A. Italy Has the Absolute Advantage in Chocolate Bars

Study Guide – Midterm I

Ch. 3

1. Which below is correct?

a.  Italy has the absolute advantage in Chocolate Bars.

b.  Austria has the comparative advantage in Leather Jackets as well as the absolute advantage in Leather Jackets.

c.  Italy has the comparative advantage in Chocolate Bars.

d.  None of the above.

2. What is the opportunity cost of Italy of a Leather Jacket?

a.  0.5 Chocolate Bars.

b.  45 Leather Jackets.

c.  2 Chocolate Bars.

d.  2.25 Leather Jackets.

3. What is the opportunity cost of Austria of a Chocolate Bar?

a.  9 Leather Jackets.

b.  0.11 Leather Jackets

c.  10 Chocolate Bars.

d.  .44 Leather Jackets.

ANS: D, C, B

Practice #1. Suppose that the pre-trade price ratio is 2 grain:5 hardware and that the international terms of trade are 3 grain:5 hardware. Which commodity will the country in question export? Why?

Practice #2. Set up a comparative advantage numerical example with two countries and two goods. Distinguish “absolute advantage” from “comparative advantage” in the context of your example. Then select an international terms-or-trade ratio and explain in some detail how trade between the two countries benefits each of them in comparison with autarky. When would either of your countries NOT benefit from engaging in trade? Explain.

Ch. 5

1. The equilibrium condition for consumer behavior pertaining to goods A and B is

______.

a. (MUB/PA) = (MUA/PB)

b. MUB = MUA

c. (MPPB/MPPA) = (PB/PA)

d. (MUB/MUA) = (PB/PA)

2. In the Edgeworth box diagram in production with two goods and two factors of production,

a. a movement from any point off the “production efficiency locus” (“contract curve”)

to any point on the locus must involve greater production of one good and less

production of the other good.

b. a movement from any point on the “production efficiency locus” (“contract curve”)

to any point off the locus must involve less production of both goods.

c. a point that is off the “production efficiency locus” (“contract curve”) must be

associated with unemployment of at least one of the factors of production.

d. a movement from any point on the “production efficiency locus” (“contract curve”)

to another point on the locus must involve greater production of one good and

less production of the other good.

3. The curve in the following diagram is called an ______, and its slope (ignoring the

negative sign) indicates the ratio ______.

a.. isoquant; w/r

b. isoquant; MPPL/MPPK

c. isocost line; w/r

d. isocost line; MPPL/MPPK

ANS: D, D, B

Practice #1. Suppose that, from an initial individual consumer equilibrium position in the indifference curve-budget line diagram, the price of good X rises while the price of good Y falls. What will happen to the relative consumption of the two goods by the consumer and why? Can it be specified whether the consumer’s level of satisfaction has increased or decreased because of this change in absolute and relative prices? Why or why not? Could the satisfaction level of some consumers increase and the satisfaction level of other consumers decrease because of the price changes? Explain.

Practice #2. Explain, using the isoquant-isocost diagram, why a rise in the rental rate of capital coupled with no change in the wage rate will lead to a rise in the price of the capital-intensive good relative to the price of the labor-intensive good.

Ch. 6

1. Given the diagram below, in which country A is producing at point P and consuming at point C:

Country A is ______, and the ratio of the price of food relative to the price of books [i.e., (Pfood/Pbooks)] reflected by price line P0 is ______than the (Pfood/Pbooks) ratio that existed when country A was in autarky.

a. exporting food and importing books; lower

b. exporting food and importing books; higher

c. exporting books and importing food; lower

d. exporting books and importing food; higher

2. Given the above diagram, in autarky the terms of trade _____

a. would be the same.

b. would have made food more expensive.

c. would have made books more expensive.

d. can’t tell without more information

ANS: B, C

Practice #1. Using an increasing opp’t cost production-possibilities frontier/indifference curve approach, build the case that free trade is preferable to autarky for a country. Show the PPFs, CPFs terms of trade and label points of consumption and production.

Ch. 8

1. The Stolper-Samuelson theorem suggests that, when a country is opened to international

trade, the real income of the country’s abundant factor of production will ______

and the real income of the country’s scarce factor of production ______.

a. rise; also will rise

b. rise; will fall

c. fall; will rise

d. fall; also will fall

2. If country I is defined as “relatively capital-abundant” in relation to country II by the “price” (or “economic”) definition of factor abundance, then the price of labor relative to the price of capital is ______in country I than in country II, and the Heckscher-Ohlin theorem would suggest that country I would export relatively ______goods to country II.

a. higher; capital-intensive

b. higher; labor-intensive

c. lower; capital-intensive

d. lower; labor-intensive

3. If relatively capital-abundant country A opens trade with relatively labor-abundant

country B and the trade takes place in accordance with the Heckscher-Ohlin theorem,

what would be the consequence for factor prices (w/r) in the two countries?

a. (w/r) rises in A and falls in B

b. (w/r) rises in A and also rises in B

c. (w/r) falls in A and rises in B

d. (w/r) falls in A and also falls in B

ANS: B, A, C

Practice #1.

(a) State the Heckscher-Ohlin theorem. Then, in the context of a 2x2x2 model (make up MC curves and different factor prices) illustrate and explain how this theorem is obtained.

(b) Using your numbers from part (a), show and explain what happens to the relative factor prices in the two countries as the countries move from autarky to free trade.