BUS 313 Section 3

Midterm Exam Practice Questions

Fall 2018

Part I: Multiple Choice. Choose the one alternative that best completes the statement or
answers the question.

(1) Countries such as the United States that have large populations tend to have
A) lower trade-to-GDP ratios.
B) higher trade-to-GDP ratios.
C) relatively greater capital outflows.
D) relatively smaller capital outflows.

(2)  Using the specific factors model, assume that strawberry production requires the
specific factor of land, tractor production requires the specific factor of capital, and labor
is variable. If the United States is capital abundant compared to Mexico, and Mexico is
land abundant compared to the United States, then in the short run with trade we would
expect
A) the income of Mexican workers to increase.
B) the income of U.S. workers to increase.
C) the income of Mexican land owners to increase.
D) the income of U.S. land owners to increase.

(3)  Which of the following is NOT a criticism of international institutions such as the
IMF, the World Bank, or the WTO?
A) They violate national sovereignty by imposing unwanted domestic policies.
B) They fail to understand the effects of their policies on the vulnerable.
C) Their decision-making is biased in favor of underdeveloped nations.
D) They ignore potentially large adjustment costs for developing nations of
implementing their policies.

(4) High tariffs on intermediate inputs

A) have no impact on the effective rate of protection on final goods.
B) lower the nominal rate of protection on final goods.
C) increase the effective rate of protection on final goods.
D) decrease the effective rate of protection on final goods.

(5)
U.S. U.K
Wheat 12 6
Cloth 6 18

The table above shows United States and United Kingdom production of wheat (bushels
per hour) and cloth (yards per hour).
According to Adam Smith, which of the following is true?
A) The United States will gain more from trade than the United Kingdom.
B) There is no basis for trade between these countries.
C) The United States has an absolute advantage in the production of cloth.
D) The United States has an absolute advantage in the production of wheat.

(6)  Certain kinds of tropical fruits are impossible to grow outdoors in the United States.
Suppose, however, that in order to create jobs in Wyoming, the U.S. government offered
extensive subsidies to firms to produce bananas. With the subsidies, firms could build
greenhouses and offer the fruit at world prices.
A) The United States has a comparative advantage and is competitive.
B) The United States has a comparative advantage, but is not competitive.
C) The United States now has a comparative advantage in bananas.
D) The United States is competitive, but does not have a comparative advantage.

Part II: Short Answers

1) How does trade improve consumption? Use Productions Possibilities Curve (PPC)
and Consumptions Possibilities Curve (CPC) to explain your answer.

If there is no trade, countries are limited in their consumption to the goods that they
produce at home. Thus, they are not able to consume outside their productions
possibilities curves (PPC). However, with the opening of trade, countries can choose
to specialize in the production that they have comparative advantages in and trade to
raise their consumption levels. The trading possibilities are illustrated by the
consumption possibilities curves (CPC).

2) What arguments do nations use to justify protection for particular industries? Which
are economic, and which are noneconomic?

The arguments are (1) revenue, (2) the labor argument, (3) the infant industry
argument, (4) the national security argument, (5) cultural protection, and (6) the
retaliation argument. The first three arguments are about government revenue, jobs,
and manufacturing, so they are economic arguments. Arguments 4 and 5 have
economic components, but are primarily based on noneconomic considerations. The
retaliation argument is perhaps more explicitly economic as well.

Part III: Problems

1) Suppose one unit of labor can produce the following goods in the following
countries:
 Smart Phone Laptop
Japan 6 2
China 4 1

a) What is the opportunity cost of producing a laptop in Japan? In China?

Japan: 6/2 = 3
China: 4/1 = 4

b) What country has a comparative advantage in smart phones? In laptop? Explain your
answer.

Japan should specialize in laptops since it has the lower opportunity cost (3 smart
phones in Japan rather than 4 smart phones in China). China should specialize in
smartphones.

c) What are the upper and lower bounds for the trade price of laptop?

3 <= P <= 4

2) According to the following table:

Mexico United States

Capital 5 20
Labor 30 100

a) Which country is relatively more labor-abundant? Explain your answer.

Mexico, because it has lower capital/labor ratio (1/6 in Mexico rather than 1/5 in US).

b) Suppose further that the production requirement for a unit of avocado is 0.5 unit of
capital and 4 workers, and the requirement for a unit of soybean is 1 unit of capital
and 4 workers. Which country should export avocado? Why?

Mexico, because avocado is a labor intensive good (1/8 for avocado and 1/4 for
soybean).

3) The graph below, not drawn to scale, shows the market for seat covers in United
States. The demand curve (D) suggests that the price in $ follows P = 8 - 0.1Q, and the
supply curve (S) suggests the price P = 1 + 0.1Q. When there is free trade, the price in
United States is equal to the world price Pw = $2. If the US government imposes a
tariff of $1 per cover, the price rises to Pt = $3. Please answer the following questions
 (read them carefully and show your work step by step):

d
a) Prior to the imposition of the tariff, what is the domestic consumption of covers Q w

s
as well as the domestic production Q w?

d
The domestic consumption of covers is Q w = 60 and the domestic production is

s
Q w = 10.

d
b) After the imposition of the tariff, what is the domestic consumption of covers Q t as

s
well as the domestic production Q t?

d s
The domestic consumption of covers is Q t = 50 and the domestic production is Q t =

20.

c) By how much does the consumer surplus reduce and producer surplus increase as a
result of the tariff?

Prior consumer surplus: 1/2 × (8 − 2) × 60 = $180

 New consumer surplus: 1/2 × (8 − 3) × 50 = $125
Reduction in consumer surplus: $55
Prior producer surplus = 1/2 × (2 − 1) × 10 = $5
New producer surplus = 1/2 × (3 − 1) × 20 = $20
Greater domestic producer surplus: $15

d) How much revenue does the government earn from the tariff?

(3 - 2) (50 - 20) = $30

e) What is the national welfare loss as a result of the tariff?

180 + 5 – 125 – 20 – 30 = $10