DIVISION OF ECONOMICS

ECONOMICS 3: Westville Campus

ECON306W1

INTERNATIONAL ECONOMICS
CLASS TEST 1: 16 March 2009

DURATION: 75 MINUTES TOTAL MARKS: 60

______________________________________

INSTRUCTIONS TO CANDIDATES:

THIS TEST CONSISTS OF TWO SECTIONS:

Section A: Short Questions Mark Allocation: 30 marks

Suggested Time: 40 mins
Answer EITHER question 1 OR 2.

Section B: Multiple Choice Questions Mark Allocation: 30 marks

Suggested Time: 35 mins
Answer all 15 questions.
No negative marks will be awarded.
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 2

SECTION A: SHORT QUESTIONS

Answer EITHER question 1 OR 2 below:

Question 1

(a) Discuss the factors that can cause real world trade to deviate from the predictions of
the gravity model of international trade. [8]

(b) The table below summarises the unit labour requirements for a two-country, two-
good world economy. Home‟s total labour supply is 900 units of labour and foreign‟s
total labour supply amounts to 600 units of labour.

Unit Labour Requirements

Cloth Widgets
Home 60 30
Foreign 100 200

i. Construct the world relative supply of cloth curve. [Show all calculations and the
appropriate labels and values in the diagram.] [6]

ii. In what range must the world equilibrium relative price of cloth lie for trade to be
mutually beneficial to both countries? [2]

iii. Using the data provided and your calculations in (i) above, explain the gains
from trade for each country if the world equilibrium relative price of cloth is 1. [3]

(c) Consider the Ricardian model with more than two goods. Suppose the unit labour
requirements for country A and B are the following:
Country A Country B
corn 2 20
avocado 6 48
tomato 5 20
apples 7 20
wheat 12 6

If the wage rate in country A is five times that of B, which goods will country A
export? And which goods will country B export? [3]

(d) Discuss the key differences and similarities of the Ricardian and Heckscher-Ohlin
models of international trade. [8]

Total Marks [30]

DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 3

Question 2

(a) Consider the production decision of a cellular phone chip producer who behaves
as a monopolistic competitor facing a demand curve with parameter b =1/1000.
Fixed costs are R500,000 and the marginal cost of producing a cellular phone
chip is R100. Suppose Home has annual cellular phone chip sales of 50,000 units
and its economy is initially closed to international trade.

i. Determine the optimal number of firms in Home‟s cellular phone chip industry.
[Show all calculations using the appropriate equations of the monopolistic
competition model of internal economies of scale.] [5]

Foreign, also a closed economy, at least initially, has double the annual
cellular phone chip sales than Home, and is symmetrical in all respects to
Home’s cellular phone chip industry.

ii. Determine the optimal number of firms in Foreign‟s cellular phone chip
industry. [Show all calculations using the appropriate equation(s) of the
monopolistic competition model of internal economies of scale.] [2]

Now suppose that both economies open-up to international trade.

iii. Determine the optimal number of firms in the integrated cellular phone chip
industry. [Show all calculations using the appropriate equation(s) of the
monopolistic competition models of internal economies of scale.] [2]

iv. From i), ii) and iii) above, what conclusions can be drawn about price and
average cost in a closed economy compared with an integrated economy?
Provide an economic justification for these results. [You may use the PP-CC
diagrammatic framework to assist you in this regard.] [5]

(b) Explain the concepts „inter-industry trade‟ and „intra-industry trade‟ and the relative
importance of each type of trade with specific reference to the basis for trade and
the standard formula for calculating the importance of each. [8]

(c) Consider a Heckscher-Ohlin economy that produces two goods with labour and
capital. Explain with a graph how the increase in the relative price of the capital-
intensive good affects the relative factor price w / r (i.e., the wage rate over the
rental rate). [8]

Total Marks [30]

DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 4

SECTION B: MULTIPLE CHOICE QUESTIONS

Answer all questions.

No negative marks will be awarded for incorrect answers.

1. Consider the following information on the economic size and distance between the
following list of economies:
GDP ($million) Distance (Km)
(between A and ….)
A 2,500 0
B 1,500 2,000
C 2,000 1,000
D 1,000 400

According to the gravity model of trade, the value of trade between economies _ and _ will
be greatest.
(a) A and B.
(b) A and C.
(c) A and D.
(d) B and C.
(e) B and D.

2. Refer to the following figure:

The Netherlands, Belgium, and Ireland trade considerably more with the United States
than do many other countries.
(a) This is explained by the gravity model, since these are all large countries.
(b) This is explained by the gravity model, since these are all small countries.
(c) This is explained by the gravity model, since these are all geographically proximate
countries.
(d) This fails to be consistent with the gravity model since these are small countries.
(e) This fails to be consistent with the gravity model since these are large countries.
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 5

3. Assume that labour is the only factor of production and that wages in the United States
equal $20 per hour while wages in Japan are $10 per hour. Production costs would be
lower in the United States as compared to Japan if:
(a) U.S. labour productivity equals 40 units per hour and Japan's 15 units per hour.
(b) U.S. productivity equals 30 units per hour whereas Japan's is 20.
(c) U.S. labour productivity equals 20 and Japan's 30.
(d) U.S. labour productivity equals 15 and Japan's 25 units per hour.
(e) None of the above.

4. Consider the following information in the context of the Ricardian model of trade:

Given the information in the table above, if the world equilibrium price of widgets were 4
cloths, then:
(a) both countries have a comparative cost advantage in production.
(b) both countries could benefit from trade with each other.
(c) both countries produce both goods for export.
(d) both countries will want to specialise in cloth production.
(e) both countries will want to specialise in widget production.

5. In a study of South African international cost competitiveness and exports, the authors
Golub and Edwards (2003) find that:
(a) Relative wages are more important determinants of South African exports than relative
productivity.
(b) Relative productivity levels are more important determinants of South African exports
than relative wages.
(c) South African rapid export growth in the 1990s cannot be explained by improvements
in unit labour costs of production.
(d) South African industry level rankings of competitiveness are easily identified with
observable characteristics and do not change substantially over time.
(e) Government should favour certain industrial sectors over others since the process of
picking winners on the basis of competitive unit labour costs and industry
characteristics is an easy task.
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 6

6. Refer to the following figure:

Which of the following statements is TRUE?

(a) In the real world, national wage rates reflect differences in productivity levels and
hence provide a basis for trade between nations.
(b) In the real world, labour productivity differences do NOT provide a basis for trade
between nations as suggested by the Ricardian model.
(c) In the real world, a nation‟s ability to compete internationally depends only on the level
of its wage rates relative to its productivity levels.
(d) In the real world, if national wages are exactly proportional to productivity levels then
no country has a comparative advantage and there is no basis for trade.
(e) In the real world, the cost of high wages cannot be offset by high productivity levels
and hence there is no basis for trade between nations.
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 7

Consider the following figure:

7. Given the relative factor endowments of the countries shown in the figure, which of the
following is TRUE for Switzerland?
(a) Capital is the factor that Switzerland is most scarcely endowed with.
(b) Land is the factor that Switzerland is most richly endowed with.
(c) Capital-intensive goods could be either exported or imported by Switzerland
depending upon demand conditions for this factor of production.
(d) Switzerland‟s exportation of capital-intensive goods would be consistent with a
“Leontief type” prediction of its trade patterns.
(e) Switzerland‟s importation of land-intensive goods would be consistent with a
“Heckscher-Ohlin” prediction of its trade patterns.
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 8

8. Consider the following figure in the context of the Rybczynski theorem‟s predictions.

Assuming that the shift in the PPF illustrated is as a result of an increase in the
endowment of the factor labour rather than capital which of the following is TRUE?
(a) The ratio of capital to labour used in the production of both goods will change.
(b) The ratio of the prices of the goods produced will change.
(c) There will be a reversal in the factor intensities of the goods produced.
(d) Good 1 must be capital-intensive and Good 2 labour-intensive.
(e) Good 1 must be labour-intensive and Good 2 capital-intensive.

9. In the presence of factor-intensity reversals as depicted in the following figure:

(a) The countries will trade goods in accordance with the predictions of the Heckscher-
Ohlin theorem.
(b) A Leontief paradox scenario with respect to the pattern of trade is impossible.
(c) Free trade will equalise both relative factor prices and the absolute returns to
homogenous factors across countries.
(d) Free trade will equalise only relative factor prices but not the absolute returns to
homogenous factors across countries.
(e) The factor price equalisation theorem can fail and this is more likely if the countries
involved in trade differ significantly in their factor endowments.
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 9

10. Consider the following figure which depicts equilibrium in a monopolistically competitive
market before trade.

The gains from an increase in market size as a result of trade will result in:
(a) An inward shift of the PP curve.
(b) An outward shift of the PP curve.
(c) An inward shift of the CC curve.
(d) A decrease in price and an increase in product variety.
(e) An increase in price and a decrease in product variety.

11. Consider the following figure which depicts the equilibrium price and quantity of watches
with trade under external economies of scale.

C0

In comparison to the trade in watches scenario, which of the following is TRUE without
trade?
(a) Both the home and foreign country would be worse-off.
(b) Both the home and foreign country would be better-off.
(c) The home country would be worse-off and the foreign country would be better-off.
(d) The home country would be better-off and the foreign country would be worse-off.
(e) It is impossible to determine which country would be better-off and which would be
worse-off.
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 10

Consider the figure below, which represents the demand, marginal revenue and cost
functions facing a Brazilian steel producer.

12. If this firm initially produces for only the domestic market and then with trade for both the
domestic and foreign markets, how much would the firm charge for its product in the
domestic market?
(a) $80 before trade and $100 after trade.
(b) $100 before trade and $80 after trade.
(c) $80 before trade and $50 after trade.
(d) $50 before trade and $80 after trade.
(e) $80 before and after trade with the foreign market.

You are given the following information pertaining to the personal computer (PC)
industry in the Coconut Republic (a small developing country):

World price of PCs $ 2500

Cost of imported memory chips $ 1000
Domestic value added (free trade) $ 1500
Tariffs on PCs $ 250

13. Suppose that in addition to the 50 percent tariff on imported memory chips, the
government of the Coconut Republic decides to grant a 50% tariff rebate to exporters in an
attempt to overcome any existing anti-export bias (AEB), which exporters may face. Given
this, the export protection rate (XPR) for the personal computer industry is:
(a) 1.24
(b) 1.00
(c) 0.333
(d) 0.167
(e) -0.167
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 11

14. If the following diagram were to depict the situation under a voluntary export restraint
agreement, the welfare costs to the large importing country would be?

$10

(a) $6,000.
(b) $8,000.
(c) $12,000.
(d) $18,000.
(e) $20,000.
DIVISION OF ECONOMICS: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST 1: 16 March 2009 PAGE: 12

The United States is a large exporting country. Initially, the United States exports
motorbikes at the world price of $98. Motorbike producers in the United States then
lobby heavily and receive a $30 export subsidy.
Figure 10.3

Price Price
($ per bike) ($ per bike)
Supply
120
100 120
100 of exports
a e g b+h
98 b h 98
96 96
c f g j m n s t
d
90 90

Foreign demand
for imports

Dd

0 6 12 30 12 Quantity
Quantity 24 24
(millions of bikes) (millions of bikes)

Domestic Market for Motorbikes International Market for Motorbikes

15. With reference to the domestic market panel in the figure above, the net welfare loss to the
United States arising from the export subsidy is?
(a) 132
(b) 192
(c) 324
(d) 528
(e) 720

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