CFA Level 1 - Economics Session 6 - Reading 20

CFA Level 1 - Economics Session 6 - Reading 21 (Notes, Practice Questions, Sample Questions) 1. Which of the following statements about the costs and benefits of international trade is most accurate? . A)The costs of trade primarily affect those in domestic industries that compete with imports. B)The costs of trade are greater than the benefits with regard to domestic employment. C)Increased international trade benefits all groups in the trading countries. [Explanation: The benefits of trade are greater than the costs for the overall economy, but those in domestic industries competing with imports may suffer costs in the form of reduced profits or employment] 2. Suppose labor in Venezuela is less productive than labor in the United States in all areas of production. Which of the following statements about trading between Venezuela and the U.S. is most accurate? A)Venezuela will not have a comparative advantage in any good. B)Both nations can benefit from trade. C)Venezuela can benefit from trade but the U.S. cannot. [Explanation: Although one country may have an absolute advantage in all areas, trade is based on differences in opportunity costs, or comparative advantage. Any country will always have a comparative advantage in the production of some goods; thus, all countries can benefit from trade] 3. The law of comparative advantage explains why a nation will benefit from trade when it: A)exports more than it imports. B)exports goods for which it is a low-cost producer, while importing those for which it is a high-cost producer. C)exports goods for which it is a high-cost producer, while importing those for which it is a low-cost producer. [Explanation:Comparative advantage is the ability to produce a good at a lower opportunity cost than others can produce it. When trading partners specialize in producing products for which they have a comparative advantage; costs are minimized, output is greater, and both trading partners benefit] 4. According to the law of comparative advantage: A)a nation will benefit from trade when it imports goods for which it is the high cost producer and exports goods for which it is the low-cost producer. B)if a foreign government subsidizes the textile industry, the domestic government should impose a tariff. C)Mexico is considered to have a comparative advantage in plastics if Mexico can produce plastic using fewer resources than the U.S. [Explanation: This statement is the law of comparative advantage. The other choices are incorrect. The law of comparative advantage supports international trade. According to the law of comparative advantage, both trading partners are better off if they specialize in the production of goods for which they are the low-opportunity cost producer and trade for those goods for which they are the high-opportunity cost producer. Mexico is considered to have an absolute advantage in plastics if Mexico can produce plastic using fewer resources than the U.S.] 5. A country has a comparative advantage over another when: A)a nation has the ability to produce a good with a lower opportunity cost than another nation. B)a nation can produce more output with a given amount of input than another nation. C)it can produce a product with the fewest resources. [Explanation: A nation will have a comparative advantage in the production of good A when the number of units of B, given up to produce one unit of A, is lower than that for any other country] 6. Which type of advantage determines the pattern of trade in the world? A)Absolute advantage. B)Advantages due to tariffs and quotas. C)Comparative advantage [Explanation: Comparative advantage is the ability to produce a good at a lower opportunity cost than others can produce it. According to the law of comparative advantage, trading partners are both better off if they specialize in the production of goods for which they are the low-opportunity cost producer and trade for goods for which they are the high-opportunity cost producer] 7. The law of comparative advantage holds that trading partners can be made better off if they: A)specialize in production of goods for which they are the low exchange rate adjusted producer. B)import those goods for which they have a comparative advantage. C)specialize in production of goods for which they are the low opportunity cost producer [Explanation: The law of comparative advantage holds that trading partners can be made better off if they specialize in production of goods for which they are the low opportunity cost producer. They should export, not import, goods for which they have a comparative advantage. Absolute and exchange rate adjusted costs are not relevant to the concept of comparative advantage] 8. The table below outlines the possible tradeoffs of producing beer and cheese for Germany and Holland. Germany Holland Cheese Beer Cheese Beer 0 10 0 6 5040 Which of the following statements is most accurate? A)Both countries would gain if Germany traded beer for Holland's cheese. B)Both countries would gain if Germany traded cheese for Holland's beer. C)Germany would not gain from trade, because it has an absolute advantage in the production of both goods. [Explanation: Germany has an absolute advantage in both beer and cheese because it can produce more of both than Holland. Holland has a comparative advantage in producing cheese because it can produce either 4 cheeses or 6 beers, which is a ratio of 2 to 3, whereas Germany can produce 5 cheeses or 10 beers, which is a ratio of 1 to 2. Because of Holland's comparative advantage in producing cheese, both countries would benefit if Germany used its absolute advantage in producing beer in exchange for Holland's comparative advantage in cheese] 9. In the Ricardian model of trade, the source of comparative advantage is: A)labor productivity. B)capital productivity. C)the difference between labor productivity and capital productivity. [Explanation: The Ricardian model of trade only considers labor as a factor of production. Comparative advantage results from differences in labor productivity. Labor and capital inputs are both considered in the Heckscher–Ohlin model of trade] 10. Which of the following arguments in favor of trade restrictions is least likely to be supported by economists? A)Infant industries should be protected. B)Trade with low-wage countries depresses wage rates in high-wage countries. C)National defense industries should be protected. [Explanation: Trade with low-wage countries does not in itself depress wage rates since productivity must be considered. The other arguments have some support among economists] 11. Which of the following groups in the country of Minidonia would least likely be helped by the imposition of tariffs on Minidonian imports of transportation equipment? A)Automotive manufacturers. B)Minidonia's government. C)Trucking companies [Explanation: Tariffs on transportation equipment benefit the government in the form of tariff revenue, and benefit domestic producers and industry workers in the form of higher prices for transportation equipment. The users of transportation equipment, such as trucking companies, suffer from higher costs due to the higher prices of transportation equipment] 12. The primary benefits derived from tariffs usually accrue to: A)foreign producers of goods protected by tariffs. B)domestic suppliers of goods protected by tariffs. C)domestic producers of export goods [Explanation: Tariffs raise domestic prices, benefiting domestic suppliers] 13. In what way does a tariff differ from a quota? A tariff is: A)not significantly different from a quota; tariffs are imposed by world organizations, whereas quotas are imposed by individual countries. B)a tax imposed by a foreign government, whereas a quota is a limit on the total amount of trade allowed. C)a tax imposed on imports, whereas a quota is a limit on the number of units of a good that can be imported [Explanation: The difference between a tariff and a quota is that a tariff is a tax imposed on imported goods, while a quota is an import quantity limitation. Also, a tariff will generate tax revenue, but a quota does not] 14. Who benefits least from tariffs? A)Foreign consumers. B)Domestic consumers. C)Domestic producers. [Explanation: A tax imposed on imports is called a tariff, which benefits domestic producers and domestic governments. Domestic consumers lose through higher prices, less choice of products, and lower quality products] 15. Who benefits the most from a quota? A)Foreign consumers. B)Domestic producers. C)Foreign producers [Explanation: Quotas restrict the supply of imported goods, which increases the price domestically benefiting domestic producers. Some foreign producers also benefit from the higher prices created by the quota if they receive the revenue transfer (due to higher prices received for all goods sold under the import license). However, overall the foreign producers do not sell as much of their product and have lost revenues] 16. Suppose the world price of Mercury tennis shoes is $60, but they sell in the U.S. for $75 due to a $15 import tariff. Who will most likely be negatively affected by the tariff? A)U.S. consumers. B)Producers. C)Foreign consumers [Explanation: Tariffs benefit domestic producers of products because the level of imports will be reduced due to an effective increase in the price of the goods. Consumers in the country lose due to higher prices] 17. Prior to the beginning of summer, the government of Japan places a 150 percent tariff on imported chain saws. Assume for this example that this tariff has a significant impact on the supply of chain saws. The government’s action: A)will protect the jobs and high wages of Japanese chain saw industry workers. B)benefits the Japanese government and domestic producers. C)is more harmful than if the government had limited the amount of chain saws imported [Explanation: The Japanese government’s action is an example of a tariff. A tariff is a tax imposed on imports and benefits the Japanese government because it collects the tariff. Domestic producers benefit because the reduction in the supply of imported goods means a higher domestic price. The other choices are incorrect. A tariff is considered less harmful than a quota (an import quantity limitation) because under a quota, the domestic government does not receive any funds as it would under a tariff (the foreign producers receive the revenue transfer). In the long run, trade restrictions do not protect the net number of jobs in the country. The number of jobs protected by import restrictions will be offset by jobs lost in the import/export industry. Import/export firms will be unable to sell the overpriced domestic products abroad or import and sell the lower priced restricted foreign-made product] 18. The anti-dumping argument in favor of trade restrictions is the argument that restrictions should be imposed to: A)discourage foreign firms from engaging in price competition. B)prevent foreign firms from dumping unwanted products in domestic markets. C)prevent foreign firms from selling their product below cost [Explanation: The anti-dumping argument is that restrictions should be used to prohibit foreign firms from increasing market share by selling products below cost] 19. An anti-dumping restriction on trade: A)keeps some highly sensitive products in the country. B)prohibits foreign firms from selling products below cost to gain market share. C)protects infant industries [Explanation: Firms dump their goods at a price lower than cost in order to drive out the competition. Once this is complete, they will be able to raise prices to much higher levels in order to gain abnormal profits. Of course, once prices are increased, new competitors may arise.] 20. Which of the items below is NOT a valid reason why nations adopt trade restrictions? To: A)prohibit foreign firms from increasing market share by selling products below cost. B)protect industries that are highly sensitive to national security. C)protect industries in which they have a comparative advantage. [Explanation: If a particular country enjoys a comparative advantage in a particular industry, no protection is needed] 21. David Forsythe and Linda Novak are discussing the advantages and disadvantages of import restrictions. They state the following: Forsythe: One of the groups that benefits from import restrictions is often the government that imposes them. Novak: Import restrictions impose costs on specific groups, such as the country’s import industries, but these costs are more than offset by the benefits to other groups and to the economy as a whole. With respect to these statements: A)both are correct. B)only one is correct. C)both are incorrect. [Explanation: Forsythe is correct. A primary reason why trade restrictions remain widespread is the revenue that governments receive from tariffs. Novak is incorrect. Trade restrictions benefit specific groups, such as workers in the protected industries, but those benefits are most often less than the costs imposed on consumers and other industries as a whole] 22. The North American Free Trade Agreement (NAFTA) is most accurately described as a: A)customs union. B)common market. C)free trade area [Explanation: NAFTA is a free trade area, in which the member nations remove barriers to imports and exports among themselves. In a customs union, all members adopt common trade policies with non-members. A common market goes further, removing all barriers to movement of labor and capital among members] 23. The form of regional trading agreement (RTA) least likely to have the unintended negative effect of reducing a member country’s low-cost imports from a non-member country is a: A)common market. B)customs union. C)free trade area [Explanation: A free trade area removes barriers to trade among its members but does not require any of its members to change their trade policies with non-members. A common market and a customs union both impose uniformity on trade rules with non-member nations, which could restrict a member’s low-cost imports from a nation that is not a member] 24. In 20X5, Tunisia’s merchandise imports exceeded the value of its merchandise exports. In this case, Tunisia would most likely have which of the following? A)Balance of trade surplus. B)Capital account surplus. C)Current account surplus [Explanation: The capital account includes investment in real assets and financial securities. If a country is running a current account deficit, as in the case of Tunisia, a way to make up the difference in the current account is to be a net borrower creating a surplus in the capital account.] 25. Sales and purchases of non-financial assets are included in which of a country’s trade accounts? A)Capital account. B)Financial account. C)Current account. [Explanation: The capital account consists of sales and purchases of non-financial assets plus capital transfers] 26. Holding other factors constant, a country can reduce its trade deficit by increasing its: A)private saving. B)government budget deficit. C)domestic capital investment [Explanation: Other things equal, increasing savings would decrease a current account deficit, while increasing a government budget deficit or domestic investment would increase a current account deficit] 27. The most accurate description of the relative roles played by the International Monetary Fund, World Bank, and World Trade Organization is that is that the only one explicitly focused on: A)expanding international trade is the World Trade Organization. B)providing funding to member nations is the International Monetary Fund. C)reducing poverty is the World Bank. [Explanation: The World Bank has the explicit mission of fighting poverty. Both the WTO and IMF work to expand international trade. Both the World Bank and IMF provide funds to member nations, the World Bank for development and the IMF when member nations experience balance of payments difficulties]