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Question 1Trade Theory

In classical trade theory, which statement correctly describes the principle of absolute advantage as developed by Adam Smith?

  1. A country should restrict imports to protect domestic industries from foreign competition
  2. A country should balance its exports and imports so that trade is always equal in value
  3. A country should specialize in goods it can produce more efficiently than its trading partner and import the rest Correct answer.
  4. A country should produce and export goods in which it has the lowest opportunity cost relative to its trading partner

Explanation

Absolute advantage compares productivity levels between countries: a nation gains by specializing where it is more efficient than its partner and trading for goods where it is less efficient. Opportunity-cost reasoning belongs to comparative advantage, not Smith's absolute-advantage formulation.

Question 2Trade Theory

Country A can produce 10 units of cloth or 5 units of wine per worker-day. Country B can produce 6 units of cloth or 4 units of wine per worker-day. According to comparative advantage, which pattern of specialization is efficient?

  1. Neither country benefits from specialization because A is larger in both goods
  2. Both countries specialize in cloth
  3. Country A specializes in cloth and Country B in wine Correct answer.
  4. Country A specializes in wine and Country B in cloth

Explanation

A's opportunity cost of one cloth is 0.5 wine, while B's is about 0.67 wine, so A has the lower cost in cloth. B's opportunity cost of one wine is 1.5 cloth versus A's 2 cloth, giving B the comparative edge in wine. Each country should specialize where its opportunity cost is lower.

Question 3Trade Theory

The Heckscher-Ohlin model predicts that a country will export the good that intensively uses its relatively abundant factor. Which underlying assumption is essential to that prediction?

  1. Factors of production are perfectly mobile between countries
  2. Governments set tariffs to equalize factor prices
  3. Technology differs significantly between the trading partners
  4. Consumers in both countries have identical and homothetic preferences Correct answer.

Explanation

The Heckscher-Ohlin theorem relies on identical, homothetic demand so that trade patterns are driven by relative factor endowments rather than demand differences. With common tastes, production-cost differences translate directly into export patterns.

Question 4Trade Theory

Which outcome is predicted by the Stolper-Samuelson theorem when a country opens to trade?

  1. Real returns to the abundant factor rise and real returns to the scarce factor fall Correct answer.
  2. Real returns to both factors fall because of foreign competition
  3. Factor returns are unaffected because trade only changes goods prices temporarily
  4. Real returns to both factors rise equally

Explanation

Stolper-Samuelson links goods prices to factor rewards: protection raises the return to the scarce factor, so liberalization lowers it while raising the return to the abundant factor. The theorem therefore predicts distributional conflict, not uniform gains.

Question 5Trade Theory

The Linder hypothesis explains trade in manufactured goods primarily through which mechanism?

  1. Government industrial policy that targets export sectors
  2. Economies of scale achieved through a single large domestic market
  3. Differences in factor endowments between trading partners
  4. Similarity of per capita income, which generates overlapping demand for differentiated products Correct answer.

Explanation

Linder argued that firms first serve domestic demand shaped by income level, then export to countries with similar per capita incomes and therefore similar demand structures. Trade in manufactures should thus be most intense between countries at comparable development levels.

Question 6Trade Theory

A large country imposes an import tariff. Under standard partial-equilibrium analysis, which welfare effect distinguishes it from a small country's tariff?

  1. It generates a terms-of-trade gain that may offset part of the deadweight loss Correct answer.
  2. It has no effect on the world price of the imported good
  3. It eliminates all deadweight loss because domestic prices do not change
  4. It always improves national welfare regardless of tariff size

Explanation

A large country can depress the world price of its imports, capturing a terms-of-trade gain that a small country cannot obtain. Whether national welfare rises depends on whether that gain exceeds the efficiency losses from distorted production and consumption.

Question 7Trade Theory

In a customs union, which combination of policies is required by definition?

  1. Free internal trade plus independent national external tariffs
  2. Free movement of labor and capital plus a common currency
  3. Common external tariff without free internal trade
  4. Free internal trade plus a common external tariff Correct answer.

Explanation

A customs union removes barriers among members and erects a common external tariff against non-members. This distinguishes it from a free trade area, where each member keeps its own external tariff.

Question 8Trade Theory

Trade creation and trade diversion are the two static effects of a customs union identified by Viner. Which situation describes trade diversion?

  1. Consumption rises because the tariff on intra-union imports is removed
  2. The union's terms of trade improve against non-members
  3. Imports shift from a high-cost domestic producer to a lower-cost partner producer
  4. Imports shift from a low-cost non-member to a higher-cost partner producer because of the common external tariff Correct answer.

Explanation

Trade diversion occurs when preferential treatment causes sourcing to switch to a partner whose true cost is higher than a non-member's, wasting resources. Trade creation, by contrast, replaces high-cost domestic production with lower-cost partner supply.

Question 9Trade Theory

Which instrument is classified as a non-tariff barrier to trade?

  1. A technical standard requiring imported goods to meet domestic safety specifications Correct answer.
  2. A specific duty levied per unit on imported textiles
  3. A tariff-rate quota's in-quota duty rate
  4. An ad valorem duty of 12 percent on imported steel

Explanation

Technical standards, licensing, and conformity assessment are non-tariff measures because they restrict market access without using a price-based tax at the border. Tariffs and the duty components of quotas are price-based instruments.

Question 10Trade Theory

Under a voluntary export restraint, which party typically administers the restriction and captures the quota rent?

  1. The rent is eliminated because the restraint is voluntary
  2. The importing country's government collects the rent through customs duties
  3. The exporting country's government or exporters allocate licenses and capture the rent Correct answer.
  4. Importing-country consumers capture the rent through lower prices

Explanation

A VER is administered by the exporting country, so the scarcity rent accrues to foreign exporters or their government rather than to the importing country's treasury. This makes a VER more costly to the importing economy than an equivalent tariff.

Question 11Trade Theory

Which statement accurately describes the most-favoured-nation principle of the WTO?

  1. A member must apply the lowest tariff it has ever negotiated to every product
  2. A member may discriminate among trading partners according to political alliance
  3. A member must grant any trade advantage given to one member immediately and unconditionally to all other members Correct answer.
  4. A member must treat foreign and domestic goods identically in all regulatory matters

Explanation

MFN requires non-discriminatory treatment among trading partners, so a concession granted to one member extends to all. National treatment, a separate principle, governs the equal treatment of imported and domestic goods once inside the border.

Question 12Trade Theory

The effective rate of protection on a finished good differs from its nominal tariff rate because it accounts for which element?

  1. The domestic sales tax applied at retail
  2. Tariffs levied on imported intermediate inputs used in producing the good Correct answer.
  3. The transport cost of shipping the finished good
  4. The exchange rate prevailing at the time of importation

Explanation

Effective protection measures the percentage change in value added per unit caused by the tariff structure, so tariffs on inputs matter as much as the tariff on output. A high input tariff can make effective protection much lower than the nominal rate, or even negative.

Question 13Trade Theory

Which policy is most consistent with the infant industry argument for temporary protection?

  1. A permanent tariff on all manufactured imports to raise revenue
  2. A time-limited subsidy or tariff for a new industry expected to achieve cost competitiveness Correct answer.
  3. An export tax on the industry's output to fund general government spending
  4. A quota that permanently limits foreign competitors regardless of industry performance

Explanation

The infant industry case rests on dynamic learning effects: a temporary intervention helps a new sector reach scale and lower costs, after which protection should be withdrawn. A subsidy is often preferred to a tariff because it does not distort consumer prices.

Question 14Trade Theory

In the gravity model of trade, bilateral trade flows are predicted to be positively related to which pair of variables?

  1. Population growth of the two countries and their exchange-rate volatility
  2. Economic size of the two countries and their geographic distance Correct answer.
  3. Tariff levels of the two countries and their geographic proximity
  4. Economic size of the two countries and their cultural dissimilarity

Explanation

The gravity equation predicts trade rises with the product of the partners' economic masses and falls with distance, which proxies transport and information costs. This simple relationship fits empirical trade data remarkably well.

Question 15Trade Theory

Which concept best captures the welfare loss from a tariff that arises because domestic consumers reduce consumption of the imported good?

  1. The terms-of-trade gain
  2. The quota rent
  3. The consumption distortion loss Correct answer.
  4. The production distortion loss

Explanation

A tariff raises the domestic price, causing consumers to substitute away from the imported good even though its true resource cost has not changed. This consumption distortion is one of the two deadweight-loss triangles, alongside the production distortion.

Question 16Trade Theory

Which statement best characterizes the product life cycle theory of international trade?

  1. Countries trade primarily according to differences in their factor endowments
  2. Trade patterns are fixed by comparative advantage and never change over time
  3. Production of a new product shifts from the innovating country to other advanced countries and eventually to developing countries as the product matures Correct answer.
  4. Trade is determined by the size of the domestic market and economies of scale

Explanation

Vernon's product life cycle theory traces a good from innovation and export by the pioneer, through standardized mass production abroad, to eventual import by the original innovator. It emphasizes dynamic shifts in production location rather than static endowments.

Question 17Trade Theory

In the standard partial-equilibrium diagram for a small country's import tariff, what happens to the terms of trade?

  1. They remain unchanged because the country cannot influence the world price Correct answer.
  2. They improve because the world price falls
  3. They improve initially and then decline as the tariff rises
  4. They worsen because the country pays a higher domestic price

Explanation

By definition a small country faces a perfectly elastic world supply, so its tariff cannot alter the world price and the terms of trade stay fixed. All of the tariff's effect therefore shows up as deadweight loss and a transfer from consumers.

Question 18Trade Theory

Which example best illustrates intra-industry trade?

  1. A country exporting raw minerals and importing manufactured consumer goods
  2. A tropical country exporting coffee to a temperate country that exports machinery back
  3. Two advanced economies simultaneously exporting and importing different varieties of automobiles Correct answer.
  4. A firm relocating a factory abroad to serve the foreign market directly

Explanation

Intra-industry trade involves two-way exchange within the same product category, typically driven by product differentiation and scale economies. It is most common between countries with similar factor endowments and income levels.

Question 19Trade Theory

Which assumption is central to the Ricardian model's conclusion that trade benefits both countries?

  1. Countries have identical production technologies
  2. Transport costs are prohibitively high
  3. Capital and labor are both mobile internationally
  4. Labor is the only factor of production and is mobile within a country but immobile between countries Correct answer.

Explanation

The Ricardian model uses labor as the sole factor, freely mobile across sectors at home but unable to migrate abroad. This setup allows each country to specialize fully according to comparative advantage and both to gain from exchange.

Question 20Trade Theory

The terms-of-trade of a country are best defined as which ratio?

  1. The ratio of domestic production to domestic consumption
  2. The ratio of export quantity to import quantity
  3. The ratio of export prices to import prices Correct answer.
  4. The ratio of tariff revenue to total import value

Explanation

The commodity terms of trade measure the price of a country's exports relative to the price of its imports, indicating how many imports a unit of exports can buy. An improvement means exports command more imports.

Question 21Trade Theory

Which statement about dumping under WTO rules is accurate?

  1. Dumping is permitted, but members may impose anti-dumping duties after showing material injury to a domestic industry Correct answer.
  2. Dumping is automatically prohibited and triggers immediate retaliatory tariffs
  3. Anti-dumping duties may be imposed without any finding of injury
  4. Dumping refers to selling abroad at a price above the normal value in the home market

Explanation

Dumping, selling below normal value, is not itself prohibited, but members may respond with anti-dumping duties after an investigation establishes dumping, injury, and a causal link. The permitted duty is normally limited to the dumping margin.

Question 22Trade Theory

Which argument for protection is based on the idea that a country can improve its welfare by exploiting market power in trade?

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

Explanation

The optimum tariff argument holds that a large country can shift the terms of trade in its favour, maximizing national welfare where the marginal terms-of-trade gain equals the marginal deadweight loss. It is a beggar-thy-neighbour policy and invites retaliation.

Question 23Trade Theory

In the specific-factors model, which factor's return is most likely to fall when the price of the export good rises?

  1. No factor's return changes because prices do not affect factor rewards
  2. The mobile factor employed in both sectors
  3. The factor specific to the import-competing sector Correct answer.
  4. The factor specific to the export sector

Explanation

In the specific-factors model, an increase in the export price draws the mobile factor toward the export sector, raising returns to the export-specific factor and lowering returns to the import-competing specific factor. The mobile factor's return may rise or fall depending on relative factor intensities.

Question 24Trade Theory

Which statement best explains how economies of scale generate trade gains in new trade theory?

  1. Firms facing increasing returns benefit from a larger market, allowing lower average costs and more product varieties Correct answer.
  2. Scale economies eliminate the possibility of intra-industry trade
  3. Countries gain only by exploiting differences in factor endowments
  4. Trade reduces the number of varieties available to consumers

Explanation

With increasing returns to scale, trade enlarges the market and allows firms to produce at lower average cost while consumers gain access to more differentiated varieties. These gains arise even between countries with identical endowments.

Question 25Trade Theory

A country's import demand curve shifts outward. In a two-country offer-curve framework, what is the effect on the equilibrium terms of trade if the partner's offer curve is unchanged?

  1. The terms of trade move against the country whose import demand increased Correct answer.
  2. The terms of trade move in favour of the country whose import demand increased
  3. The terms of trade remain unchanged because offer curves are fixed
  4. The terms of trade become indeterminate

Explanation

An outward shift in import demand means the country is willing to offer more exports for each unit of imports, worsening its own terms of trade. The partner, facing unchanged preferences, captures the improvement in its terms of trade.

Question 26Trade Theory

In the Heckscher-Ohlin model, a country exports the good whose production is intensive in the factor with which the country is relatively well endowed. Which additional assumption is essential for this prediction to hold?

  1. Production functions are identical across countries and technologies are freely available. Correct answer.
  2. Factors of production are perfectly mobile between countries but immobile between industries.
  3. Consumer preferences differ sharply between trading partners.
  4. Each industry uses the same factor proportions regardless of factor prices.

Explanation

The Heckscher-Ohlin theorem assumes identical technologies and identical constant-returns production functions across countries, so that relative factor abundance alone drives comparative advantage. If technologies differed, a country's export pattern could reflect technical superiority rather than endowment ratios.

Question 27Trade Theory

Which statement correctly describes the Leontief paradox?

  1. US trade with developing countries grew faster than trade with other developed countries.
  2. US exports were more labour-intensive than US imports, contradicting the prediction for a capital-abundant country. Correct answer.
  3. US tariffs fell more on capital-intensive goods than on labour-intensive goods.
  4. US exports were more capital-intensive than US imports, contradicting the prediction for a capital-abundant country.

Explanation

Leontief found that US exports embodied more labour and less capital per unit than US imports, even though the United States was the most capital-abundant country. That result ran against the Heckscher-Ohlin prediction, prompting explanations based on factor-intensity reversals, human capital, and natural resources.

Question 28Trade Theory

A country's offer curve shows the quantities of exports it is willing to supply in exchange for various quantities of imports. What does the equilibrium international terms of trade correspond to in a two-country offer-curve diagram?

  1. The intersection of the two offer curves, whose slope gives the world price ratio. Correct answer.
  2. The point where the two offer curves are farthest apart horizontally.
  3. The midpoint of the two autarky price ratios on the price axis.
  4. The point where each country's offer curve is tangent to its own production possibility frontier.

Explanation

The two offer curves intersect at the trade equilibrium; the slope of the ray from the origin to that intersection is the world relative price of exports in terms of imports. At that price each country's desired exports equal the other's desired imports.

Question 29Trade Theory

Which feature distinguishes a free trade area from a customs union?

  1. Members of a free trade area permit free movement of labour and capital.
  2. Members of a free trade area harmonise their competition and subsidy policies.
  3. Members of a free trade area eliminate internal tariffs but each keeps its own external tariff. Correct answer.
  4. Members of a free trade area adopt a common external tariff against non-members.

Explanation

A free trade area removes barriers among members while each member retains independent external trade policy, which is why rules of origin are needed to prevent trade deflection. A customs union adds a common external tariff, and a common market goes further by freeing factor movements.

Question 30Trade Theory

Under a quota, the welfare effect of the quota rent depends on who receives it. In which case is the importing country's loss closest to that of an equivalent tariff that generates the same import volume?

  1. The quota rent accrues to foreign exporters through a voluntary export restraint.
  2. The quota licences are allocated to domestic importers free of charge.
  3. The quota is administered by an international commodity agreement.
  4. The quota licences are auctioned competitively by the importing government. Correct answer.

Explanation

A competitive auction transfers the quota rent to the importing government, so the welfare loss is limited to the consumption and production distortion triangles, exactly as with a tariff. When the rent goes abroad or is dissipated, an additional rectangle of loss appears.

Question 31Trade Theory

Which outcome follows from the Stopler-Samuelson theorem when the price of the labour-intensive good rises in a two-good, two-factor economy?

  1. The real return to capital rises and the real return to labour falls in terms of both goods.
  2. Factor returns are unchanged because factor supplies are fixed.
  3. Both factor returns rise in proportion to the price increase.
  4. The real return to labour rises and the real return to capital falls in terms of both goods. Correct answer.

Explanation

Stopler-Samuelson states that an increase in the relative price of a good raises the real return to the factor used intensively in that good and lowers the real return to the other factor, measured in terms of both goods. The magnification effect means the change in factor rewards exceeds the price change.

Question 32Trade Theory

Which statement best captures the core insight of the Rybczynski theorem?

  1. At constant relative prices, an increase in one factor endowment raises output of both goods proportionally.
  2. An increase in a factor endowment lowers the economy's production possibility frontier.
  3. An increase in a factor endowment raises the relative price of the good intensive in that factor.
  4. At constant relative prices, an increase in one factor endowment expands output of the good intensive in that factor and contracts output of the other good. Correct answer.

Explanation

Rybczynski shows that with fixed relative goods prices, growth in one factor shifts production toward the sector using that factor intensively and reduces output of the other sector. This magnification result explains how endowment growth can alter a country's trade pattern.

Question 33Trade Theory

A small country introduces an export subsidy on a good it exports. Which welfare outcome does standard partial-equilibrium analysis predict?

  1. National welfare falls because the subsidy creates consumption and production distortions and worsens the terms of trade. Correct answer.
  2. National welfare rises because the subsidy lowers the domestic price paid by consumers.
  3. National welfare is unchanged because the subsidy is merely a transfer from taxpayers to producers.
  4. National welfare rises because domestic producers capture larger export volumes at unchanged world prices.

Explanation

For a small country the world price is given, so the subsidy raises the domestic price above it, stimulating excess production and discouraging consumption while the subsidy bill exceeds the gain to producers. The net effect is a deadweight loss from the two distortion triangles.

Question 34Trade Theory

Which pair of conditions is required for an optimal currency area according to Mundell's original criterion?

  1. Fixed exchange rates with separate national currencies and capital controls.
  2. Divergent inflation rates and independent monetary policies in each region.
  3. High labour mobility across member regions and symmetric shocks affecting them. Correct answer.
  4. A shared fiscal budget with no factor mobility between regions.

Explanation

Mundell argued that factor mobility, especially labour mobility, can substitute for exchange-rate adjustment when regions face asymmetric shocks. Symmetric shocks or effective adjustment mechanisms reduce the cost of surrendering an independent monetary policy.

Question 35Trade Theory

Which statement correctly describes the difference between balance-of-payments accounting under a fixed and a floating exchange rate regime?

  1. Under fixed rates the current account must always be in surplus.
  2. Under floating rates the exchange rate adjusts to clear the market, so reserves need not change to finance a deficit. Correct answer.
  3. Under fixed rates the exchange rate adjusts automatically to eliminate surpluses and deficits.
  4. Under floating rates central banks must intervene daily to keep the current account balanced.

Explanation

With a floating rate, a payments imbalance is corrected through exchange-rate movements rather than reserve flows, so official reserves stay roughly unchanged. Under a fixed rate the central bank must buy or sell reserves to defend the parity, so the balance of payments reflects reserve changes.

Question 36Trade Theory

Which assumption is required for the Marshall-Lerner condition to predict that a devaluation improves the trade balance?

  1. Import demand is perfectly inelastic while export demand is unit elastic.
  2. Domestic and foreign income levels are held at zero.
  3. The sum of the absolute values of export and import demand elasticities is less than one.
  4. The sum of the absolute values of export and import demand elasticities exceeds one. Correct answer.

Explanation

The Marshall-Lerner condition states that a real depreciation improves the trade balance when the absolute sum of the export and import demand elasticities exceeds unity. If elasticities are too low, the quantity response is too small to offset the higher cost of imports.

Question 37Trade Theory

Which statement accurately describes the J-curve effect following a currency depreciation?

  1. The trade balance improves only if the country also raises tariffs.
  2. The trade balance improves immediately and then deteriorates as prices adjust.
  3. The trade balance initially worsens and then improves as quantity responses build up over time. Correct answer.
  4. The trade balance is unaffected because depreciation is neutral in the long run.

Explanation

In the short run, contracts and habits fix quantities, so a depreciation raises the import bill and worsens the trade balance. Over time, volumes adjust and, if the Marshall-Lerner condition holds, the balance improves, tracing a J shape.

Question 38Trade Theory

Which concept explains why two countries with similar factor endowments and similar income levels trade intensively with each other?

  1. Intra-industry trade driven by product differentiation and economies of scale. Correct answer.
  2. Inter-industry trade driven by differences in factor abundance.
  3. Trade driven solely by differences in consumer preferences.
  4. Trade driven by differences in technology alone.

Explanation

When countries are similar, comparative advantage based on endowments explains little of their trade. Intra-industry trade in differentiated varieties, sustained by increasing returns and love of variety, accounts for the large two-way flows observed between similar economies.

Question 39Trade Theory

In the Krugman monopolistic competition trade model, what happens to the number of varieties available to consumers when two symmetric countries open to trade?

  1. The number of varieties increases but prices rise because of trade costs.
  2. The number of varieties is unchanged and prices are unchanged.
  3. The number of varieties available in each country falls while prices rise.
  4. The number of varieties available in each country increases while the price of each variety falls. Correct answer.

Explanation

Market integration enlarges the effective market, allowing more firms to operate at a larger scale, so consumers gain access to more varieties at lower average cost. This variety effect and scale effect are the sources of gains from trade in the model.

Question 40Trade Theory

Which statement best describes the role of the most-favoured-nation principle in limiting discriminatory trade policy?

  1. The principle requires all members to apply identical tariff schedules.
  2. A tariff concession granted to one WTO member must be extended to all members immediately and unconditionally. Correct answer.
  3. The principle applies only to services and not to goods.
  4. A country may grant preferential access to any trading partner without notifying the WTO.

Explanation

MFN requires that any advantage, favour, privilege, or immunity granted to one member's product be accorded immediately and unconditionally to like products of all members. It binds tariff levels to the lowest rate extended, subject to exceptions such as free trade areas and preferential schemes for developing countries.

Question 41Trade Theory

Which situation is most likely to generate trade diversion rather than trade creation when a customs union is formed?

  1. A low-cost partner replaces a high-cost domestic producer because of the removal of internal tariffs.
  2. A high-cost partner replaces a low-cost non-member as the source of imports because the partner enjoys tariff-free access. Correct answer.
  3. The union negotiates a lower common external tariff with non-members.
  4. Domestic consumption rises because the internal tariff removal lowers the price of imports.

Explanation

Trade diversion occurs when preferential access shifts imports from an efficient non-member to a less efficient partner, so the tariff saving is partly offset by higher resource costs. Trade creation, by contrast, replaces high-cost domestic production with lower-cost partner production.

Question 42Trade Theory

Which statement correctly describes the effective rate of protection on a final good?

  1. It measures protection on value added and can exceed the nominal tariff when imported inputs face lower tariffs. Correct answer.
  2. It equals the nominal tariff on the final good by construction.
  3. It measures the tariff revenue collected as a share of import value.
  4. It is always lower than the nominal tariff on the final good.

Explanation

The effective rate of protection relates the tariff-induced change in domestic value added to free-trade value added. Because inputs enter with their own tariffs, the effective rate exceeds the nominal rate whenever input tariffs are lower than the output tariff, and it can even be negative.

Question 43Trade Theory

Which statement best explains why a large country can gain from an optimal tariff?

  1. The tariff eliminates all import competition and raises domestic welfare through scale economies.
  2. The tariff raises the world price of its imports, improving its terms of trade.
  3. The tariff lowers the world price of its imports, improving its terms of trade by more than the distortion loss. Correct answer.
  4. The tariff generates government revenue that exactly offsets the deadweight loss.

Explanation

A large country faces an upward-sloping foreign export supply curve, so restricting imports pushes the world price down and shifts part of the burden onto foreign exporters. Up to the optimal level, the terms-of-trade gain exceeds the consumption and production distortion losses.

Question 44Trade Theory

Which statement accurately describes the difference between a specific tariff and an ad valorem tariff?

  1. A specific tariff is a fixed amount per unit imported, while an ad valorem tariff is a percentage of the import value. Correct answer.
  2. A specific tariff is levied on exports, while an ad valorem tariff is levied on imports.
  3. A specific tariff applies only to agricultural goods, while an ad valorem tariff applies only to manufactures.
  4. A specific tariff is a percentage of value, while an ad valorem tariff is a fixed amount per unit.

Explanation

A specific tariff is expressed as a fixed sum per physical unit, so its protective effect rises when import prices fall. An ad valorem tariff is levied as a percentage of the customs value and therefore moves with prices.

Question 45Trade Theory

Which statement best describes the concept of a customs union's common external tariff in relation to WTO rules?

  1. It must not on average be more restrictive than the general incidence of the duties previously applied by the members. Correct answer.
  2. It must be set at the highest tariff previously applied by any member.
  3. It must be zero for all products to satisfy WTO requirements.
  4. It is unconstrained because customs unions are exempt from all WTO disciplines.

Explanation

GATT Article XXIV permits customs unions and free trade areas as exceptions to MFN, but requires that the common external tariff not raise the general incidence of protection relative to what members applied before. Members must notify the arrangement and may be required to compensate affected partners.

Question 46Trade Theory

Which statement best captures the difference between the Ricardian and Heckscher-Ohlin explanations of comparative advantage?

  1. Both models require increasing returns to scale to generate trade.
  2. Ricardian advantage arises from factor endowments, while Heckscher-Ohlin advantage arises from differences in labour productivity.
  3. Both models attribute comparative advantage to differences in consumer preferences.
  4. Ricardian advantage arises from differences in labour productivity, while Heckscher-Ohlin advantage arises from differences in factor endowments. Correct answer.

Explanation

In the Ricardian model, technology differences expressed as unit labour requirements create comparative advantage even with one factor. Heckscher-Ohlin assumes identical technologies and derives advantage from relative factor abundance and factor intensity.

Question 47Trade Theory

A country has a current account deficit and a flexible exchange rate. Which combination of transactions is consistent with the balance-of-payments identity?

  1. A current account deficit matched by a net capital outflow and rising reserves.
  2. A current account deficit with no corresponding financial account entry.
  3. A current account deficit matched by a net capital inflow or a reduction in official reserves. Correct answer.
  4. A current account deficit financed only by higher tariffs.

Explanation

The balance-of-payments identity requires the current account plus the capital and financial account plus the change in reserves to sum to zero. A current account deficit must therefore be financed by net capital inflows or by drawing down reserves.

Question 48Trade Theory

Which statement best explains how a devaluation affects the domestic price level and real balances in the absorption approach?

  1. Devaluation raises the price of tradables, reducing real money balances and absorption, which can improve the trade balance. Correct answer.
  2. Devaluation raises absorption directly by increasing nominal income.
  3. Devaluation has no effect on the price level because it is a nominal change only.
  4. Devaluation lowers the domestic price level, raising real balances and absorption.

Explanation

In the absorption approach, a devaluation improves the trade balance only if it raises output relative to absorption. One channel is the real balance effect: higher tradable prices reduce real money holdings, inducing lower spending and thus lower absorption.

Question 49Trade Theory

Which statement accurately describes the terms-of-trade concept known as the commodity terms of trade?

  1. The ratio of tariff revenue to the value of imports.
  2. The ratio of a country's GDP to its total trade volume.
  3. The ratio of the price index of a country's exports to the price index of its imports. Correct answer.
  4. The ratio of import volume to export volume.

Explanation

The commodity or net barter terms of trade express the purchasing power of exports over imports as the export price index divided by the import price index, usually multiplied by 100. An increase means a unit of exports buys more imports.

Question 50Trade Theory

Which statement best describes the Prebisch-Singer thesis concerning developing countries?

  1. Developing countries gain equally from trade in primary commodities and manufactures.
  2. The terms of trade of manufactured exporters tend to deteriorate over time relative to primary commodities.
  3. Primary commodity prices rise faster than manufactured prices because of resource scarcity.
  4. The terms of trade of primary commodity exporters tend to deteriorate over time relative to manufactured goods. Correct answer.

Explanation

Prebisch and Singer argued that low income elasticities of demand for primary commodities and market power in manufacturing cause commodity prices to lag behind manufactured goods prices. This provided an argument for industrialisation strategies in developing countries.