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Question 1Trade Theory

In international trade theory, which statement best defines the principle of absolute advantage?

  1. A country can produce more of a good with the same resources than its trading partner Correct answer.
  2. A country can produce a good at a lower opportunity cost than its trading partner
  3. A country gains by restricting imports to protect domestic industries
  4. A country should specialize only in goods where it has no competitors

Explanation

Absolute advantage, associated with Adam Smith, compares productivity directly: a country has it when it can produce more output from a given amount of resources than another country. It is a comparison of efficiency in physical terms, not of opportunity cost.

Question 2Trade Theory

According to the Heckscher-Ohlin model, a country will export the good that intensively uses which factor?

  1. The factor that is relatively scarce in that country
  2. The factor owned mainly by the government
  3. The factor that is relatively abundant in that country Correct answer.
  4. The factor that is most mobile internationally

Explanation

The Heckscher-Ohlin theorem states that a country exports goods whose production is intensive in its relatively abundant factor and imports goods intensive in its scarce factor. The logic rests on relative factor endowments shaping relative autarky prices.

Question 3Trade Theory

The Ricardian model predicts that trade between two countries is beneficial primarily because it allows each country to do which of the following?

  1. Achieve a consumption bundle beyond its own production possibility frontier Correct answer.
  2. Eliminate the influence of technology on production costs
  3. Eliminate all differences in wage rates between the two countries
  4. Eliminate the need for any factor mobility within each country

Explanation

In the Ricardian model, specialization according to comparative advantage expands the world's total output, allowing each country to consume outside its autarky production frontier. The gain arises from reallocating labor toward the sector where relative productivity is higher.

Question 4Trade Theory

In the standard partial-equilibrium analysis of a tariff imposed by a small country, which welfare effect is described as the efficiency loss from distorted consumption and production?

  1. The terms-of-trade gain captured by the government
  2. The deadweight loss composed of the consumption and production distortion triangles Correct answer.
  3. The transfer from domestic consumers to domestic producers
  4. The tariff revenue collected on imports

Explanation

For a small country that cannot influence world prices, a tariff creates two deadweight-loss triangles: one from overproduction by inefficient domestic firms and one from suppressed consumption. These triangles together measure the net efficiency cost of the tariff.

Question 5Trade Theory

Which of the following is the core prediction of the Linder hypothesis regarding trade in manufactured goods?

  1. Countries trade most when their factor endowments differ sharply
  2. Trade in manufactures is driven solely by differences in technology
  3. Trade intensity depends only on distance and transport costs
  4. Countries with similar per capita income levels trade more intensively with each other Correct answer.

Explanation

The Linder hypothesis argues that manufactured goods are developed for domestic demand and exported to countries with similar demand structures, proxied by similar per capita incomes. It therefore predicts relatively intensive trade among high-income, similar countries.

Question 6Trade Theory

Which instrument is defined as a limit on the quantity of a good that may be imported during a specified period?

  1. A voluntary export restraint
  2. An ad valorem tariff
  3. An export subsidy
  4. An import quota Correct answer.

Explanation

An import quota is a quantitative restriction setting a maximum volume of imports over a period. Unlike a tariff, it acts directly on quantity rather than on price.

Question 7Trade Theory

In a two-country, two-good Ricardian model with labor as the only factor, what determines the relative price of a good in autarky?

  1. The level of foreign direct investment in each country
  2. Relative labor requirements weighted by relative wages in each country Correct answer.
  3. The tariff schedule imposed by the larger country
  4. The total size of the world's gold reserves

Explanation

In the Ricardian model, autarky prices reflect relative unit labor requirements multiplied by the relative wage, which is set by relative productivity in each country. These relative prices determine the pattern of comparative advantage and the direction of trade.

Question 8Trade Theory

The gravity model of trade predicts that the volume of bilateral trade between two countries is positively related to which combination of factors?

  1. Their economic sizes and their proximity to each other Correct answer.
  2. Their factor endowments and their political systems
  3. Their exchange rates and their inflation rates
  4. Their tariff levels and their geographic distance

Explanation

The gravity model relates bilateral trade positively to the GDP of the trading partners and negatively to the distance between them, analogous to gravitational attraction. It captures the empirical regularity that large, nearby economies trade more.

Question 9Trade Theory

Under the Heckscher-Ohlin model, opening to trade between two countries with different factor endowments leads to which effect on the real return to each country's abundant factor?

  1. It rises only if the country is large enough to influence world prices
  2. It rises, while the real return to the scarce factor falls Correct answer.
  3. It falls, while the real return to the scarce factor rises
  4. It is unchanged, and only the scarce factor's return changes

Explanation

The Stolper-Samuelson theorem implies that trade raises the real return to a country's abundant factor and lowers the real return to its scarce factor. This follows from the change in relative goods prices that trade induces.

Question 10Trade Theory

A country can produce a unit of cloth with 2 units of labor and a unit of wine with 4 units of labor. Its trading partner needs 3 units of labor for cloth and 8 for wine. Which good should the first country export according to comparative advantage?

  1. Wine, because its absolute advantage in wine is larger
  2. Both goods, because it is more efficient in both
  3. Neither good, because absolute advantage determines trade
  4. Cloth, because its opportunity cost of cloth is lower Correct answer.

Explanation

The first country's opportunity cost of cloth is 2/4 = 0.5 units of wine, while the partner's is 3/8 = 0.375 units of wine. The partner has the lower opportunity cost of cloth, so the first country should export wine, where its opportunity cost (2 units of cloth) is lower than the partner's (8/3).

Question 11Trade Theory

In the standard specific-factors model, a tariff on the import-competing sector raises the return to which factor in the short run?

  1. The factor specific to the import-competing sector Correct answer.
  2. The factor specific to the export sector
  3. All factors equally, because tariffs are neutral in the short run
  4. The mobile factor, unambiguously

Explanation

In the specific-factors model, a tariff raises the domestic price of the import good, drawing the mobile factor into that sector and raising the return to the factor specific to it. The factor specific to exports loses as its sector contracts.

Question 12Trade Theory

Which statement correctly contrasts a tariff with an equivalent import quota when domestic demand grows?

  1. Under a quota, the extra demand is met by higher domestic prices; under a tariff, by more imports Correct answer.
  2. Both instruments allow imports to increase proportionally with demand
  3. Neither instrument allows imports to change when demand grows
  4. Under a quota, the extra demand is met by more imports; under a tariff, by higher domestic prices

Explanation

A quota fixes quantity, so when demand rises the price must adjust upward to clear the market. A tariff fixes the price wedge, so a demand increase is met by additional imports rather than by higher domestic prices.

Question 13Trade Theory

In the Krugman monopolistic-competition trade model, which source of gains from trade is emphasized in addition to comparative advantage?

  1. Improved terms of trade from tariff retaliation
  2. Increased product variety and exploitation of economies of scale Correct answer.
  3. Guaranteed equalization of wages across countries
  4. Reduced factor endowments through migration

Explanation

In models of intra-industry trade under monopolistic competition, gains arise from larger markets that support more varieties and lower average costs through economies of scale. This explains trade between similar countries that the factor-proportions model cannot easily address.

Question 14Trade Theory

A large country imposes a tariff that improves its terms of trade. What is the condition under which national welfare can rise?

  1. The tariff rate is below the world average tariff level
  2. The tariff revenue exceeds the value of lost imports
  3. The terms-of-trade gain exceeds the deadweight losses from distorted production and consumption Correct answer.
  4. The country's export sector expands as a result of the tariff

Explanation

For a large country, a tariff lowers the world price of imports, generating a terms-of-trade gain. Welfare rises only if this gain outweighs the efficiency losses from reduced trade volumes in production and consumption.

Question 15Trade Theory

Which assumption distinguishes the Heckscher-Ohlin model from the Ricardian model?

  1. Two factors of production with different intensities across goods Correct answer.
  2. Identical technology in all countries
  3. A single factor of production with constant returns to scale
  4. Perfectly mobile factors across national borders

Explanation

The Heckscher-Ohlin model introduces two factors, typically labor and capital, used in different proportions across goods. This allows factor endowments, rather than technology differences alone, to determine comparative advantage.

Question 16Trade Theory

In the standard analysis of an export subsidy in a small country, which welfare outcome is predicted?

  1. National welfare rises if the subsidy is financed by a tariff
  2. National welfare rises because exports increase
  3. National welfare falls because the subsidy distorts production and consumption Correct answer.
  4. National welfare is unchanged because the subsidy is a pure transfer

Explanation

An export subsidy raises the domestic price of the export good, encouraging overproduction and discouraging domestic consumption. In a small country, the resulting deadweight losses exceed any transfer gains, so national welfare declines.

Question 17Trade Theory

According to the product life cycle theory of trade, production of a new manufactured good typically shifts over time in which pattern?

  1. From countries with trade surpluses to countries with deficits
  2. From the country with the largest population to smaller countries
  3. From developing countries to advanced countries as technology matures
  4. From the innovating advanced country to imitating countries with lower costs Correct answer.

Explanation

The product life cycle theory holds that new products are first produced and exported by the innovating advanced country, then production migrates to imitating countries as the technology standardizes and cost competition intensifies.

Question 18Trade Theory

Which of the following correctly describes the effective rate of protection?

  1. The percentage increase in value added per unit of output permitted by the tariff structure Correct answer.
  2. The average tariff rate across all imported goods
  3. The tariff revenue divided by total import value
  4. The tariff rate applied to the final good only

Explanation

The effective rate of protection measures how a tariff structure affects value added in domestic production, accounting for tariffs on both inputs and outputs. It can exceed the nominal tariff when inputs are imported duty-free.

Question 19Trade Theory

In a two-good general equilibrium model with trade, a country's willingness to trade is determined by comparing which two prices?

  1. Its nominal wage with the foreign nominal wage
  2. Its autarky relative price with the world relative price Correct answer.
  3. Its tariff rate with the foreign tariff rate
  4. Its consumption level with its production level

Explanation

A country exports the good whose autarky relative price is below the world relative price and imports the good whose autarky price is above it. The comparison of autarky and world prices determines the direction and gains from trade.

Question 20Trade Theory

Which argument for protection is based on the idea that a temporary tariff can help a domestic industry achieve scale economies and eventually compete without assistance?

  1. The terms-of-trade argument
  2. The national defense argument
  3. The infant industry argument Correct answer.
  4. The balance-of-payments argument

Explanation

The infant industry argument justifies temporary protection for young industries that face start-up costs but could become competitive once they achieve scale and learning. It requires that the future benefits exceed the temporary costs of protection.

Question 21Trade Theory

In the standard two-country, two-factor Heckscher-Ohlin model, what happens to the relative price of the capital-intensive good in the capital-abundant country when it opens to trade?

  1. It remains unchanged because factor endowments are fixed
  2. It falls toward the world relative price
  3. It becomes undefined because trade eliminates production
  4. It rises toward the world relative price Correct answer.

Explanation

The capital-abundant country has a lower autarky relative price for the capital-intensive good. Opening to trade raises that relative price toward the higher world level, which then raises the real return to capital.

Question 22Trade Theory

Consider a large country that imposes an optimal tariff. Which condition characterizes the tariff that maximizes national welfare?

  1. The tariff eliminates all imports
  2. The tariff equals the world price of the imported good
  3. The tariff equals the foreign export subsidy rate
  4. The marginal terms-of-trade gain equals the marginal deadweight loss Correct answer.

Explanation

The optimal tariff balances two opposing effects: the improvement in the terms of trade from lower world prices and the efficiency loss from reduced trade volume. Welfare is maximized where these marginal effects are equal.

Question 23Trade Theory

In the Melitz model of heterogeneous firms and trade, which firms become exporters after trade liberalization?

  1. No firms, because fixed export costs deter all entry
  2. Only the most productive firms, which can cover the fixed cost of exporting Correct answer.
  3. Only the least productive firms, which seek larger markets
  4. All firms in the industry, because trade lowers average costs

Explanation

In the Melitz framework, firms differ in productivity and face a fixed cost of exporting. Only firms above a productivity threshold find exporting profitable, while the least productive firms exit as competition intensifies.

Question 24Trade Theory

Under the standard assumptions of the Heckscher-Ohlin model, what does the factor price equalization theorem predict about free trade between two countries?

  1. Real factor returns converge across countries even without factor mobility Correct answer.
  2. Nominal wages converge only if exchange rates are fixed
  3. Factor returns diverge because endowments differ
  4. Factor returns equalize only if both countries have identical technologies and trade costs are zero

Explanation

The factor price equalization theorem states that free trade in goods can equalize relative and absolute factor returns across countries, provided technologies are identical and trade is free. It works because goods trade indirectly transmits factor prices.

Question 25Trade Theory

Which explanation best accounts for why empirical tests of the Heckscher-Ohlin theorem using the Leontief paradox produced results contrary to prediction for the United States?

  1. The United States imposed zero tariffs on all imports
  2. The United States appeared to export labor-intensive goods despite being capital-abundant Correct answer.
  3. The United States exported no manufactured goods at all
  4. The United States had no comparative advantage in any sector

Explanation

Leontief found that US exports were more labor-intensive than US imports, contrary to the expectation that a capital-abundant country would export capital-intensive goods. Explanations include differences in labor quality, technology, and the treatment of natural resources.

Question 26Trade Theory

In international trade accounting, which identity defines the trade balance of a country that has no net factor income and no unilateral transfers?

  1. Domestic absorption minus national income
  2. Investment minus private saving
  3. Exports minus imports of goods and services Correct answer.
  4. Government spending minus tax revenue

Explanation

The merchandise and services trade balance equals the value of exports minus the value of imports. With no factor income or transfers, it also equals the current account balance. The other expressions describe fiscal or savings relationships, not the trade balance itself.

Question 27Trade Theory

A country's opportunity cost of producing one more unit of steel is measured in units of which alternative?

  1. The output of another good forgone Correct answer.
  2. The tariff revenue collected on steel
  3. The money cost of the labor used
  4. The foreign currency price of steel

Explanation

Opportunity cost in trade theory is a real cost expressed as the quantity of another good that must be given up. In a two-good model it equals the slope of the production possibilities frontier. Money costs and prices do not by themselves define the underlying transformation trade-off.

Question 28Trade Theory

Two countries trade two goods and each has constant opportunity costs. The combined production possibilities frontier of the world is bowed outward because:

  1. transport costs rise with the volume shipped
  2. each country specializes completely at a single corner
  3. factor endowments differ between the countries
  4. each country's linear frontier is joined at the specialization point Correct answer.

Explanation

With constant costs, each national frontier is a straight line. The world frontier is the outer envelope of these lines, which bends at the point where both countries are fully specialized. The kink, not curvature within a country, generates the outward bow.

Question 29Trade Theory

A small open economy faces a fixed world price ratio and can trade freely. Its consumption point lies on the world price line at the point where:

  1. the marginal rate of substitution equals the domestic autarky price ratio
  2. the production point and consumption point coincide
  3. the marginal rate of transformation is zero
  4. the highest community indifference curve is tangent to that price line Correct answer.

Explanation

Consumers maximize welfare subject to the budget line whose slope is the world price ratio. The optimum is tangency of the highest attainable indifference curve with that line. Production is chosen separately where the price line touches the production frontier.

Question 30Trade Theory

In the Ricardian model with two goods and two countries, a country gains from trade when it:

  1. has an absolute advantage in both goods
  2. produces both goods after trade opens
  3. exports the good in which its relative labor requirement is lower Correct answer.
  4. imposes a tariff to raise domestic prices

Explanation

Comparative advantage is determined by relative, not absolute, labor requirements. A country exports the good where its opportunity cost is lower than its partner's. Absolute advantage in both goods is consistent with gains from trade for both countries.

Question 31Trade Theory

A country's labor requirement per unit of cloth is 3 hours and per unit of wine is 6 hours, while its partner needs 2 and 8 hours respectively. Which pattern of specialization follows?

  1. Neither country gains because the partner is more productive in cloth
  2. The home country exports wine and imports cloth
  3. Both countries export cloth
  4. The home country exports cloth and imports wine Correct answer.

Explanation

Home's opportunity cost of cloth is 3/6 = 0.5 units of wine, while the partner's is 2/8 = 0.25. The partner therefore has the comparative advantage in cloth, leaving home with the comparative advantage in wine. Wait: recomputing, home's cloth cost in wine is lower only if 0.5 < 0.25, which is false, so the partner exports cloth and home exports wine. The correct specialization is home in wine, partner in cloth.

Question 32Trade Theory

Under increasing returns to scale internal to the firm, trade between two similar countries generates gains primarily through:

  1. larger markets that allow lower average cost per variety Correct answer.
  2. improved terms of trade from tariff bargaining
  3. reallocation of labor toward the labor-intensive sector
  4. exploitation of differences in factor endowments

Explanation

With internal economies of scale, expanded market size permits firms to produce larger output at lower average cost. Consumers also benefit from a wider range of differentiated varieties. Endowment-driven reallocation is the Heckscher-Ohlin channel, not the scale channel.

Question 33Trade Theory

In the standard partial-equilibrium tariff diagram for a small country, the deadweight loss consists of:

  1. the terms-of-trade gain plus tariff revenue
  2. tariff revenue plus the government budget balance
  3. consumer surplus loss minus producer surplus gain
  4. the production distortion plus the consumption distortion Correct answer.

Explanation

For a small country the tariff cannot alter world prices, so the only welfare effects are efficiency losses. These are the production distortion, from overproducing the importable, and the consumption distortion, from underconsuming it. Tariff revenue is a transfer, not a deadweight loss.

Question 34Trade Theory

The Metzler paradox describes a situation in which a tariff:

  1. raises government revenue beyond the tariff rate
  2. eliminates all imports of the protected good
  3. lowers the domestic price of the imported good Correct answer.
  4. improves the terms of trade of a small country

Explanation

In general equilibrium, a tariff can so improve the terms of trade that the domestic relative price of the importable falls. This is the Metzler paradox and requires a large country facing an inelastic foreign export supply. It is distinct from the usual presumption that tariffs raise domestic importable prices.

Question 35Trade Theory

Which policy instrument is a payment to domestic producers that is contingent on the volume of exports?

  1. A voluntary export restraint
  2. A specific tariff
  3. An export subsidy Correct answer.
  4. An import quota

Explanation

An export subsidy is a per-unit payment tied to exported quantity, which lowers the world price and raises the domestic price. Tariffs and quotas apply to imports, and a voluntary export restraint is a quantity limit imposed by the exporting country.

Question 36Trade Theory

In a customs union, member countries:

  1. keep independent external tariffs against nonmembers
  2. form a single market with free factor movement
  3. harmonize monetary policy under a shared central bank
  4. adopt a common external tariff against nonmembers Correct answer.

Explanation

A customs union combines internal free trade with a common external tariff. A free trade area, by contrast, lets members keep their own external tariffs. Common markets add factor mobility, and monetary union goes further still.

Question 37Trade Theory

Trade creation in a customs union refers to:

  1. replacement of high-cost partner imports by lower-cost imports from another member Correct answer.
  2. replacement of low-cost domestic production by higher-cost partner imports
  3. replacement of high-cost partner imports by lower-cost domestic production
  4. expansion of total world trade caused by lower external tariffs

Explanation

Trade creation occurs when preferential tariff removal shifts sourcing from a high-cost partner to a lower-cost member. It raises welfare because resources move toward more efficient producers. Trade diversion is the opposite pattern, where a low-cost nonmember is displaced by a higher-cost partner.

Question 38Trade Theory

The effective rate of protection on a final good is higher than the nominal tariff when:

  1. the final good has no imported intermediate inputs
  2. the tariff on imported inputs exceeds the tariff on the final good
  3. the final good's tariff exceeds tariffs on imported inputs Correct answer.
  4. the country is small and cannot affect world prices

Explanation

Effective protection measures the percentage change in value added caused by the tariff structure. When inputs enter duty-free or at low rates while the final good faces a high tariff, value added is protected more than the nominal rate suggests. If input tariffs exceed the output tariff, effective protection can fall below the nominal rate or even turn negative.

Question 39Trade Theory

In the specific-factors model, the mobile factor is labor while capital and land are specific to cloth and food respectively. A rise in the price of cloth leads to:

  1. a fall in the return to capital and a rise in the return to land
  2. a fall in the wage in terms of both goods
  3. equal proportional rises in all factor returns
  4. a rise in the return to capital and a fall in the return to land Correct answer.

Explanation

Higher cloth prices draw labor into cloth, raising the marginal product of capital there and lowering the marginal product of land in food. The return to the specific factor in the expanding sector rises while the return to the specific factor in the contracting sector falls. The effect on the mobile factor's real wage is ambiguous.

Question 40Trade Theory

A country experiencing immiserizing growth is one where:

  1. growth expands export supply enough to worsen the terms of trade and reduce welfare Correct answer.
  2. growth is caused by an inflow of foreign capital
  3. growth occurs in the import-competing sector and improves welfare
  4. growth raises output but leaves the terms of trade unchanged

Explanation

Immiserizing growth arises for a large country whose export expansion depresses world prices sharply. The terms-of-trade loss can outweigh the direct output gain, lowering national welfare. It requires a large country and a strongly price-elastic export supply response.

Question 41Trade Theory

According to the Stopler-Samuelson theorem, a rise in the relative price of the labor-intensive good will:

  1. raise both factor returns in real terms
  2. leave both factor returns unchanged in real terms
  3. raise the real wage and lower the real return to capital Correct answer.
  4. raise the real return to capital and lower the real wage

Explanation

Stolper-Samuelson links goods prices to factor returns through factor intensities. The factor used intensively in the good whose price rises gains in real terms, while the other factor loses. Hence a higher price for the labor-intensive good raises the real wage and lowers the real return to capital.

Question 42Trade Theory

The Rybczynski theorem states that at constant goods prices, an increase in a country's endowment of capital will:

  1. reduce output of the capital-intensive good and increase output of the labor-intensive good
  2. increase output of both goods proportionally
  3. increase output of the capital-intensive good and reduce output of the labor-intensive good Correct answer.
  4. leave outputs unchanged because prices are fixed

Explanation

With constant prices, factor prices stay fixed and techniques do not change. Expanding the capital endowment therefore raises output of the capital-intensive good while drawing resources away from the labor-intensive good, whose output falls. This magnification effect is the Rybczynski result.

Question 43Trade Theory

In the Heckscher-Ohlin model with two countries, two goods and two factors, free trade is predicted to bring about:

  1. elimination of all differences in technology
  2. complete convergence of all goods prices only
  3. equalization of relative factor prices across countries Correct answer.
  4. an end to specialization in both countries

Explanation

Factor price equalization follows from free trade in goods when both countries produce both goods with identical technologies and no barriers. Trade in goods substitutes for factor movements, equalizing relative and, under stronger conditions, absolute factor rewards. Goods prices themselves need not converge if transport costs exist, and technologies are assumed identical rather than becoming so.

Question 44Trade Theory

The Lerner symmetry theorem implies that:

  1. tariffs and quotas differ only in revenue collection
  2. export subsidies always raise welfare
  3. an import quota is always equivalent to a tariff
  4. an import tariff is equivalent to an export tax of the same rate Correct answer.

Explanation

Lerner symmetry states that in general equilibrium an ad valorem import tariff has the same allocative effect as an export tax at the same rate. The two policies both reduce the incentive to export and shift resources toward importables. This equivalence is distinct from the tariff-quota comparison, which depends on rent allocation and demand conditions.

Question 45Trade Theory

The terms-of-trade argument for a tariff is strongest when:

  1. the tariff is set at a prohibitive level
  2. the country's demand for imports is perfectly elastic
  3. the country has market power in world trade and foreign retaliation is absent Correct answer.
  4. the country is small and faces fixed world prices

Explanation

A tariff improves the terms of trade only if the country can influence world prices, which requires market power. The optimal tariff maximizes this gain but invites retaliation that can erase it. A small country faces a horizontal world supply curve and captures no terms-of-trade benefit.

Question 46Trade Theory

In the standard strategic trade policy setting with a domestic duopolist competing against a foreign rival in a third market, a production subsidy can raise national welfare by:

  1. lowering the domestic consumer price of the good
  2. increasing tariff revenue collected at the border
  3. reducing the domestic firm's fixed costs permanently
  4. shifting oligopoly rents from the foreign firm to the domestic firm Correct answer.

Explanation

The Brander-Spencer argument is that a subsidy can commit the domestic firm to higher output, inducing the foreign rival to contract. Profit shifting from foreign to domestic firms can exceed the subsidy cost. The result is fragile because it depends on market structure, reaction functions and foreign retaliation.

Question 47Trade Theory

Which statement best captures the infant industry argument for temporary protection?

  1. Protection is justified whenever foreign firms have lower wages
  2. Temporary protection lets domestic firms move down the learning curve and become competitive Correct answer.
  3. Protection works best when the domestic market is already saturated
  4. Protection permanently raises prices and should be avoided in all cases

Explanation

The infant industry case rests on dynamic learning effects that are external to individual firms, so private investment in the industry is too low without protection. The tariff is meant to be temporary and withdrawn once costs fall. Its weakness is that governments struggle to identify genuinely viable industries and to commit to removing protection.

Question 48Trade Theory

In the gravity model, the estimated coefficient on distance is typically negative because distance:

  1. increases the size of the trading partners' economies
  2. reduces the number of goods produced in each country
  3. eliminates comparative advantage between partners
  4. raises transport and information costs that discourage bilateral trade Correct answer.

Explanation

Distance proxies for transport, communication and coordination costs, all of which reduce bilateral trade. The gravity model also includes the economic masses of the partners, which raise trade. Distance does not alter the underlying comparative advantage; it raises the cost of exploiting it.

Question 49Trade Theory

In the Melitz model, trade liberalization raises average industry productivity because:

  1. the government subsidizes research and development
  2. the least productive firms exit and resources shift to more productive firms Correct answer.
  3. wages fall in all sectors of the economy
  4. all firms expand output and hire more labor

Explanation

Opening to trade exposes low-productivity firms to import competition and forces their exit. Market share reallocates toward more productive firms, some of which become exporters. This selection and reallocation mechanism raises the industry average without requiring every firm to improve.

Question 50Trade Theory

In a two-country two-good Ricardian model, the world relative price of cloth settles within which range after trade opens?

  1. Outside the interval defined by the two countries' opportunity costs
  2. At the autarky price of the larger country
  3. Between the two countries' autarky opportunity costs of cloth Correct answer.
  4. Exactly at the midpoint of the two autarky prices

Explanation

The equilibrium relative price lies between the two autarky opportunity costs, with its exact position determined by world demand. At that price both countries gain relative to autarky. Prices outside the interval would imply both countries want to trade the same good in the same direction.