Benefits of international trade practice questions.

With one unit of resources, Country A can produce 10 tonnes of wheat or 5 metres of cloth, while Country B can produce 4 tonnes of wheat or 4 metres of cloth. According to comparative advantage, which country should specialize in cloth?

• Country A, because it can produce more cloth in total
• Country B: its opportunity cost of cloth (1 wheat) is below A's (2 wheat)
• Country A, because it holds an absolute advantage in producing both goods
• Neither, because Country B is less productive in both goods

Answer: Country B: its opportunity cost of cloth (1 wheat) is below A's (2 wheat)

One metre of cloth costs A 2 tonnes of wheat but costs B only 1 tonne, so B has the comparative advantage in cloth and should specialize in it.

Country X can produce both cars and textiles using fewer resources per unit than Country Y. It follows that Country X has:

• an absolute advantage in both goods
• a comparative advantage in both goods
• no possibility of gaining from trade with Country Y
• a comparative disadvantage in cars

Answer: an absolute advantage in both goods

Producing with fewer resources means absolute advantage; a country can never have a comparative advantage in both goods, and mutually beneficial trade is still possible based on opportunity costs.

For a developing country, export earnings are an important benefit of trade chiefly because they:

• guarantee that the government budget is balanced
• eliminate the need for domestic saving
• reduce the degree of specialization in the economy
• provide foreign exchange to buy essential imports

Answer: provide foreign exchange to buy essential imports

Exports earn foreign currency, which the country needs to purchase imported capital goods, fuel and other essentials — a recognized source-of-foreign-exchange gain from trade.

When a country opens its market to imports, domestic firms often respond by cutting costs and improving product quality. Which gain from trade does this describe?

• Access to a source of foreign exchange
• More competition, greater efficiency
• Higher prices for domestic consumers
• Greater government tariff revenue

Answer: More competition, greater efficiency

Foreign competition disciplines domestic firms, pushing them to become more efficient and innovative, which benefits consumers through lower prices and better quality.

A country with no domestic oil deposits imports crude oil to run its industries. Which benefit of international trade does this illustrate?

• Access to resources not available at home
• Economies of scale in oil production
• Improved terms of trade through specialization
• Protection of infant industries

Answer: Access to resources not available at home

Trade allows countries to obtain factors of production and raw materials they lack, which would otherwise make certain production impossible.

When two countries specialize according to comparative advantage and trade with each other, the key result is that each country can:

• produce at a point outside its production possibilities curve
• shift its production possibilities curve inward
• consume beyond its own production possibilities curve
• eliminate all unemployment permanently

Answer: consume beyond its own production possibilities curve

Specialization and trade do not change what a country can produce alone, but exchange allows consumption combinations beyond the domestic PPC — the essence of the gains from trade.