INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 3
1. Suppose the marginal rate of substitution of wheat for cloth in a country equals 1.5
and the international exchange ratio is 1.0. Explain how this country will adjust its
consumption of wheat and cloth if it can trade at international prices.
2. A country has the opportunity to export wheat in exchange for cloth. If engaging in
trade redistributes income to individuals who have a stronger preference for cloth,
how does the redistribution complicate any judgment that trade makes the nation
better off?
3. In isolation, Country A produces 8 million tons of rice and 14 million tons of beans.
One ton of rice exchanges for 2 tons of beans, and there are constant costs.
a. Construct Country A’s production-possibility curve, and label its endpoints.
b. Suppose Country A now has the opportunity to trade with Country C at the
exchange ratio 1R:1B. In equilibrium Country A consumes 16 million tons of
beans.
(i) What will Country A produce after trade?
(ii) What will Country A consume after trade? Show its consumption point
and its trade triangle.
(iii) What is the gain from trade (in real terms) to Country A?
4. “Trade theory assumes that resources are fully employed both before and after trade
and that technology remains unchanged. But if the same amounts of resources are
actually used, both before and after trade, I don’t see how any gain to the world as a
whole can occur.” Explain the basis for gains from trade to occur even when worker
effort and technology remain the same.
5. Suppose Honduras can produce 120 million tons of bananas if it uses all of its
productive resources in the banana industry, or 90 million square meters of cloth if it
uses all of its resources in the cloth industry. Use a diagram to illustrate your answers
to the following questions. Label the diagram and explain in words.
a. Assuming constant opportunity costs, draw the Honduran production-possibility
curve.
b. With no trade, suppose Honduran consumers choose to consume 40 million
tons of bananas. How much cloth will Honduras then be able to produce?
c. What is the autarky price or barter exchange ratio in Honduras?
d. Now suppose that Honduras has the opportunity to engage in foreign trade and
that the world exchange ratio is 1B:1C. What will happen to the allocation of
resources in Honduras? Explain why.
e. If Honduras consumes 50 million tons of bananas after trade begins, how much
cloth will it consume?
f. What is the gain from trade to Honduras?
6. How do increasing-cost conditions affect the extent of international specialization and
exchange? Why is a country less likely to become completely specialized in this
situation compared to one of constant costs?
7. Suppose Countries A and B have identical production-possibility curves subject to
increasing opportunity cost, but A consumers have a stronger preference for wheat
relative to cloth than B consumers. What can you say about the autarky price in each
country before trade takes place? How will the opportunity to trade affect A’s
production and consumption of wheat compared to the initial autarky condition?
8. What is meant by the terms of trade? Use the figures below to determine the extent
of any improvement or worsening in Country A’s terms of trade.
Prices 2000 2008
Exports 1.0 1.5
Imports 0.5 1.2
9. Consider the international trade framework shown in Figure 3.10. Suppose Country
A, the exporter of cloth, finds that rising oil prices make it more expensive to transport
goods to serve the export market.
a. Explain in which of the three diagrams we should shift a supply or demand
curve.
b. Indicate what elasticity conditions make it more likely that Country B will face an
increase in the price of cloth that is nearly as large as the additional cost of
transporting the goods.
c. Suggest how the price of cloth in Country A is affected by this change in the
cost of serving the export market. Be sure to distinguish between the price paid
by consumers in A’s domestic market and the price paid by consumers in the
world market.
10. Consider trade between Kenya and the E.U. in the offer curve framework.
a. Draw an offer curve for Kenya that shows its willingness to trade tea for
machinery. Include both an elastic and an inelastic range in Kenya’s offer curve.
b. Draw an offer curve for the E.U. that shows its willingness to trade machinery
for tea. Show this E.U. curve intersecting the Kenyan offer curve in the inelastic
range of the Kenyan curve. Note the equilibrium terms of trade established.
c. Compare the equilibrium international price you found in question (b) to the
autarky prices in Kenya and the E.U. (You can find a country’s autarky price by
drawing a line tangent to the offer curve at the origin.) Explain which country
benefits the most from a more favorable movement in its terms of trade when it
abandons its autarky position.
d. “The Kenyan offer curve is likely to be less elastic than the E.U. offer curve.”
Justify this claim by explaining what factors determine the elasticity of an offer
curve.
INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 3: Answers
1. If the marginal rate of substitution of wheat for cloth is 1.5, and the initial
2. Consider Country A’s offer of wheat for cloth based on an unchanged distribution
of income, as given by the offer curves OA0 and OB0. Relative to that situation, if
trade raises the incomes of those who prefer cloth, Country A is now willing to
3. a. Country A’s PPC can be constructed from knowledge of its current production
point and the relative cost of 2 tons of beans equal to 1 ton of rice. If bean output
equals 0, then rice production can rise from 8 to 15; if rice output is 0, then bean
4. The gains from trade based on comparative advantage do not come from a
reduction in unemployment and an increase in employment or from people
5. a. From knowing the two endpoints of the Honduran PPC, and letting cloth be the
good we represent on the horizontal axis, we know the cost of cloth is given by the
slope of the PPC, 120 T bananas / 90 square meters cloth, or 4/3. The equation for
6. Under increasing cost conditions, the potential for mutually beneficial trade also
7. Country A will have a higher initial price of wheat or a lower price of cloth than
Country B. Given an opportunity to trade, A will export cloth to B and import
8. The terms of trade is the price of exports divided by the price of imports. The
9. a. Shift up the export supply curve in the middle diagram.
b. B consumers will bear more of this cost increase if their elasticity of demand
10. a) Kenya’s offer of tea, OK, is shown below.
O
K
b) Adding the EU offer of manufactures allows the equilibrium terms of trade to
be determined.
K
OE
