Chapter 7:

Growth and Trade

Multiple Choice Questions

1. One fundamental source of long-run economic growth would be:

a. External scale economies.

b. Lower wages.

c. Improvements in production technologies.

d. Exploiting comparative advantage.

ANSWER: C

Figure 7.1

Wheat

2. Referring to Figure 7.1, this outward shift of the production possibilities frontier is an
example of:

a. Biased growth.

b. Balanced growth.

c. The move from autarky to free trade.

 d. A fall in production costs.

ANSWER: A

3. Referring to Figure 7.1, the outward shift of the production possibilities frontier is
likely the result of:

a. A fall in production costs.

b. The move from autarky to free trade.

c. An increase in the labor force.

d. An increase in arable land.

ANSWER: D

4. Which of the following statements is true?

I. Increases in a country's endowments of land, labor, and capital will lead to long-run
economic growth.

II. Improvements in the technology used in production can lead to increases in output,
but cannot lead to long-run economic growth.

III. Improvements in technology and increases in the endowments of productive inputs

can both cause the production-possibility curve to shift outward.

a. I and II

b. I and III

c. I, II and III

d. None of the above

ANSWER: B

5. Given a country that produces wine and guns, which of the following is least likely to
lead to biased growth?

a. A new type of grape is discovered that yields twice as much wine as the old
grapes.
 b. Significant immigration results in great influx of unskilled workers who can be
as easily trained to work in the wine industry as in the gun industry.

c. The technology used to produce guns improves while the technology used to
produce wine does not change.

d. Due to significant immigration, the number of workers skilled at producing

wine increases while the number of workers skilled at producing guns does not
change.

ANSWER: B

6. The Rybczynski theorem asserts that in a two-good world, and assuming that product
prices stay constant, growth in the endowment of one factor of production, with the
other factor unchanged, will lead to:

a. An equal percentage increase in the output of both goods.

b. An increase in the output of the good that uses the growing factor intensively
and a decrease in the output of the other good.

c. An increase in the output of both goods but a greater percentage increase in the
output of the good that uses the growing factor intensively.

d. An increase in the output of the good that uses the growing factor intensively
and no change in the output of the other good.

ANSWER: B

7. A capital-abundant country trades two goods with the rest of the world, medical
equipment and corn. Medical equipment is relatively capital-intensive. An increase in
the country’s endowment of capital, with no change in the price of either medical
equipment or corn, will cause the output of medical equipment to __________ and the
output of corn to __________.

a. Rise; fall

b. Fall; rise

c. Rise; rise

d. Fall; fall
 ANSWER: A

8. A large capital-abundant country trades two goods with the rest of the world, medical
equipment and corn. Medical equipment is relatively capital-intensive. An increase in
the country’s endowment of capital will cause the price of medical equipment relative
to the price of corn to:

a. Rise.

b. Fall.

c. Stay the same.

d. Rise at first and then fall.

ANSWER: B

9. Growth in a country’s scarce factor of production will lead to:

a. An increased willingness to trade.

b. Balanced growth.

c. A decreased willingness to trade.

d. A deterioration in the country’s terms of trade.

ANSWER: C

10. Assume a country that produces wine and guns. Both wine and gun production require
inputs of both land and labor. Assume that wine production is a relatively land-intensive
production process while gun production is a relatively labor-intensive production
process. A significant rise in immigration will likely lead to:

a. An increase in the production of both wine and guns.

b. Wine production increasing by a greater proportion than the proportion by

which labor increased as a result of the immigration.

c. Gun production increasing by a greater proportion than the proportion by which

labor increased as a result of the immigration.
 d. Wine production increasing by a greater proportion than gun production will
increase.

ANSWER: C

11. The development of newly discovered oil reserves in a country:

a. Results in balanced growth.

b. Will cause GDP to fall.

c. Will increase output in all sectors of the economy.

d. May cause output in the country’s manufacturing sector to fall.

ANSWER: D

12. The rapid accumulation of capital and worker skills in the United States in the 1800’s:

a. Led to one of the first examples of the “Dutch Disease.”

b. Made the United States more dependent on imported minerals.

c. Made the United States more self-sufficient and led to a reduction in foreign
trade.

d. Caused deindustrialization.

ANSWER: B

13. Assume a country that produces cloth and coal. Assume that cloth production requires
significant amounts of labor and capital, but relatively little land. Assume that coal
production requires relatively little labor and capital, but relatively large amounts of
coal-rich land. Given increases in the country's endowments of capital and labor, we can
expect that:

a. Both cloth and coal production will increase.

b. Cloth production will increase, but coal production will remain constant.

c. Cloth production will increase, but coal production will decline.

d. Coal production will increase, but cloth production will remain constant.
 ANSWER: C

14. Country X produces two goods, food and clothing. Presently, 40 units of food are
produced and 20 units of clothing are produced. 10 units of food are exported and 10
units of clothing are imported. Now suppose new technology in Country X leads to
balanced growth while leaving the prices of food and clothing unchanged. Production
of food rises to 50 units and production of clothing rises to 25 units. If consumption of
food rises to 42 units, we can conclude:

a. Consumption of clothing has risen to 32 units.

b. Country X’s trade triangle has increased in size.

c. Country X’s willingness to trade has fallen.

d. Consumers of clothing are worse-off.

ANSWER: C

15. Country X produces two goods, food and clothing. Presently, 40 units of food are
produced and 20 units of clothing are produced. 10 units of food are exported and 10
units of clothing are imported. Now suppose new technology in Country X leads to
balanced growth while leaving the prices of food and clothing unchanged. Production
of food rises to 50 units and production of clothing rises to 25 units. If consumption of
food rises to 42 units, we can conclude:

a. Consumption of clothing has risen to 33 units.

b. 10 units of food are exported.

c. 17 units of clothing are imported.

d. Consumption of food has fallen.

ANSWER: A

16. Suppose a large country experiences economic growth which leads to a reduced
willingness to trade. The country’s terms of trade will __________ because the fall in
demand for imports will cause the price of its exports to __________ relative to the
price that it has to pay for its imports.

a. Worsen; fall
 b. Improve; rise

c. Improve; fall

d. Worsen; rise

ANSWER: B

17. Suppose a large country experiences economic growth which leads to an increased
willingness to trade. The country’s terms of trade will __________ because the increase
in demand for imports will cause the price of its exports to __________ relative to the
price that it has to pay for its imports.

a. Worsen; fall

b. Improve; rise

c. Improve; fall

d. Worsen; rise

ANSWER: A

18. Suppose a small country experiences economic growth which leads to an increased
willingness to trade. The country’s terms of trade will __________ because the price of
its exports will __________ relative to the price that it has to pay for its imports.

a. Worsen; fall

b. Improve; rise

c. Remain constant; remain constant

d. Remain constant; rise

ANSWER: C

19. Large countries are __________ susceptible to immiserizing growth than small
countries because when large countries expand their exports, their terms of trade
__________.

a. Less; improve.
 b. Less; worsen.

c. More; improve.

d. More; worsen.

ANSWER: D

20. Suppose a labor-abundant country experiences a significant increase in its capital stock.
This change in endowments can:

a. Lead to immiserizing growth.

b. Lead to an increase in the exportation of labor-intensive goods.

c. Lead to a reversal of the country’s trade pattern.

d. Lead to reduced growth rates.

ANSWER: C

21. Which of the following is unlikely to lead to a reversal of a country’s trade pattern?

a. Growth in the country’s endowment of the factor of production that is initially

scarce.

b. Balanced growth.

c. International diffusion of technology.

d. Shifting tastes of the country’s consumers.

ANSWER: B

22. Suppose a capital-abundant country experiences a significant increase in its capital

stock. This change in endowments will:

a. Lead to an improvement in the country’s terms of trade.

b. Lead to a decreased willingness to trade.

 c. Lead to no change in the country’s willingness to trade.

d. Lead to an increased willingness to trade.

ANSWER: D

23. A country moving from autarky to free trade:

a. Will have its trade triangle shrink.

b. Will experience deteriorating terms of trade.

c. Cannot suffer from immiserizing growth.

d. Will experience an outward shift of their production possibilities frontier.

ANSWER: C

24. Immiserizing growth occurs when:

a. A country develops a new natural resource such as oil.

b. A small amount of economic growth leads to a large improvement in a country’s

terms of trade.

c. The benefits from economic growth are not shared by all residents of the
country.

d. Economic growth leads to a deterioration in a country’s terms of trade whose

impact outweighs the production benefit from growth.

ANSWER: D

25. When economic growth expands a country's willingness to trade it can result in such a
large decline in that country's terms of trade that the country can be worse off. This is
called:

a. Dutch Disease.

b. Biased growth.

c. Immiserizing growth.
 d. Diffusion.

ANSWER: C

26. When economic growth causes a country's willingness to trade to contract, it can result
in:

a. An improvement in the country’s terms of trade.

b. Biased growth.

c. Immiserizing growth.

d. Dutch Disease.

ANSWER: A

27. Suppose a drought drastically reduces the world’s production of coffee. Those countries
who rely on their coffee exports and who continue to export coffee to the rest of the
world:

a. May experience an improvement in economic welfare as terms of trade shift in

their favor.

b. Will experience deterioration in economic welfare as their terms of trade

worsen.

c. Will experience deterioration in economic welfare as import prices rise.

d. May experience an improvement in economic welfare as production in import-

competing industries rises.

ANSWER: A

28. Which of the following conditions is NOT necessary for immiserizing growth to
develop?

a. The country's growth must be strongly biased toward expanding the country's
supply of exports and the increase in exports must be large enough to have a
noticeable impact on world prices.
 b. The foreign demand for the country's exports must be price inelastic so that an
expansion in the country's export supply leads to a large drop in the international
price of the export product.

c. Before the growth, the country must be heavily engaged in trade so that the
welfare loss from the decline in the terms of trade is great enough to offset the
gains from being able to produce more.

d. The country must specialize in the production of a single export good and
import all the other goods consumed in the economy.

ANSWER: D

29. The international spread of technology is called:

a. Immiserizing growth.

b. Diffusion.

c. Dutch disease.

d. Research and development.

ANSWER: B

30. Investment by businesses that focuses on improvements in production technologies for

existing products and on new production technologies for new or improved products is
called:

a. Immiserizing growth.

b. Diffusion.

c. Dutch disease.

d. Research and development.

ANSWER: D

31. Technology-based comparative advantage:

a. Can help explain how the United States went from being a net exporter of steel
to being a net importer of steel.
 b. Is totally contradictory to the Heckscher-Ohlin theory of comparative
advantage.

c. Results in immiserizing growth.

d. Ensures that poorer less industrialized nations can never compete in world
markets with richer more industrialized nations.

ANSWER: A

32. The Heckscher-Ohlin theory suggests that research and development activity would
most likely occur in countries that:

a. Are capital-abundant.

b. Are skilled-labor-abundant.

c. Are more open to trade.

d. Are more self-sufficient.

ANSWER: B

33. The product cycle hypothesis was first presented by:

a. Adam Smith

b. David Ricardo

c. Eli Heckscher

d. Raymond Vernon

ANSWER: D

34. Which of the following explains that the production of a good moves from invention
through the perfection of production methods to standardization and that the country
that initially exports the good likely becomes the importing country?

a. Immiserizing growth.
 b. Diffusion.

c. Product cycle hypothesis.

d. Research and development.

ANSWER: C

35. Countries that are open to international trade:

a. Cannot suffer from immiserizing growth.

, b. Tend to grow faster.

c. Tend to lose out on the benefits of diffusion.

d. Do not experience biased growth.

ANSWER: B

Figure 7.2

Wheat Cloth
36. The situation illustrated in Figure 7.2 is an example of:

a. A small country experiencing a balanced growth.

b. A large country experiencing a balanced growth.

c. A small country experiencing growth biased toward cloth production.

d. A large country experiencing growth biased toward wheat production.

ANSWER: D

37. Referring to Figure 7.2, the country’s well-being:

a. Increases due to the increased production of wheat.

b. Increases because the country experiences an unbalanced growth.

c. Deteriorates because the price lines intersect.

d. Deteriorates because the growth cannot compensate for the decline in the
country’s terms of trade

ANSWER: D

38. The situation presented in Figure 7.2 illustrates:

a. How the openness to trade affects growth.

b. The validity of the product cycle hypothesis.

c. The immiserizing growth effect.

d. How a small country can benefit from trade.

ANSWER: C

39. Immiserizing growth effect can occur when:

a. A large country experiences a growth in the production of its export-oriented

goods.
 b. There is a decline in the research and development investments in a large
country.

c. The terms of trade of a small country decline.

d. The import-competing goods are overproduced in a large country.

ANSWER: A

40. Suppose a country experiences a wave of immigration of highly skilled workers.

According to the Rybczynski theorem, this country:

a. Will start producing more of the good intensive in highly skilled labor.

b. Will start producing less of all goods that use unskilled labor in their
production.

c. Both a. and b.

d. Will start producing more of all goods to satisfy the needs of the rising
population.

ANSWER: A

True/False Questions

41. For a country already engaged in trade, biased growth will lead to an increased
willingness to trade.

ANSWER: FALSE

42. If a country is small, then its trade will have no effect on its terms of trade.

ANSWER: TRUE

43. Given that it is irrational for a nation to undergo an expansion that makes itself worse
off, we can conclude that immiserizing growth is simply a theoretical curiosity with no
possibility to occur in the real world.

ANSWER: FALSE

44. The Rybczynski theorem states that, given a two-good world and constant prices,
growth in one of a country's inputs to production will lead to an increase in production
 in both the good that uses that input more intensively in production and the good that
uses that input less intensively in production.

ANSWER: FALSE

45. (Assume that corn and cloth are each produced using both land and labor, that corn is
relatively land-intensive, and that product prices are constant.) If the country
experiences an increase in its endowment of labor, an increase in the country's output of
cloth and a decrease in the country's output of corn will result.

ANSWER: TRUE

46. Immiserizing growth is the situation in which the expansion of a country's exporting
industry results in a reduction in the world price of the exported good and a reduction in
economic welfare in the country.

ANSWER: TRUE

47. Growth could lead to either an increase or a decrease in a country's willingness to trade.

ANSWER: TRUE

48. Growth with an increased willingness to engage in international trade will always
improve the economic well-being of a country.

ANSWER: FALSE

49. New technology created through research and development activities in the United
States will only be used by firms in the United States.

ANSWER: FALSE

50. Increases in the endowments of the factors of production will increase current output,
but will not contribute to long-run economic growth.

ANSWER: FALSE

51. Small countries are not subject to the immiserizing growth effect because their
economic growth does not have an impact on the relative international price ratio.

ANSWER: TRUE

52. The product cycle hypothesis was first advanced by Heckscher and Ohlin.
ANSWER: FALSE

53. Research and development that leads to new technologies tends to be located in
developing countries, because labor there is cheap.

ANSWER: FALSE

54. The Dutch Disease was an infectious disease that spread from the Netherlands to
Britain, Norway and Australia and caused the depopulation of these countries.

ANSWER: FALSE

55. The balanced growth of a country decreases the country’s willingness to trade because
the country produces and consumes more of each product.

ANSWER: FALSE

Essay Questions

56. A free-trade equilibrium exists in which the United States exports capital-intensive
machinery and imports clothing from the rest of the world. The goods are produced
with two factors: capital and labor. An increase now occurs in the U.S. endowment of
capital, its abundant factor.

a. What is the effect on the shape and position of the U.S. production-possibilities
curve? Illustrate your answer graphically.

POSSIBLE RESPONSE: The increase in the U.S. endowment of capital leads to an

unbalanced growth biased toward the production of machinery.

Clothing
 b. What is the effect on the actual production quantities in the United States,
assuming the product price ratio is unchanged? Explain and illustrate
graphically.

POSSIBLE RESPONSE: The unbalanced growth leads to an increased production

of machinery and a decreased production of clothing as illustrated in the graph. This
is the prediction of the Rybczynski theorem.

c. What is the effect on the U.S. willingness to trade?

POSSIBLE RESPONSE: The result is an increased willingness to trade for the U.S.
The U.S. is exporting more machinery and importing more clothing.

57. Suppose that Country A, which has a relative abundance of capital, further expands its
endowment of capital. Explain how this might affect the volume (amount) of trade and
the international terms of trade with the rest of the world? Under what conditions (if
any) would the economic well-being of Country A go down after this increase in
capital? Explain.

POSSIBLE RESPONSE: If the amount of capital in Country A increases, the result will
be a biased growth toward the production of capital-intensive goods. As a result of this
biased growth, the country will expand its production of capital-intensive goods and
will reduce its production of goods requiring the intensive use of other factors of
production (Rybczynski theorem).The country increases its willingness to trade. If the
country is large, the increased willingness will affect the international price ratio (terms
of trade) to the disadvantage of the country. If this effect is large enough, the result will
 be immizerising growth, which causes the country to lose well-being even though one
of the factors of production is growing.

58. Assume that Country X produces two goods—guns and roses—using labor and land.
Assume that gun production is relatively labor-intensive and that rose production is
relatively land-intensive. Now assume that a large number of workers emigrate from a
neighboring country to Country X. Carefully explain all of the Rybczynski theorem's
predictions about Country X’s output of both guns and roses. Be certain to carefully
explain any shifts in resources from one industry to the other.

POSSIBLE RESPONSE: The immigration of workers to Country X causes an increase

in labor in this country. The Rybczynski theorem asserts that, if one of the factors
(labor) increases and the other factor remains unchanged (land), the country will
increase its production of the labor intensive product (guns), and will decrease its
production of the land intensive product (roses). What is the logic behind this theorem?
With the increase in labor, the most obvious place to expand production is the labor-
intensive gun industry. But this industry requires the use of not only labor but also land.
Yet, the amount of land available remains constant. That means the country will have to
free some land, and this can only be done by lowering the production of roses. Thus, the
proportionate expansion of the production of guns is actually larger than the proportion
by which the overall labor endowment grows.

59. How are the effects of growth different for a large country than for a small country?

POSSIBLE RESPONSE: If a country is small, then its growth and the subsequent
change in its international trade volumes will have no impact on the international price
ratio. Small countries surely gain from growth. Their citizens are able to reach higher
community indifference curves as a result of growth and the expansion of the country’s
production possibilities curve. If a country is large, however, then its growth and
willingness to trade might have an impact on the equilibrium international price ratio. In
particular, the change in the international price ratio might lead to deterioration in the
country’s terms of trade. In contrast to the case of a small country, the effect of growth
on the well-being of a large country is an ambiguous one. If the terms of trade decline a
great deal in response to growth, the well-being of a country could indeed deteriorate.
This possibility is referred to as an immiserizing growth.

60. Explain how openness to trade can influence economic growth in a country.

POSSIBLE RESPONSE: Openness to trade can have an impact on how fast a country’s
economy is growing, how fast the production possibilities of a country are growing over
time. As a general tendency, countries that are more open to trade grow faster. This
accelerated growth is due to a variety of reasons.
 First, trade allows the import of new and improved capital goods. By international trade
a country is able to import a better technology that can be used to raise productivity.

Second, and more generally, openness to international activities gives opportunities to

people to have more contact with technology developed in other countries, and provides
a greater awareness of new technology. This facilitates the adoption of new technology
through licensing or imitation of these technologies.

Finally, the openness to trade provides pressure on the domestic firms to innovate. This
process involves seeking better technologies to raise their productivity and be more
competitive internationally.

Empirically, there is a strong positive correlation between the growth rate of a country
and its international openness, and this is consistent with theoretical analysis.

61. Explain carefully the crucial conditions for immiserizing growth to occur. In particular,
discuss the effect of the size of the country, the volume of foreign trade, the type of
growth the country experiences, and foreign demand for the exports of the country.

POSSIBLE RESPONSE: Immiserizing growth can occur when a country’s growth is

biased toward the production of the good which the country exports. If the country is
big enough, the additional supply of this good will cause the international price of this
good to decline relative to the prices of other goods. This effect will be more
pronounced the more inelastic the foreign demand for this good. Further, the country
will stand to lose more from the worsening of the terms of trade the more this country
used to export the good before the growth occurred. If the worsening of the terms of
trade offsets the gains from being able to produce more, the country experiences
immiserizing growth: reduction in the well-being of the country in spite of the growth
in production.