scale

B.  Factor endowments
C.  Structural innovation
D.  Procedural innovation

Porter theorizes four broad attributes of a nation shape the environment in which local firms
compete. These four factors are factor endowments, demand conditions, relating and supporting
industries, and firm strategy, structure, and rivalry.
 
77. Which of the following is an example of a basic factor that a nation will possess as proposed by
Porter? 
 

A.  Communication infrastructure

B.  Skilled labor
C.  Natural resources
D.  Technological knowledge

Such factors as natural resources, climate, location, and demographics are basic factors. Factors
such as communication infrastructure, sophisticated and skilled labor, research facilities, and
technological know-how are examples of and advanced factors.
 
78. Which of the following factors, according to Porter's national Diamond, is most likely to give a
country competitive advantage over another country? 
 

A.  Natural resources

B.  Climate
C.  Skilled labor
D.  Demographics

Factors such as communication infrastructure, sophisticated and skilled labor, research facilities,
and technological know-how are examples of and advanced factors. Porter argues that advanced
factors are the most significant for competitive advantage.
 
79. Porter argues that a nation's firms gain competitive advantage if: 
 

A.  their domestic consumers lack technical awareness

B.  they function in a labor intensive market
C.  the country has abundant supply of unskilled workers
D.  their domestic consumers are demanding

Porter argues that a nation's firms gain competitive advantage if their domestic consumers are
sophisticated and demanding.
 
80. Textile industry in a nation is characterized by vigorous domestic rivalry. Which of the following
observations of this nation's international competency is most likely to be true? 
 

A.  The nation will have access to such basic factors of textile industry as natural resources.
B.  The nation's textile firms will have a competitive advantage in international trade.
C.  The domestic customers of the textile firms will be less demanding.
D.  The nation's textile industry will lack the advanced factors that are necessary to be
internationally competent.

Porter's second point is that there is a strong association between vigorous domestic rivalry and
the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry
induces firms to look for ways to improve efficiency, which makes them better international
competitors.
 
81. A country's balance-of-payments accounts keep track of the: 
 

A.  basic factor endowments and advanced factor endowments that the nation possesses.
B.  payments to and receipts from other countries for a particular time period.
C.  income taxes paid by domestic firms and the spending on the firms.
D.  total value of taxes paid by domestic firms and the spending on the firms.

A country's balance-of-payments accounts keep track of the payments to and receipts from other
countries for a particular time period.
 
82. Which of the following balance-of-payment accounts records one-time changes in the stock of
assets? 
 

A.  Capital account

B.  Current account
C.  Financial account
D.  Monetary account

The capital account records one-time changes in the stock of assets.

 
83. Which of the following accounts records transactions that involve the purchase or sale of assets? 
 

A.  Capital account

B.  Current account
C.  Principal account
D.  Financial account

The financial account (formerly the capital account) records transactions that involve the purchase
or sale of assets.
 
84. When a country runs a current account deficit, what happens to the money that flows to other
countries? 
 

A.  It is used to buy assets in the deficit country.

B.  It is put into the receiving country's infrastructure.
C.  It is converted to securities.
D.  It is used to pay for social programs in the receiving country.

When a country runs a current account deficit, the money that flows to other countries can be used
to purchase assets in the deficit country.
 
85. If foreigners suddenly reduced their investments in the United States, what would happen? 
 

A.  The value of the dollar on foreign exchange markets would increase.
B.  The action would have no impact on the U.S. economy.
C.  The foreigners would sell U.S. dollars for another currency.
D.  The price of U.S. exports would increase.

Instead of reinvesting the dollars they earn from exports and investment in the United States back
into the country, they would sell those dollars for another currency. This would lead to a fall in the
value of the dollar on foreign exchange markets, and that in turn would increase the price of
imports, and lower the price of U.S. exports.
 
86. The main tenet of mercantilism is that it is in a country's best interests to: 
 

A.  maintain a trade deficit.

B.  maintain a trade surplus.
C.  Import goods made from products that it does not have in abundance.
D.  import more than it exports.

The main tenet of mercantilism is that it is in a country's best interests to maintain a trade surplus,
to export more than it imported. By doing so, a country would accumulate gold and silver and,
consequently, increase its national wealth, prestige, and power.
 
87. Which of the following is a major flaw associated with mercantilism? 
 

A.  It viewed trade as a positive-sum game.

B.  It relied on government to support trade.
C.  It viewed trade as a zero-sum game.
D.  It relied on tenuous free trade agreements.

The flaw with mercantilism was that it viewed trade as a zero-sum game. A zero-sum game is one
in which a gain by one country results in a loss by another.

 
88. Factor endowments refer to the extent to which a country: 
 

A.  supports education, research, and development.

B.  develops the infrastructure to support industrialism.
C.  supports free trade.
D.  is endowed with such resources as land, labor, and capital.

Factor endowments refer to the extent to which a country is endowed with such resources as land,
labor, and capital. Nations have varying factor endowments, and different factor endowments
explain differences in factor costs.

 
89. The _____ theory was based on the observation that for most of the twentieth century a very large
proportion of the world's new products had been developed by U.S. firms and sold first in the U.S.
market. 
 

A.  product life-cycle

B.  Heckscher-Ohlin
C.  new trade
D.  Ricardo

Vernon's theory was based on the observation that for most of the twentieth century a very large
proportion of the world's new products had been developed by U.S. firms and sold first in the U.S.
market. To explain this, Vernon argued that the wealth and size of the U.S. market gave U.S. firms
a strong incentive to develop new consumer products.
 
90. Economies of scale have a number of sources, including the ability: 
 

A.  to average out the variable costs of production.

B.  of large-volume producers to utilize specialized employees and equipment.
C.  to adjust the scale of production based upon product saturation in the marketplace.
D.  of to utilize non-specialized employees interchangeably.

Economies of scale are unit cost reductions associated with a large scale of output. Economies of
scale have a number of sources, including the ability to spread fixed costs over a large volume,
and the ability of large-volume producers to utilize specialized employees and equipment that are
more productive than less specialized employees and equipment.
 
91. One of the advantages of being the first mover in a market is: 
 

A.  there is little risk involved.

B.  to benefit from a higher cost structure.
C.  the ability to capture scale economies ahead of later entrants.
D.  local governments are more favorable to the first movers.

First-mover advantages are the economic and strategic advantages that accrue to early entrants
into an industry. The ability to capture scale economies ahead of later entrants, and thus benefit
from a lower cost structure, is an important first-mover advantage.

 
92. Which of the following is true regarding Porter's Diamond theory? 
 

A.  It predicts that countries should be importing products from those industries where all four
components of the diamond are favorable.
B.  Porter's theory has been proven to be an accurate predictor of the importing and exporting
patterns of countries.
C.  It predicts that countries should be exporting products from those industries where all four
components of the diamond those areas where the components are not favorable.
D.  Porter's theory has not been subjected to detailed empirical testing, so we do not know if it is
correct.
 
93. Underlying most of the trade theories discussed is the notion that: 
 

A.  different countries have particular advantages in different productive activities.

B.  firms that establish a first-mover advantage with regard to the production of a particular new
product will dominate global trade in that product.
C.  it usually makes sense for a firm to consolidate its productive activities in one country.
D.  despite a pivotal role in international trade, businesses are typically unable to influence
government trade policy.
 

Essay Questions
 
94. Explain the concept of free trade. 
 

Free trade refers to a situation where a government does not attempt to influence through quotas or
duties what its citizens can buy from another country, or what they can produce and sell to another
country. Smith, who proposed free trade, argued that the invisible hand of the market mechanism,
rather than government policy, should determine what a country imports and what it exports.

95. How does the Heckscher-Ohlin theory explain international trade? 

 

The Heckscher-Ohlin theory emphasizes the interplay between the proportions in which the
factors of production (such as land, labor, and capital) are available in different countries and the
proportions in which they are needed for producing particular goods. This explanation rests on the
assumption that countries have varying endowments of the various factors of production.
96. Explain how the theories of trade differ in terms of their support to governmental intervention. 
 

The theories of Smith, Ricardo, and Heckscher-Ohlin form part of the case for unrestricted free
trade. The argument for unrestricted free trade is that both import controls and export incentives
(such as subsidies) are self-defeating and result in wasted resources. Both the new trade theory and
Porter's theory of national competitive advantage can be interpreted as justifying some limited
government intervention to support the development of certain export-oriented industries.
97. Explain Smith's theory of absolute advantage. 
 

A country has an absolute advantage in the production of a product when it is more efficient than
any other country in producing it. According to Smith, countries should specialize in the
production of goods for which they have an absolute advantage and then trade these for goods
produced by other countries.

101. Explain how the principle of diminishing returns weakens the Ricardian model. 
Diminishing returns show that it is not feasible for a country to specialize to the degree suggested
by the simple Ricardian model outlined earlier. Diminishing returns to specialization suggest that
the gains from specialization are likely to be exhausted before specialization is complete.
 

 
99. What are the assumptions that we make when we discuss a simple Ricardian model to support free
trade? 
 

1. We have assumed a simple world in which there are only two countries and two goods.
2. We have assumed away transportation costs between countries.
3. We have assumed away differences in the prices of resources in different countries.
4. We have assumed that resources can move freely from the production of one good to another
within a country.
5. We have assumed constant returns to scale.
6. We have assumed that each country has a fixed stock of resources and that free trade does not
change the efficiency with which a country uses its resources.
7. We have assumed away the effects of trade on income distribution within a country.
 
100. Briefly differentiate between constant returns to specialization and diminishing returns to
specialization. 
 

By constant returns to specialization we mean the units of resources required to produce a good
(cocoa or rice) are assumed to remain constant no matter where one is on a country's production
possibility frontier (PPF). Diminishing returns to specialization occur when more units of
resources are required to produce each additional unit.
 
102. Explain the dynamic gains that are generated by opening an economy to trade. 
 

First, free trade might increase a country's stock of resources as increased supplies of labor and
capital from abroad become available for use within the country.
Second, free trade might also increase the efficiency with which a country uses its resources.
 
103. Explain the Paul Samuelson's critique. 
 

Paul Samuelson's critique looks at what happens when a rich country enters into a free trade
agreement with a poor country that rapidly improves its productivity after the introduction of a
free trade regime. Samuelson's model suggests that in such cases, the lower prices that the rich
country's consumers pay for goods imported from the poor country following the introduction of a
free trade regime may not be enough to produce a net gain for the rich country's economy if the
dynamic effect of free trade is to lower real wage rates in the rich country.
 
104. Identify a major disadvantage of the product life-cycle theory. 
 

Viewed from an Asian or European perspective, Vernon's argument that most new products are
developed and introduced in the United States seems ethnocentric and increasingly dated. This is a
major disadvantage of the product life-cycle theory.

 
105. Do you think a new trade theorist would stress the role of luck and entrepreneurship? Explain. 
 

Perhaps the most contentious implication of the new trade theory is the argument that it generates
for government intervention and strategic trade policy. New trade theorists stress the role of luck,
entrepreneurship, and innovation in giving firm first-mover advantages.

 
106. What are the four attributes that are discussed in Porter's diamond? 
 

The four factors are:

(1) Factor endowments — a nation's position in factors of production such as skilled labor or the
infrastructure necessary to compete in a given industry.
(2) Demand conditions — the nature of home demand for the industry's product or service.
(3) Relating and supporting industries — the presence or absence of supplier industries and related
industries that are internationally competitive.
(4) Firm strategy, structure, and rivalry — the conditions governing how companies are created,
organized, and managed and the nature of domestic rivalry.

 
107. Explain how the rivalry within an industry affects international competence. 
 

Porter's second point is that there is a strong association between vigorous domestic rivalry and
the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry
induces firms to look for ways to improve efficiency, which makes them better international
competitors. Domestic rivalry creates pressures to innovate, to improve quality, to reduce costs,
and to invest in upgrading advanced factors. All this helps to create world-class competitors.