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Global Business Today, 11e (Hill)
Chapter 6 International Trade Theory
1) Mercantilism, propagated in the sixteenth and seventeenth centuries, advocated that countries
should discourage exports.
Answer: FALSE
Explanation: Propagated in the sixteenth and seventeenth centuries, mercantilism advocated that
countries should simultaneously encourage exports and discourage imports.
Difficulty: 1 Easy
Topic: Trade Theories and Their Implications
Learning Objective: 06-01 Understand why nations trade with each other.
Bloom's: Understand
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation
2) Free trade exists when there is no government influence on what citizens can buy from another
country or sell to another country.
Answer: TRUE
Explanation: Free trade refers to a situation in which a government does not attempt to influence
through quotas or duties what its citizens can buy from another country or what they can produce
and sell to another country.
Difficulty: 1 Easy
Bloom's: Remember
AACSB: Reflective Thinking
3) According to Adam Smith, government policy should determine a country's imports and
exports.
Answer: FALSE
Explanation: Adam Smith argued that the invisible hand of the market mechanism, rather than
government policy, should determine what a country imports and what it exports.
Difficulty: 1 Easy
Bloom's: Remember
1
Copyright 2020 © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
4) New trade theory stresses that in some cases countries specialize in the production of particular
products because of underlying differences in factor endowments.
Answer: FALSE
Explanation: New trade theory stresses that in some cases countries specialize in the production
and export of particular products not because of underlying differences in factor endowments, but
because in certain industries the world market can support only a limited number of firms.
Difficulty: 1 Easy
Bloom's: Remember
5) Mercantilism asserted that gold and silver were the mainstays of national wealth and essential to
vigorous commerce.
Answer: TRUE
Explanation: The first theory of international trade, mercantilism, emerged in England in the
mid-sixteenth century and asserted that gold and silver were the mainstays of national wealth and
essential to vigorous commerce.
Difficulty: 1 Easy
Topic: Mercantilism
Learning Objective: 06-02 Summarize the different theories explaining trade flows between
nations.
Bloom's: Remember
6) Those who follow the mercantilist doctrine would not want government intervention to be the
reason for a surplus in the balance of trade.
Answer: FALSE
Explanation: The main tenet of mercantilism was that it was in a country's best interest to
maintain a trade surplus and those who followed the mercantilist doctrine would advocate for
government intervention to achieve a surplus of trade.
Difficulty: 2 Medium
Topic: Mercantilism
nations.
Bloom's: Understand
2
7) A country has an absolute advantage in the production of a product when it is more efficient
than any other country in producing it.
Answer: TRUE
Explanation: A country has an absolute advantage in the production of a product when it is more
efficient than any other country in producing it.
Difficulty: 1 Easy
nations.
Bloom's: Understand
8) Adam Smith disagreed with the mercantilist assumption because he believed that countries
differ in their ability to produce goods efficiently.
Answer: TRUE
Explanation: Adam Smith attacked the mercantilist assumption. Smith argued that countries
differ in their ability to produce goods efficiently. According to Adam Smith, countries should
specialize in the production of goods for which they have an absolute advantage and then trade
these for goods produced by other countries.
nations.
Bloom's: Understand
9) According to the theory of comparative advantage, potential world production is greater with
unrestricted free trade than it is with restricted trade.
Answer: TRUE
Explanation: The basic message of the theory of comparative advantage is that potential world
production is greater with unrestricted free trade than it is with restricted trade as consumers in all
nations can consume more if there are no restrictions on trade.
Difficulty: 1 Easy
nations.
Bloom's: Remember
3
10) The theory of free trade is enhanced by the idea that resources typically move easily from one
economic activity to another and allow nations to adapt quickly.
Answer: FALSE
Explanation: Resources do not always move easily from one economic activity to another. The
process creates friction and human suffering too. While the theory predicts that the benefits of free
trade outweigh the costs by a significant margin, this is of cold comfort to those who bear the costs.
Learning Objective: 06-03 Recognize why many economists believe that unrestricted free trade
between nations will raise the economic welfare of countries that participate in a free trade system.
Bloom's: Understand
11) Free trade is likely to increase a country's stock of resources and the efficiency with which it
utilizes those resources.
Answer: TRUE
Explanation: Opening an economy to trade is likely to generate dynamic gains of two sorts. First,
free trade might increase a country's stock of resources as increased supplies of labor and capital
from abroad become available for use within the country. Second, free trade might also increase
the efficiency with which a country uses its resources.
Difficulty: 1 Easy
Bloom's: Remember
12) The factor endowments of a country refer to government resources made available to help
businesses.
Answer: FALSE
Explanation: Factor endowments refer to the extent to which a country is endowed with such
resources as land, labor, and capital.
Difficulty: 1 Easy
nations.
Bloom's: Understand
4
13) The Heckscher-Ohlin theory is considered the best predictor of real-world international trade
patterns.
Answer: FALSE
Explanation: Economists prefer the Heckscher-Ohlin theory on theoretical grounds, but it is a
relatively poor predictor of real-world international trade patterns.
Difficulty: 1 Easy
nations.
Bloom's: Remember
14) Raymond Vernon's product life-cycle theory was based on the observation that for most of the
twentieth century a very large proportion of the world's new products were developed by the firms
situated in Germany and sold first in the German market.
Answer: FALSE
Explanation: Raymond Vernon's product life-cycle theory was based on the observation that for
most of the twentieth century a very large proportion of the world's new products had been
developed by U.S. firms and sold first in the U.S. market.
Difficulty: 1 Easy
nations.
Bloom's: Remember
5
15) According to the product life cycle theory, as demand for a product grows rapidly in the United
States, it will also grow rapidly in other advanced nations and diminish potential exports from the
United States.
Answer: FALSE
Explanation: Vernon went on to argue that early in the life cycle of a typical new product, while
demand is starting to grow rapidly in the United States, demand in other advanced countries is
limited to high-income groups. The limited initial demand in other advanced countries does not
make it worthwhile for firms in those countries to start producing the new product, but it does
necessitate some exports from the United States to those countries.
nations.
Bloom's: Understand
16) According to the product life-cycle theory, the locus of global production initially switches
from developing countries to other advanced nations and then from those nations to the United
States.
Answer: FALSE
Explanation: According to the product life-cycle theory, the locus of global production initially
switches from the United States to other advanced nations and then from those nations to
developing countries.
nations.
Bloom's: Understand
6
17) Vernon's product life cycle theory was based on the idea that most new products were initially
produced in the United States.
Answer: TRUE
Explanation: Just because a new product is developed by a U.S. firm and first sold in the U.S.
market, it does not follow that the product must be produced in the United States. It could be
produced abroad at some low-cost location and then exported back into the United States.
However, Vernon argued that most new products were initially produced in America.
Difficulty: 1 Easy
nations.
Bloom's: Remember
18) Factor endowments are unit cost reductions associated with a large scale of output.
Answer: FALSE
Explanation: Economies of scale are unit cost reductions associated with a large scale of output.
Factor endowments refer to a country's endowment with resources such as land, labor, and capital.
nations.
Bloom's: Understand
19) New trade theory suggests that world trade in certain products will likely be dominated by
countries who acted as late-movers and took advantage of existing innovations.
Answer: FALSE
Explanation: New trade theory makes two important points: First, through its impact on
economies of scale, trade can increase the variety of goods available to consumers and decrease
the average cost of those goods. Second, in those industries in which the output required to attain
economies of scale represents a significant proportion of total world demand, the global market
may be able to support only a small number of enterprises. Thus, world trade in certain products
may be dominated by countries whose firms were first movers in their production.
nations.
Bloom's: Understand
7
20) First-mover advantages are gained by those companies that are the early entrants to an
industry.
Answer: TRUE
Explanation: First-mover advantages are the economic and strategic advantages that accrue to
early entrants into an industry.
Difficulty: 1 Easy
Bloom's: Remember
21) Michael Porter argues that advanced factors are the most significant for competitive
advantage.
Answer: TRUE
Explanation: Michael Porter argues that advanced factors are the most significant for competitive
advantage. The benefits of investments in advanced factors of production by related and
supporting industries can spill over into an industry, thereby helping it achieve a strong
competitive position internationally. Unlike the naturally endowed basic factors, advanced factors
are a product of investment by individuals, companies, and governments.
Difficulty: 1 Easy
Topic: Porter's Diamond Model
nations.
Bloom's: Remember
22) According to Michael Porter, government can influence each of the four components of
Porter's diamond—either positively or negatively.
Answer: TRUE
Explanation: Porter contends that government can influence each of the four components of
Porter's diamond—either positively or negatively. Factor endowments can be affected by
subsidies, policies toward capital markets, policies toward education, and so on.
Difficulty: 1 Easy
Learning Objective: 06-04 Explain the arguments of those who maintain that government can
play a proactive role in promoting national competitive advantage in certain industries.
Bloom's: Remember
8
23) Porter's theory has been subjected to detailed empirical testing and it is proven that it
accurately predicts international trade patterns.
Answer: FALSE
Explanation: Porter's theory has not been subjected to detailed empirical testing. Much about the
theory rings true, but the same can be said for the new trade theory, the theory of comparative
advantage, and the Heckscher-Ohlin theory.
Difficulty: 1 Easy
Bloom's: Remember
24) From the perspective of making a profit, it is sensible for a company to disperse production
activities to countries where they can be performed most efficiently.
Answer: TRUE
Explanation: Underlying most of the theories we have discussed is the notion that different
countries have particular advantages in different productive activities. Thus, from a profit
perspective, it makes sense for a firm to disperse its productive activities to those countries where,
according to the theory of international trade, they can be performed most efficiently.
Learning Objective: 06-05 Understand the important implications that international trade theory
holds for business practice.
Bloom's: Understand
25) Porter's theory suggests that it is in the best interest of business for a firm to invest in upgrading
advanced factors of production.
Answer: TRUE
Explanation: Porter's theory suggests that it is in the best interest of business for a firm to invest
in upgrading advanced factors of production; for example, to invest in better training for its
employees and to increase its commitment to research and development.
Bloom's: Understand
9
26) Garrett works in a country where the government does not set quotas or duties on what its
citizens can buy from another country, or what they can produce and sell to another country. In
other words, Garrett's country practices
A) free trade.
B) mercantilism.
C) socialism.
D) absolute advantage.
E) a zero-sum game.
Answer: A
Explanation: Free trade refers to a situation in which a government does not attempt to influence
through quotas or duties what its citizens can buy from another country, or what they can produce
and sell to another country.
Topic: Trade Policy and Government Intervention in International Trade
Bloom's: Apply
27) The theory of ________ was the first to explain why unrestricted free trade benefits a country.
A) Heckscher-Ohlin
B) national competitive advantage
C) free trade
D) absolute advantage
E) zero-sum game
Answer: D
Explanation: Adam Smith's theory of absolute advantage was the first to explain why
unrestricted free trade is beneficial to a country.
Bloom's: Understand
10
28) Sentoria is an island nation in the Pacific Ocean. Its geographical location is advantageous
since it has access to a variety of aquatic life forms and also a number of freshwater sources that
provide for fisheries. The lack of arable land drives local demand for seafood, and Sentoria is one
of the world's major exporters of this product. Which theory of international trade best explains
Sentoria's dominance as an exporter of seafood?
A) new trade theory
B) product life-cycle theory
C) mercantilism
D) Heckscher-Ohlin theory
E) theory of national competitive advantage
Answer: E
Explanation: Michael Porter developed a theory referred to as the theory of national competitive
advantage. This attempts to explain why particular nations achieve international success in
particular industries. In addition to factor endowments, Porter points out the importance of country
factors such as domestic demand and domestic rivalry in explaining a nation's dominance in the
production and export of particular products.
Difficulty: 3 Hard
Bloom's: Apply
AACSB: Knowledge Application
11
29) According to the Smith, Ricardo, and Heckscher-Ohlin theories, a country's economy may
gain if its citizens buy some products from other nations that could be produced in their home
nation. What is the reasoning behind this idea?
A) The natural resources of a country limit the types and quantities of items that can be produced.
B) International trade is typically regulated by government forces that prevent a business from
exporting.
C) International trade allows a country to specialize in items that can be produced most efficiently
in that country.
D) First-mover advantages limit a country from producing every product that citizens need or
want.
E) Innovative products are typically produced in the home country, but high-demand products
should be imported.
Answer: C
Explanation: The theories of Smith, Ricardo, and Heckscher–Ohlin tell us that a country's
economy may gain if its citizens buy certain products from other nations that could be produced at
home. The gains arise because international trade allows a country to specialize in the manufacture
and export of products that can be produced most efficiently in that country, while importing
products that can be produced more efficiently in other countries.
Bloom's: Understand
12
30) The Salcian government decides on the products that can be imported and ensures that any
product that can be produced at home is not imported. Instead, the government wants to maximize
exports to achieve a surplus in the balance of trade. Which perspective likely influences Salcia's
approach to international trade?
A) mercantilism
B) Leontief's paradox
C) product life-cycle theory
D) new trade theory
E) first-mover advantage
Answer: A
Explanation: Mercantilism makes a crude case for government involvement in promoting
exports and limiting imports. The main tenet of mercantilism is that it is in a country's best interests
to maintain a trade surplus, to export more than it imports.
Difficulty: 3 Hard
Topic: Mercantilism
nations.
Bloom's: Apply
31) Many years ago, the Republic of Janua believed that it was in its best interests to maintain a
trade surplus, to export more than it imports. In so doing, the Republic of Janua hoped to
accumulate gold and silver, and consequently, increase its national wealth, prestige, and power.
What influenced the Republic of Marunia's approach to international trade?
A) neo-Ricardian trade theory
B) Leontief's paradox
C) product life-cycle theory
D) new trade theory
E) mercantilism
Answer: E
Explanation: Mercantilism makes a crude case for government involvement in promoting
exports and limiting imports. The main tenet of mercantilism is that it is in a country's best interests
to maintain a trade surplus, to export more than it imports.
Difficulty: 3 Hard
Topic: Mercantilism
nations.
Bloom's: Apply
13
32) As a trade theory, mercantilism was based on the idea that a trade surplus would lead to
A) absolute advantage among all trading partners.
B) first-mover advantages.
C) lower levels of inflation and a steady economy.
D) accumulations of gold and silver.
E) lower levels of national wealth.
Answer: D
Explanation: The main tenet of mercantilism was that it was in a country's best interests to
maintain a trade surplus, to export more than it imported. By doing so, a country would accumulate
gold and silver and, consequently, increase its national wealth, prestige, and power.
Topic: Mercantilism
nations.
Bloom's: Understand
33) Which theory asserts that countries should simultaneously encourage exports and discourage
imports?
A) free trade
B) capitalism
C) new trade
D) mercantilism
E) socialism
Answer: D
Explanation: Propagated in the sixteenth and seventeenth centuries, mercantilism advocated that
countries should simultaneously encourage exports and discourage imports.
Difficulty: 1 Easy
Topic: Mercantilism
nations.
Bloom's: Remember
14
34) Which strategy is in a country's best interests, according to the main tenet of mercantilism?
A) importing products from developing rather than developed countries
B) importing products even if they are efficiently produced at home
C) importing less specialized goods rather than attempting to make them at home
D) minimizing exports and maximizing imports
E) maintaining a trade surplus
Answer: E
gold and silver and, consequently, increase its national wealth, prestige, and power.
Difficulty: 1 Easy
Topic: Mercantilism
nations.
Bloom's: Remember
35) What was the principle currency of trade in the mid-sixteenth century when mercantilism came
into favor in England?
A) the pound
B) gold and silver
C) the U.S. dollar
D) salt and spices
E) human labor
Answer: B
Explanation: The principal assertion of mercantilism was that gold and silver were the mainstays
of national wealth and essential to vigorous commerce. Gold and silver were the currency of trade
between countries; a country could earn gold and silver by exporting goods, whereas importing
goods from other countries would result in an outflow of gold and silver to those countries.
Difficulty: 1 Easy
Topic: Mercantilism
nations.
Bloom's: Remember
15
36) One of the central beliefs of mercantilism is that
A) a country's government should intervene to achieve a surplus in the balance of trade.
B) a large volume of trade is essential regardless of whether it comes from imports or exports.
C) trade is a positive-sum game in which all countries benefit from trading with each other.
D) a country that has an absolute advantage in the production of all goods derives no benefits from
international trade.
E) potential world production is greater with unrestricted free trade than it is with restricted trade.
Answer: A
gold and silver and, consequently, increase its national wealth, prestige, and power. Consistent
with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus
in the balance of trade.
Topic: Mercantilism
nations.
Bloom's: Understand
37) The nation of Tazia exports agricultural products and in turn imports products that it does not
produce such as computers and electronic devices. As a result, it spends more on imports than it
gains from exports. Which perspective would frown on this form of international trade?
A) new trade theory
B) product life-cycle theory
C) mercantilism
D) Heckscher-Ohlin theory
Answer: C
maintain a trade surplus, to export more than it imported. The mercantilists saw no virtue in a large
volume of trade. Rather, they recommended policies to maximize exports and minimize imports.
To achieve this, imports were limited by tariffs and quotas, while exports were subsidized.
Difficulty: 3 Hard
Topic: Mercantilism
nations.
Bloom's: Apply
16
38) An inconsistency in the mercantilist doctrine, as pointed out by David Hume, is that
A) the volume of a country's imports increases as an indirect consequence of mercantilism.
B) the exclusion of government influence in matters pertaining to trade is not ideal.
C) in the long run, no country could sustain a surplus on the balance of trade.
D) it was not backed by either sound political principles or social ideologies.
E) trade is a zero-sum game rather than a positive-sum game as postulated by the theory.
Answer: C
Explanation: The classical economist David Hume pointed out an inherent inconsistency in the
mercantilist doctrine in 1752. According to Hume, in the long run no country could sustain a
surplus on the balance of trade and so accumulate gold and silver as the mercantilists had
envisaged.
Topic: Mercantilism
nations.
Bloom's: Understand
39) A zero-sum game occurs when

A) the market mechanism determines what a country imports and what it exports.
B) a country engages in international trade even for products it is able to produce for itself.
C) an economic gain by one country results in an economic loss by another.
D) limits on imports are done in the interests of domestic producers, but not domestic consumers.
E) one country has an absolute advantage in the production of all goods.
Answer: C
Explanation: A situation in which gain by one of the parties results in loss by another is called a
zero-sum game. This is in contrast to a positive-sum game where all countries can benefit by
trading with each other.
Topic: Mercantilism
nations.
Bloom's: Understand
17
40) When the country of Matu trades with the country of Balor, Matu experiences a gain because
of the high costs of its products while Balor experiences a loss because it is trading small amounts
of products that cost very little. Which characteristic of the mercantilist theory does this reflect?
A) factor endowments
B) first-mover advantage
C) zero-sum game
D) late-mover advantage
E) comparative advantage
Answer: C
Explanation: A situation in which gain by one of the parties results in loss by another is called a
zero-sum game. This is in contrast to a positive-sum game where all countries can benefit by
trading with each other.
Topic: Mercantilism
nations.
Bloom's: Understand
41) Neo-mercantilists equate political power with economic power and economic power with
A) corruption.
B) a balance-of-trade surplus.
C) regional dominance.
D) a trade monopoly.
E) capitalism.
Answer: B
Explanation: The mercantilist doctrine is by no means dead in the modern world.
Neo-mercantilists equate political power with economic power and economic power with a
balance-of-trade surplus.
Difficulty: 1 Easy
Topic: Mercantilism
nations.
Bloom's: Remember
18
42) A neo-mercantilist strategy would promote
A) the equal distribution of exports and imports.
B) boosting exports and limiting imports.
C) boosting both imports and exports.
D) limiting both imports and exports.
E) boosting imports and limiting exports.
Answer: B
Explanation: Neo-mercantilists equate political power with economic power and economic
power with a balance-of-trade surplus. Critics argue that several nations have adopted a
neo-mercantilist strategy that is designed to simultaneously boost exports and limit imports.
Topic: Mercantilism
nations.
Bloom's: Understand
43) Australia is a major producer of agricultural and dairy products and exports coffee, tea, spices,
and milk products to the United States. The United States is the world's third largest supplier of
machinery and exports heavy machinery to Australia. Adam Smith would say this exchange
occurs because
A) tariff barriers determine the flow of goods and services between nations.
B) countries are simultaneously encouraging exports and discouraging imports.
C) first entrants to the industry ensure their nations have the first-mover advantages.
D) nations with an absolute advantage in producing certain goods trade them for goods produced
by other countries
E) gold and silver are the mainstays of national wealth and essential to vigorous commerce.
Answer: D
Explanation: According to Adam Smith, countries differ in their ability to produce goods
efficiently. A country has an absolute advantage in the production of a product when it is more
efficient than any other country in producing it. Smith demonstrates that, by specializing in the
production of goods in which each has an absolute advantage, both countries benefit by engaging
in trade.
Difficulty: 3 Hard
nations.
Bloom's: Apply
19
44) Garments are exported from China to the United States on a daily basis. In turn, the United
States exports agricultural products like soybeans to China. Which statement best explains the
trade equation between China and the United States?
A) Tariff barriers determine the flow of goods and services between nations.
B) Countries are simultaneously encouraging exports and discouraging imports.
C) First entrants to the industry ensure their nations have the first-mover advantages.
D) Nations with an absolute advantage in producing certain goods trade them for goods produced
by other countries.
E) Gold and silver are the mainstays of national wealth and essential to vigorous commerce.
Answer: D
Explanation: According to Adam Smith, countries differ in their ability to produce goods
efficiently. A country has an absolute advantage in the production of a product when it is more
efficient than any other country in producing it. Smith demonstrates that, by specializing in the
production of goods in which each has an absolute advantage, both countries benefit by engaging
in trade.
Difficulty: 3 Hard
nations.
Bloom's: Apply
45) Cadmia and Rhodia specialize in the production of electronics and pharmaceutical products
respectively. They are considered the best at their specializations. Cadmia trades electronics with
Rhodia in exchange for pharmaceutical products. Which perspective is illustrated by this form of
trade between Cadmia and Rhodia?
A) product life-cycle theory
B) Heckscher-Ohlin theory
C) absolute advantage
D) mercantilism
Answer: C
efficient than any other country in producing it. According to Smith, countries should specialize in
the production of goods for which they have an absolute advantage and then trade these for goods
produced by other countries.
Difficulty: 3 Hard
nations.
Bloom's: Apply
20
46) India is the largest exporter of information technology services to the United States In turn, the
United States exported $3 billion worth of aircraft to India. What theory is illustrated by this form
of trade between India and the United States?
A) product life-cycle theory
B) Heckscher-Ohlin theory
D) mercantilism
Answer: C
efficient than any other country in producing it. According to Smith, countries should specialize in
the production of goods for which they have an absolute advantage and then trade these for goods
produced by other countries.
Difficulty: 3 Hard
nations.
Bloom's: Apply
47) The country of Zeran specializes in the production of beef and produces beef more efficiently
than any other country. It buys soybeans, which it produces less efficiently than beef, from Canta,
even though it produces soybeans more efficiently than Canta. Which theory of international trade
supports Zeran's decision to buy wheat from Canta?
A) Samuelson critique
B) mercantilism
C) Ricardo's theory of comparative advantage
D) Adam Smith's theory of absolute advantage
E) Leontief's paradox
Answer: C
Explanation: According to Ricardo's theory of comparative advantage, it makes sense for a
country to specialize in the production of those goods that it produces most efficiently and to buy
the goods that it produces less efficiently from other countries, even if this means buying goods
from other countries that it could produce more efficiently itself.
Difficulty: 3 Hard
nations.
Bloom's: Apply
21
48) India specializes in business process outsourcing and does this more efficiently than any other
country. It buys agricultural commodities, which it produces less efficiently than outsourcing
activities, from the United States, even though it produces these agricultural commodities more
efficiently than the United States Which international trade theory supports India's decision to buy
agricultural commodities from the United States?
A) Samuelson critique
B) mercantilism
C) Ricardo's theory of comparative advantage
D) Adam Smith's theory of absolute advantage
E) Leontief's paradox
Answer: C
Explanation: According to Ricardo's theory of comparative advantage, it makes sense for a
country to specialize in the production of those goods that it produces most efficiently and to buy
the goods that it produces less efficiently from other countries, even if this means buying goods
from other countries that it could produce more efficiently itself.
Difficulty: 3 Hard
nations.
Bloom's: Apply
49) According to the theory of comparative advantage, consumers in all nations can consume more
if there are
A) stronger restrictions on trade.
B) more monopolistic businesses.
C) fewer incentives for intellectual property.
D) no restrictions on trade.
E) fewer monopolistic businesses.
Answer: D
Explanation: Ricardo's theory of comparative advantage suggests that consumers in all nations
can consume more if there are no restrictions on trade even if they lack an absolute advantage in
the production of any goods.
nations.
Bloom's: Understand
22
50) Which trade theory suggests that trade is a positive-sum game in which all participating
countries fetch economic gains?
A) Heckscher-Ohlin theory
B) mercantilism
C) comparative advantage
D) Leontief's paradox
E) Samuelson critique
Answer: C
Explanation: Ricardo's theory of comparative advantage suggests that consumers in all nations
can consume more if there are no restrictions on trade even if they lack an absolute advantage in
the production of any goods. In other words, to an even greater degree than the theory of absolute
advantage, the theory of comparative advantage suggests that trade is a positive-sum game in
which all countries that participate realize economic gains.
nations.
Bloom's: Understand
51) Argonia and Selenia specialize in the production of medical equipment and rice respectively.
Argonia exports medical equipment to Selenia, which in turn exports rice to Argonia. According to
the theory of comparative advantage, this mutually beneficial trade relationship is an example of
A) the significance of trade barriers.
B) a positive-sum game.
C) a first-mover advantage.
D) the advantages of mercantilism.
E) a zero-sum game.
Answer: B
production is greater with unrestricted free trade than it is with restricted trade. The theory of
comparative advantage suggests that trade is a positive-sum game in which all countries that
participate realize economic gains.
Difficulty: 3 Hard
nations.
Bloom's: Apply
23
52) Nikoli lives in New Salom which specializes in component parts, while its geographical
neighbor, Durma specializes in heavy machinery. New Salom exports component parts to Durma,
which in turn exports heavy machinery to New Salom. According to the theory of comparative
advantage, this mutually beneficial trade relationship best illustrates
A) the significance of trade barriers.
B) a positive-sum game.
C) a first-mover advantage.
D) the advantages of mercantilism.
E) a zero-sum game.
Answer: B
production is greater with unrestricted free trade than it is with restricted trade. The theory of
comparative advantage suggests that trade is a positive-sum game in which all countries that
participate realize economic gains.
Difficulty: 3 Hard
nations.
Bloom's: Apply
53) In Latuna, it takes 10 resources to produce 1 ton of coffee and 13.5 resources to produce 1 ton
of wheat. In South Narnia, it takes 40 resources to produce 1 ton of coffee and 12 resources to
produce 1 ton of wheat. Latuna has a comparative advantage over South Narnia in
A) both coffee and wheat.
B) coffee
C) wheat
D) both coffee and wheat if combined.
E) neither coffee nor wheat.
Answer: A
Explanation: The theory of comparative advantage suggests that it makes sense for a country to
specialize in producing those goods that it can produce most efficiently, while buying goods that it
can produce relatively less efficiently from other countries—even if that means buying goods from
other countries that it could produce more efficiently itself. Latuna can produce 4 times as much
coffee as South Narnia with the same resources.
Difficulty: 3 Hard
nations.
Bloom's: Apply
24
54) Consider the two countries of Swala and Atlantis. Swala is a major producer of wheat and rice
while Atlantis specializes in the production of marble and automobile parts. Engaging in free trade
benefits both countries since Swala is an agrarian nation and Atlantis lacks arable land. This
follows the theory of comparative advantage, and we can say that engaging in free trade benefits
all countries that participate in it; however, this conclusion is based on which inaccurate
assumptions?
A) We have assumed a simple world in which there are only two countries.
B) We have assumed the prices of resources and exchange rates in the two countries are dynamic.
C) We have assumed there are barriers to the movement of resources from the production of one
good to another within the same country.
D) We have assumed that agrarian nations do not specialize in producing fertilizers.
E) We have assumed diminishing returns to specialization.
Answer: A
Explanation: The conclusion that free trade is universally beneficial is a rather bold one to draw
from such a simple model as we have unrealistically assumed a simple world in which there are
only two countries and two goods. In the real world, there are many countries and many goods.
Difficulty: 3 Hard
Bloom's: Apply
25
55) In Lurnee, it takes 10 resources to produce 1 ton of cocoa and 13.5 resources to produce 1 ton
of rice. In South Tyberg, it takes 40 resources to produce 1 ton of cocoa and 20 resources to
produce 1 ton of rice. Lurnee has a comparative advantage over South Tyberg in cocoa. This
follows the theory of comparative advantage, and we can say that engaging in free trade benefits
all countries that participate in it; however, this conclusion stems from which of these inaccurate
assumptions?
A) We have assumed constant returns to scale.
B) We have assumed the prices of resources and exchange rates in the two countries are dynamic.
C) We have assumed there are barriers to the movement of resources from the production of one
good to another within the same country.
D) We have assumed that agrarian nations do not specialize in producing particular products.
E) We have assumed diminishing returns to specialization.
Answer: A
Explanation: The conclusion that free trade is universally beneficial is a rather bold one to draw
from such a simple model as we have unrealistically assumed constant returns to scale. In reality,
both diminishing and increasing returns to specialization exist. The amount of resources required
to produce a good might decrease or increase as a nation specializes in production of that good.
Difficulty: 3 Hard
Bloom's: Apply
56) Based on the last quarterly report, Jason realizes that it is now taking more resources to
produce each of the laptop computers his company makes. What aspect of comparative advantage
is Jason noticing?
A) increasing tariffs
B) diminishing returns
C) JIT inventory
D) economies of scale
E) constant returns
Answer: B
Explanation: Diminishing returns to specialization occur when more units of resources are
required to produce each additional unit.
Bloom's: Apply
26
57) In Appellia, it takes 10 units of resources to increase its output of sugar from 12 tons to 13 tons,
but 11 units of resources to increase output from 13 tons to 14 tons, and 12 units of resources to
increase output from 14 tons and 15 tons, and so on. The need for increasing resources is an
example of
A) comparative advantage.
B) diminishing returns to specialization.
C) absolute advantage.
D) mercantilism
E) Porter's diamond model.
Answer: B
Explanation: Diminishing returns to specialization occur when more units of resources are
required to produce each additional unit.
Difficulty: 3 Hard
Bloom's: Apply
58) Why do diminishing rather than constant returns to specialization sometimes occur?
A) All resources are of the same quality.
B) Resources can shift from the production of one good to another seamlessly.
C) Each country has a fixed stock of resources.
D) Different goods use different resources in different proportions.
E) Trade does not affect the distribution of income within a country.
Answer: D
Explanation: Constant returns to specialization means the units of resources required to produce
a good are assumed to remain constant no matter where one is on a country's production possibility
frontier (PPF). It is more realistic to assume diminishing returns to specialization as not all
resources are of the same quality and different goods use resources in different proportions.
Bloom's: Understand
27
59) Paul Samuelson's critique of free trade is based on the idea that the wealthier nation in the trade
agreement might not recognize a net gain if the trade creates
A) the development of a monopoly.
B) a barrier from trading with other nations.
C) more job opportunities in the wealthier nation.
D) lower real wage rates in the wealthier nation.
E) an economic downturn in the poorer nation.
Answer: D
Explanation: Paul Samuelson's model suggests that in certain cases, the lower prices that
consumers in rich countries pay for goods imported from poor countries following the introduction
of a free trade regime may not be enough to produce a net gain for the richer economy if the
dynamic effect of free trade is to lower real wage rates in the rich country.
Bloom's: Understand
60) One of the rebuttals to Samuelson's critique of the free trade model is that
A) the United States' ability to achieve constant returns to specialization is unparalleled.
B) the strict immigration policies of the United States help insulate the economy from inward
migration.
C) introducing trade barriers may in fact be beneficial to developed nations to some extent.
D) developing nations are unlikely to upgrade the skill level of their workforce rapidly enough.
E) the developing nations are unlikely to run into diminishing returns in a near future.
Answer: D
Explanation: While not questioning Samuelson's analysis, some economists note that developing
nations are unlikely to be able to upgrade the skill level of their workforce rapidly enough to give
rise to the situation in Samuelson's model. In other words, the countries will quickly run into
diminishing returns.
Bloom's: Understand
28
61) What is true of the relationship between trade and economic growth?
A) Countries open to international trade display higher growth rates than those that close their
economies to trade.
B) Within a group of developing countries, closed economies grow faster than open economies.
C) The Leontief paradox notes that adopting an open economy and embracing free trade does not
reward a nation with higher economic growth.
D) Free trade hampers economic growth and leads to lower living standards in the long run.
E) Free trade has historically benefited poor counties and hence trade barriers should be introduced
to protect rich countries from exploitation.
Answer: A
Explanation: Many economic studies have looked at the relationship between trade and
economic growth. In general, these studies suggest that, as predicted by the standard theory of
comparative advantage, countries that adopt a more open stance toward international trade enjoy
higher growth rates than those that close their economies to trade.
Bloom's: Understand
62) According to the Heckscher-Ohlin theory, the pattern of international trade is determined by
differences in
A) labor productivity.
B) diminishing returns.
C) factor endowments.
D) management practices.
E) trade barriers.
Answer: C
Explanation: Unlike Ricardo's theory, the Heckscher-Ohlin theory argues that the pattern of
international trade is determined by differences in factor endowments, rather than differences in
productivity.
Difficulty: 1 Easy
nations.
Bloom's: Remember
29
63) Sandvor and Milese specialize in the production of dairy and textiles respectively. While
Sandvor doesn't produce textiles, Milese is not as technologically advanced as Sandvor. In this
situation, according to the Heckscher-Ohlin theory,
A) Sandvor will import textiles from Milese and export dairy to it.
B) Sandvor will invest more than Milese in the production of textiles to exploit its comparative
advantage.
C) Sandvor and Milese will raise their trade barriers to protect their economies.
D) Milese will recruit experts from Sandvor to specialize in the production of dairy.
E) Sandvor will recruit workers from Milese to improve its standing in the textile industry.
Answer: A
Explanation: Heckscher and Ohlin argued that comparative advantage arises from differences in
national factor endowments. Their theory predicts that countries will export those goods that make
intensive use of factors that are locally abundant, while importing goods that make intensive use of
factors that are locally scarce.
Difficulty: 3 Hard
nations.
Bloom's: Apply
64) The difference between Ricardo's theory and the Heckscher-Ohlin theory is that the
Heckscher-Ohlin theory
A) makes more simplifying assumptions.
B) cannot be subjected to empirical tests.
C) actually predicts trade patterns with greater accuracy.
D) argues that the pattern of international trade is determined by differences in national factor
endowments.
E) suggests that trade is a positive-sum game in which all countries that participate realize
economic gains.
Answer: D
Explanation: Unlike Ricardo's theory, the Heckscher-Ohlin theory argues that the pattern of
international trade is determined by differences in factor endowments, rather than differences in
productivity.
nations.
Bloom's: Understand
30
65) Which theory predicts that countries will export those goods that make intensive use of factors
that are locally abundant, while importing goods that make intensive use of factors that are locally
scarce?
A) mercantilism
B) theory of absolute advantage
C) Heckscher-Ohlin theory
D) theory of comparative advantage
E) Samuelson's critique
Answer: C
Explanation: The Heckscher-Ohlin theory predicts that countries will export those goods that
make intensive use of factors that are locally abundant, while importing goods that make intensive
use of factors that are locally scarce. Thus, the Heckscher-Ohlin theory attempts to explain the
pattern of international trade that we observe in the world economy.
nations.
Bloom's: Understand
66) The country of Dalima has long been a substantial exporter of seafood, reflecting its unusual
abundance of coastal waters; in contrast, its continental neighbor, Bundeeza, has excelled in the
export of goods produced in labor-intensive manufacturing industries. Based on this information,
the export policies of the two countries is best explained by
A) mercantilism.
B) theory of absolute advantage.
C) Heckscher-Ohlin theory.
D) theory of comparative advantage.
E) Samuelson's critique.
Answer: C
Explanation: The Heckscher-Ohlin theory predicts that countries will export those goods that
make intensive use of factors that are locally abundant, while importing goods that make intensive
use of factors that are locally scarce. Thus, the Heckscher-Ohlin theory attempts to explain the
pattern of international trade that we observe in the world economy.
Difficulty: 3 Hard
nations.
Bloom's: Apply
31
67) U.S. exports are less capital-intensive than U.S. imports, despite the relative abundance of
capital in the country. This is in opposition to the Heckscher-Ohlin theory and has been labelled
A) a zero-sum game.
B) Leontief's paradox.
C) a positive-sum game.
D) Samuelson's critique.
E) a first-mover advantage.
Answer: B
Explanation: Using the Heckscher-Ohlin theory, Wassily Leontief postulated that since the
United States was relatively abundant in capital compared to other nations, the United States
would be an exporter of capital-intensive goods and an importer of labor-intensive goods.
However, he found that U.S. exports were less capital-intensive than U.S. imports and this has
become known as the Leontief paradox.
nations.
Bloom's: Understand
68) One reason used to explain the Leontief paradox observed in the case of the United States is
that the United States
A) imports goods that heavily use skilled labor and innovative entrepreneurship.
B) has a special advantage in producing new products made with innovative technologies.
C) exports heavy manufacturing products that use large amounts of capital.
D) has a strong absolute advantage over other nations because of its advantageous factor
endowments.
E) imports goods that make intensive use of factors that are locally abundant.
Answer: B
Explanation: No one is quite sure why we observe the Leontief paradox. One possible
explanation of the Leontief paradox is that the United States has a special advantage in producing
new products or goods made with innovative technologies.
nations.
Bloom's: Understand
32
69) Raymond Vernon's product life cycle theory stemmed from the idea that for most of the
twentieth century,
A) European industries guided the rest of the world in new products.
B) cost-saving processes were not as important as the development of new products.
C) many of the world's new products were developed and first sold in the United States.
D) most new products were developed for the manufacturing and agricultural industries.
E) the United States had lower technology-driven innovations than other developed nations.
Answer: C
Explanation: Vernon's theory was based on the observation that for most of the twentieth century
a very large proportion of the world's new products had been developed by U.S. firms and sold first
in the U.S. market. To explain this, Vernon argued that the wealth and size of the U.S. market gave
U.S. firms a strong incentive to develop new consumer products.
Topic: Factor Proportions and International Product Life Cycle Theories
nations.
Bloom's: Understand
70) According to the product life-cycle theory, the high cost of U.S. labor gave U.S. firms an
incentive to
A) lower costs of services to offset a fall in demand.
B) develop cost-saving process innovations.
C) invite foreign direct investment in domestic industries.
D) embrace and promote open market capitalism.
E) import new consumer products and export agricultural products.
Answer: B
Explanation: Vernon's theory was based on the observation that for most of the twentieth century
a very large proportion of the world's new products had been developed by U.S. firms and sold first
in the U.S. market. In addition, the high cost of U.S. labor gave U.S. firms an incentive to develop
cost-saving process innovations.
Difficulty: 1 Easy
nations.
Bloom's: Remember
33
71) Vernon argues that pioneering firms in the United States kept production facilities closer to the
market and centers of decision making because
A) of the uncertainty and risks inherent in introducing new products.
B) they believed that foreign production facilities were inferior in technical skills.
C) they believed that U.S. labor costs were much lower than those in foreign markets.
D) the U.S. government was critical of outsourcing production to other countries.
E) of the high trade barriers implemented by several Asian and European countries.
Answer: A
Explanation: Just because a new product is developed by a U.S. firm and first sold in the U.S.
market, it does not follow that the product must be produced in the United States. It could be
produced abroad at some low-cost location and then exported back into the United States.
Apparently, pioneering firms believed it was better to keep production facilities close to the market
and to the firm's center of decision making, given the uncertainty and risks inherent in introducing
new products.
nations.
Bloom's: Understand
72) According to Vernon, what eliminates the need for pioneering U.S. firms to look for low-cost
production sites in other countries?
A) The uncertainties and risks inherent in introducing new products are very low.
B) The demand for most new products tends to be based mainly on price.
C) U.S. labor costs are relatively low compared to global standards.
D) Firms can charge relatively high prices for new products.
E) The production of innovative products in other advanced countries limits the potential for
exports from the United States.
Answer: D
Explanation: The demand for most new products tends to be based on nonprice factors.
Consequently, firms can charge relatively high prices for new products, which obviates the need to
look for low-cost production sites in other countries.
nations.
Bloom's: Understand
34
73) According to the product life-cycle theory, while demand for new products is starting to grow
rapidly in the United States, demand in other advanced countries
A) remains limited to high-income groups.
B) necessitates production of that product in those countries.
C) necessitates outsourcing of production to low-cost locations.
D) raises the cost of production in the United States.
E) causes a shift in the position of the United States from that of an exporter to an importer.
Answer: A
Explanation: Vernon argues that early in the life cycle of a typical new product, while demand is
growing rapidly in the United States, demand in other advanced countries is limited to
high-income groups. The limited initial demand in other advanced countries does not make it
worthwhile for firms in those countries to start producing the new product, but it does necessitate
some exports from the United States to those countries.
Difficulty: 1 Easy
nations.
Bloom's: Remember
74) Intricate Wiring Corp., based in Ohio, creates a brand new high-tech product. The demand for
the product in the United States is high but very low or non-existent elsewhere. The company
decides not to locate manufacturing facilities elsewhere and will simply meet the small foreign
demand via exports. The theory that best explains the company's policy is
A) product life cycle theory.
B) mercantilism.
C) the Leontief paradox.
D) Heckscher-Ohlin theory.
E) free trade theory.
Answer: A
Explanation: Vernon argues that early in the life cycle of a typical new product, while demand is
growing rapidly in the United States, demand in other advanced countries is limited to
high-income groups. The limited initial demand in other advanced countries does not make it
worthwhile for firms in those countries to start producing the new product, but it does necessitate
some exports from the United States to those countries.
Difficulty: 3 Hard
nations.
Bloom's: Apply
35
75) Vernon predicts that as the demand for a new product starts to grow in other advanced
countries, in the long run
A) the cost of labor in these advanced countries begins to increase.
B) it becomes profitable for foreign firms to invest in production facilities in the United States.
C) the firms in the United States begin to gain an absolute advantage.
D) it begins to limit the potential for exports from the United States.
E) the same product will begin to command a higher price.
Answer: D
Explanation: Over time, demand for a new product starts to grow in other advanced countries. As
it does, it becomes worthwhile for foreign producers to begin producing for their home markets.
Consequently, production within other advanced countries begins to limit the potential for exports
from the United States.
Difficulty: 1 Easy
nations.
Bloom's: Remember
76) Vernon theorizes that as the market in the United States and other advanced nations matures,
________ becomes the main competitive weapon.
A) placement
B) standardization
C) marketing
D) price
E) customization
Answer: D
Explanation: As the market in the United States and other advanced nations matures, the product
becomes more standardized, and price becomes the main competitive weapon.
nations.
Bloom's: Understand
36
77) According to Vernon, what influences the movement of the locus of global production from
advanced countries to developing countries?
A) cost considerations
B) factor endowments
C) domestic competition
D) supporting industries
E) firm structure
Answer: A
Explanation: As the market in the United States and other advanced nations matures, cost
considerations start to play a greater role in the competitive process. The locus of global
production initially switches from the United States to other advanced nations and then from those
nations to developing countries.
nations.
Bloom's: Understand
78) According to the product life-cycle theory, the locus of global production initially switches
from the United States to other advanced nations and then from those nations to developing
countries. As a result,
A) U.S. imports become less capital-intensive than U.S. exports.
B) the pattern of international trade is affected by differences in factor endowments rather than
differences in productivity.
C) over time, the United States switches from being an exporter of a product to an importer of the
product.
D) the wage rates in the United States decrease.
E) developing nations fail to upgrade their skill levels to compete with advanced countries.
Answer: C
Explanation: The consequence of the trends for the pattern of world trade, as determined by the
product life-cycle theory, is that over time the United States switches from being an exporter of the
product to an importer of the product as production becomes concentrated in lower-cost foreign
locations.
nations.
Bloom's: Understand
37
79) For years, many U.S. corporations made cameras. Today; however, most cameras sold in the
United States are imported from Japan and few are manufactured in the United States. Which trade
theory does this demonstrate?
A) product life cycle
B) Heckscher-Ohlin
D) comparative advantage
E) mercantilism
Answer: A
Explanation: The product life-cycle theory is based on the idea that the product, while originally
manufactured in the U.S. and exported to other countries has now become only an import for the
U.S.
nations.
Bloom's: Apply
80) Bethany works for a company that makes sports socks. Unlike many smaller companies,
Bethany's company ships out such large quantities of sports socks that their unit cost is less than
half of the competition. What does this company benefit from?
A) mercantilism
C) economies of scale
D) product life-cycle
E) JIT inventory
Answer: C
Explanation: Economies of scale are unit cost reductions associated with a large scale of output.
Economies of scale have a number of sources, including the ability to spread fixed costs over a
large volume and the ability of large-volume producers to utilize specialized employees and
equipment that are more productive than less specialized employees and equipment.
nations.
Bloom's: Apply
38
81) Economies of scale are achieved as the result of ________ that creates unit cost reductions.
A) trade policies
B) increased tariffs
C) large scale output
D) diminishing returns
E) absolute advantages
Answer: C
Explanation: Economies of scale are unit cost reductions or cost advantages associated with a
large scale of output.
nations.
Bloom's: Understand
82) Intel spreads the huge fixed costs of developing new generation chips over the nearly 2 billion
chips it sells to computer makers. Intel benefits from
A) comparative advantages.
B) factor endowments.
C) economies of scale.
D) diminishing returns.
E) absolute advantages.
Answer: C
Explanation: Economies of scale are unit cost reductions or cost advantages associated with a
large scale of output.
Difficulty: 3 Hard
nations.
Bloom's: Apply
39
83) New trade theory argues that, through its impact on economies of scale, trade can
A) increase the average costs of goods.
B) enable the global market to support a wide range of enterprises.
C) negatively affect the first-mover advantage for all products
D) increase the variety of goods available to consumers.
E) prevent diminishing of returns and promote constant returns to specialization.
Answer: D
Explanation: New trade theory argues that, through its impact on economies of scale, trade can
increase the variety of goods available to consumers and decrease the average costs of those goods.
Difficulty: 1 Easy
nations.
Bloom's: Remember
84) Which of the following theories states that in those industries where the output required to
attain economies of scale represents a significant proportion of total world demand, the global
market may be able to support only a small number of enterprises?
A) Heckscher-Ohlin
B) comparative advantage
C) product life-cycle
D) new trade
E) absolute advantage
Answer: D
Explanation: New trade theory states that in those industries where the output required to attain
economies of scale represents a significant proportion of total world demand, the global market
may be able to support only a small number of enterprises.
Difficulty: 1 Easy
nations.
Bloom's: Remember
40
85) Software development is an expensive process, but manufacturers are able to spread out the
costs of the development over the hundreds of thousands of software packages sold to consumers.
What is helping to drive down costs per unit in this situation?
A) antidumping measures
B) economies of scale
C) diminishing returns
D) labor productivity
E) first-mover advantages
Answer: B
Explanation: Microsoft realizes economies of scale by spreading the fixed costs of developing
new versions of its Windows operating system, which runs to about $10 billion, over the 2 billion
or so personal computers on which each new system is ultimately installed. Similarly, automobile
companies realize economies of scale by producing a high volume of automobiles from an
assembly line where each employee has a specialized task.
nations.
Bloom's: Understand
86) According to new trade theory, trade, through its impact on economies of scale, is most likely
to
A) reduce the volume of the goods produced.
B) decrease the variety of goods available to consumers.
C) decrease the average costs of goods.
D) inhibit first-mover advantages in all industries.
E) benefit only nations that differ in resource endowments or technology.
Answer: C
Explanation: New trade theory argues that, through its impact on economies of scale, trade can
increase the variety of goods available to consumers and decrease the average costs of those goods.
nations.
Bloom's: Understand
41
87) What might result in the absence of trade, if certain products have small national markets?
A) The variety of products available to consumers increases.
B) Limited demand for such products leads to non-realization of economies of scale.
C) Each nation will specialize in producing a narrower range of products than it would in the
presence of trade.
D) At low volumes of production, unit costs and prices would be lowered.
E) The first movers in an industry may get a lock on the world market that discourages subsequent
entry.
Answer: B
Explanation: In the absence of trade, if a national market is small, there may not be enough
demand to enable producers to realize economies of scale for certain products.
Bloom's: Understand
88) According to new trade theory, what is most likely to be a result of market expansion due to
trade?
A) A wide variety of products is produced at greater unit costs than in the absence of trade.
B) As the variety of products increases, demand for individual products decreases, leading to
non-realization of economies of scale.
C) Each nation may specialize in producing a narrower range of products, importing goods that it
does not make.
D) The ability to capture first-mover advantages is restricted in a world that allows trade.
E) When countries do not differ in their resource endowments or technology, trade does not offer
mutual benefits.
Answer: C
Explanation: As the size of the market expands due to trade, individual firms may be able to
better attain economies of scale. The implication is that each nation may be able to specialize in
producing a narrower range of products than it would in the absence of trade, yet by buying goods
that it does not make from other countries, each nation can simultaneously increase the variety of
goods available to its consumers and lower the costs of those goods.
Bloom's: Understand
42
89) New trade theory dictates that trade offers an opportunity for mutual gain when countries do
not differ in their resource endowments or technology because trade
A) results in a contraction of the size of the markets of individual firms.
B) allows for production of products at higher prices.
C) increases the variety of goods available to consumers and lowers the costs of those goods.
D) allows countries to attain self-sufficiency in the production of all goods.
E) guarantees first-mover advantages to all the countries that engage in trade.
Answer: C
Explanation: As the size of the market expands due to trade, individual firms may be able to
better attain economies of scale. The implication, according to new trade theory, is that each nation
may be able to specialize in producing a narrower range of products, buying goods that it does not
make from other countries. Thus, each nation can simultaneously increase the variety of goods
available to its consumers and lower the costs of those goods—thus trade offers an opportunity for
mutual gain even when countries do not differ in their resource endowments or technology.
Bloom's: Understand
90) Mallory works for a company that produces cell phone component parts. Her company
developed a component that no competitor had and was soon enjoying economies of scale as the
only producers of the part. Which trade theory is most reflected in the success of this company?
A) Product-life cycle
B) Absolute advantage
C) New trade theory
D) Mercantilism
E) Comparative advantage
Answer: C
Explanation: A second theme in new trade theory is that the pattern of trade we observe in the
world economy may be the result of economies of scale and first-mover advantages. First-mover
advantages are the economic and strategic advantages that accrue to early entrants into an industry.
Difficulty: 3 Hard
Bloom's: Apply
43
91) The economic and strategic advantages that accrue to early entrants in an industry are called
A) first-mover advantages.
B) comparative advantages.
C) absolute advantages.
D) economies of scale.
E) factor endowments.
Answer: A
early entrants into an industry. The ability to capture scale economies ahead of later entrants, and
thus benefit from a lower cost structure, is an important first-mover advantage.
Difficulty: 1 Easy
Bloom's: Remember
92) Airbus pioneered the development of the new superjumbo jet at a cost of $15 billion. It quickly
obtained contracts for much of the 400 units that are expected to be ordered in the next 20 years,
thereby effectively shutting out its competitor, Boeing. Airbus benefits from
A) first-mover advantages.
B) comparative advantages.
C) absolute advantages.
D) economies of scale.
E) factor endowments.
Answer: A
Difficulty: 3 Hard
Bloom's: Apply
44
93) What is an advantage that is realized by a company as a part of first-mover advantages?
A) increasing returns to specialization
B) positive-sum game due to lack of competition
C) ability to capture scale economies ahead of later entrants
D) absolute advantage and higher efficiency
E) ability to specialize in the production of a particular product
Answer: C
Bloom's: Understand
94) One of the suggestions of new trade theory is that

A) differences in technology leads to differences in productivity, which in turn, drives
international trade patterns.
B) nations may benefit from trade irrespective of resource endowments or technology.
C) the demand for most new products tends to be based on nonprice factors.
D) globally dispersed production reduces the production costs of mature products.
E) comparative advantage does not arrive from a difference in factor endowments but from a
difference in productivity.
Answer: B
Explanation: The new trade theory suggests that nations may benefit from trade even when they
do not differ in resource endowments or technology.
Bloom's: Understand
45
95) One barrier to subsequent entries in an industry dominated by first movers is
A) a laissez-faire stance toward trade adopted by first movers.
B) implementation of policies to maximize imports and minimize exports.
C) specializing in the production of goods for which firms have a comparative advantage.
D) the ability of first movers to benefit from increasing returns.
E) a decrease in the variety of goods available to consumers and increase in the cost of existing
goods.
Answer: D
Explanation: Because they are able to gain economies of scale, the first movers in an industry
may get a lock on the world market that discourages subsequent entry. First movers' ability to
benefit from increasing returns creates a barrier to entry.
Bloom's: Understand
96) The new trade theory is at variance with which theory, which suggests that a country will
predominate in the export of a product when it is particularly well endowed with those factors used
intensively in its manufacture?
A) Heckscher-Ohlin
B) product life-cycle
C) comparative advantage
D) absolute advantage
E) national competitive advantage
Answer: A
Explanation: New trade theory is at variance with the Heckscher-Ohlin theory, which suggests
that a country will predominate in the export of a product when it is particularly well endowed with
those factors used intensively in its manufacture. The new trade theory suggests that a country may
predominate in the export of a good simply because it was lucky enough to have one or more firms
among the first to produce that good.
Difficulty: 1 Easy
Bloom's: Remember
46
97) New trade theory supports the ideas that trade increases specialization of production and it also
A) lowers average prices.
B) decreases the number of available products.
C) is not dependent on government intervention to succeed.
D) distances itself from customization of products.
E) is reliant upon factor endowments.
Answer: A
Explanation: This theory is quite useful in explaining trade patterns. Empirical studies seem to
support the predictions of the theory that trade increases the specialization of production within an
industry, increases the variety of products available to consumers, and results in lower average
prices.
Bloom's: Understand
98) One of the most controversial aspects of ________ is that it supports government intervention
and strategic trade policy.
A) the theory of absolute advantage
B) the theory of comparative advantage
C) Heckscher-Ohlin theory
D) new trade theory
E) product life-cycle theory
Answer: D
Explanation: Perhaps the most contentious implication of the new trade theory is the argument
that it generates for government intervention and strategic trade policy.
Difficulty: 1 Easy
Bloom's: Remember
47
99) The new trade theory diverts from its advocacy of free trade by suggesting that
A) the price of a new product increases along with the increase in the popularity of the product.
B) nations benefit from trade even in the absence of resource endowments and technology.
C) there is an economic rationale for a proactive trade policy.
D) the role of luck, entrepreneurship, and innovation is important in giving a firm first-mover
advantages.
E) market expansion leads to better realization of economies of scale.
Answer: C
Explanation: By stressing first-mover advantages in certain industries, new trade theory provides
a rationale for government intervention to increase the chances of its domestic firms becoming
first movers in newly emerging industries, as the U.S. government apparently did with Boeing.
Bloom's: Understand
100) The purpose of Porter's study of national competitive advantage was to

A) identify the various stages of the life cycle of a product.
B) determine why a country achieves international success in a particular industry.
C) determine how trade barriers affect the prices of products in the international market.
D) determine how pre-industrialization theories predict international trade patterns.
E) organize the relationship between factor endowments and economies of scale.
Answer: B
Explanation: Like the work of the new trade theorists, Porter's work was driven by a belief that
existing theories of international trade told only part of the story. For Porter, the essential task was
to explain why a nation achieves international success in a particular industry.
nations.
Bloom's: Understand
48
101) Factor endowments, demand conditions, related and supporting industries, and ________ are
the four broad attributes that make up Porter's Diamond Model
A) firm strategy, structure, and rivalry
C) government intervention policies
D) first-mover advantages
E) staff hierarchy and training
Answer: A
Explanation: Porter theorizes that four broad attributes of a nation shape the environment in
which local firms compete, and these attributes promote or impede the creation of competitive
advantage. These attributes are Factor endowments; demand conditions; related and supporting
industries; and firm strategy, structure, and rivalry.
Difficulty: 1 Easy
nations.
Bloom's: Remember
102) What most accurately describes the four attributes that make up Porter's diamond?
A) Absence of any single attribute does not impact effectiveness of the diamond.
B) The effect of one attribute is contingent on the state of others.
C) The diamond is not a mutually reinforcing system.
D) Chance events, such as major innovations, do not affect Porter's diamond.
E) Only in the absence of one of the four attributes can government policies influence Porter's
diamond.
Answer: B
Explanation: Porter theorizes that four broad attributes of a nation shape the environment in
which local firms compete, and these attributes constituting the diamond. The diamond is a
mutually reinforcing system in which the effect of one attribute is contingent on the state of others.
nations.
Bloom's: Understand
49
103) Consideration of competitors is taken into account in which attribute of Porter's diamond?
A) purchasing power parity
B) factor endowments
C) economies of scale
D) firm strategy, structure, and rivalry
E) demand conditions
Answer: D
Explanation: The four factors in Porter's diamond are factor endowments, demand conditions,
related and supporting industries, and firm strategy, structure, and rivalry. Firm strategy,
structure, and rivalry refer to the conditions governing how companies are created, organized, and
managed and the nature of domestic rivalry.
nations.
Bloom's: Understand
104) Which factor endowment would be classified as a basic factor by Michael Porter?
A) communication infrastructure
B) research facilities
C) natural resources
D) skilled labor
E) technological know-how
Answer: C
Explanation: Porter recognizes hierarchies among factors, distinguishing between basic factors
(e.g., natural resources, climate, location, and demographics) and advanced factors (e.g.,
communication infrastructure, sophisticated and skilled labor, research facilities, and
technological know-how).
Difficulty: 1 Easy
nations.
Bloom's: Remember
50
105) Porter believed that two additional variables can influence the national diamond along with
the four original attributes. What are those two additional variables?
A) education and geography
B) nature and nurture
C) competition and globalization
D) chance and government
E) geography and history
Answer: D
Explanation: Porter maintains that two additional variables can influence the national diamond in
important ways: chance and government. Chance events, such as major innovations, can reshape
industry structure and provide the opportunity for one nation's firms to supplant another's.
Government, by its choice of policies, can detract from or improve national advantage.
nations.
Bloom's: Understand
106) Which component of Porter's diamond is particularly important in shaping the attributes of
domestically made products and in creating pressures for innovation and quality?
A) basic factor endowments
B) advanced factor endowments
C) firm strategy
D) demand conditions
E) supporting industries
Answer: D
Explanation: The characteristics of home demand are particularly important in shaping the
attributes of domestically made products and in creating pressures for innovation and quality.
Porter argues that a nation's firms gain competitive advantage if their domestic consumers are
sophisticated and demanding and pressure local firms to meet high standards of product quality
and to produce innovative products.
nations.
Bloom's: Understand
51
107) Porter noted a lack of attention to improving manufacturing processes and product design in
the United States He pointed to ________ as the reason for this.
A) a predominance of company leaders having finance backgrounds
B) a lack of trust between management and laborers
C) the flexible nature of competition
D) the abundance of domestic industries
E) moving too quickly to globalization
Answer: A
Explanation: In contrast, Porter noted a predominance of people with finance backgrounds
leading many U.S. firms. He linked this to U.S. firms' lack of attention to improving
manufacturing processes and product design.
nations.
Bloom's: Understand
108) Porter, in his diamond model, suggested that there is a strong association between ________
and the creation and persistence of competitive advantage in an industry.
A) trade barriers
B) vigorous domestic rivalry
C) purchasing power parity
D) the availability of a captive market
E) first-mover advantages
Answer: B
Explanation: Porter asserts that there is a strong association between vigorous domestic rivalry
and the creation and persistence of competitive advantage in an industry. Vigorous domestic
rivalry induces firms to look for ways to improve efficiency, which makes them better
international competitors.
nations.
Bloom's: Understand
52
109) Which statement reflects a pervasive finding of Porter's study?
A) Successful industries within a country tend to be grouped into clusters of related industries.
B) Trade increases the specialization of production within an industry.
C) The pattern of trade we observe in the world economy may be the result of first-mover
advantages.
D) Purchasing power parity of a country determines its demand conditions.
E) Differences in technology may lead to differences in productivity, which in turn, drives
international trade patterns.
Answer: A
Explanation: One of the most pervasive findings of Porter's study was that successful industries
within a country tend to be grouped into clusters of related industries.
Difficulty: 1 Easy
nations.
Bloom's: Remember
110) If a company were to draw from the ideas proposed in the various theories of international
trade, from a profit perspective, how would it go about selecting locations for its businesses?
A) It would concentrate its productive activities mostly in developing countries.
B) It would concentrate its productive activities in its home country.
C) It would disperse its productive activities to those countries where they can be performed most
efficiently.
D) It would disperse its productive activities across all countries that serve as its market.
E) It would concentrate its productive activities mostly in developed countries.
Answer: C
Explanation: Underlying most of the theories is the notion that different countries have particular
advantages in different productive activities. Thus, from a profit perspective, it makes sense for a
firm to disperse its productive activities to those countries where, according to the theory of
international trade, they can be performed most efficiently.
Bloom's: Understand
53
111) Which of the following helps a firm to preempt available demand, gain cost advantages
related to volume, and build an enduring brand ahead of later competitors?
A) monopolistic practices
B) comparative advantages
C) absolute advantages
D) first-mover advantages
E) mercantilism
Answer: D
Explanation: For the individual firm, the clear message is that it pays to invest substantial
financial resources in trying to build a first-mover or early-mover advantage even if that means
several years of losses before a new venture becomes profitable. The idea is to preempt the
available demand, gain cost advantages related to volume, build an enduring brand ahead of later
competitors, and, consequently, establish a long-term sustainable competitive advantage.
Difficulty: 1 Easy
Bloom's: Remember
112) What is meant by the term free trade? Is free trade compatible with the concept of
mercantilism?
Answer: Free trade refers to the absence of government barriers to the free flow of goods and
services between countries. Free trade refers to a situation where a government does not attempt to
influence through quotas or duties what its citizens can buy from another country or what they can
produce and sell to another country. The concept of mercantilism is not compatible with the
concept of free trade. The main tenet of mercantilism is that it is in a country's best interests to
maintain a trade surplus by exporting more than it imports. Consistent with this belief, the
mercantilist doctrine advocated government intervention to achieve a surplus in the balance of
trade through policies to maximize exports and minimize imports. To achieve this, imports were
limited by tariffs and quotas, while exports were subsidized.
Topic: Mercantilism; Trade Theories and Their Implications
nations.; 06-01 Understand why nations trade with each other.
Bloom's: Understand
54
113) Discuss how Adam Smith and David Ricardo turned the conversation and demonstrated that
trade is a positive-sum game. How has the neo-mercantilist approach viewed trade?
Answer: Mercantilism viewed trade as a zero-sum game, where a gain by one country results in a
loss by another. Adam Smith and David Ricardo demonstrated the shortsightedness of this
approach and argued that trade is a positive-sum game, or a situation in which all countries can
benefit. However, the mercantilist doctrine is by no means dead. Neo-mercantilists equate political
power with economic power and economic power with a balance-of-trade surplus. Critics argue
that many nations have adopted a neo-mercantilist strategy that is designed to simultaneously
boost exports and limit imports. For example, critics charge that China is pursuing a
neo-mercantilist policy, deliberately keeping its currency value low against the U.S. dollar in order
to sell more goods to the United States, and thus amass a trade surplus and foreign exchange
reserves.
nations.
Bloom's: Understand
114) Explain the concept of absolute advantage and provide an example of this concept.
Answer: According to Smith, countries should specialize in the production of goods for which
they have an absolute advantage and then trade those goods for the goods produced by other
countries. For instance, during Smith's time, England had an absolute advantage in the production
of textiles, and France had an absolute advantage in the production of wine. According to the
concept of absolute advantage, it then only makes sense for England to produce textiles (and
export them to France), and France to produce wine (and export it to England). Smith's basic
argument, therefore, was that a country should never produce goods at home that it can buy at a
lower cost from other countries. Moreover, Smith argued that by specializing in the production of
goods in which each has an absolute advantage, both countries benefit by engaging in trade.
nations.
Bloom's: Understand
55
115) Describe the concept of comparative advantage and provide an example.
Answer: The basic message of the theory of comparative advantage is that potential world
production is greater with unrestricted free trade than it is with restricted trade. According to
Ricardo's theory of comparative advantage, it makes sense for a country to specialize in the
production of those goods that it produces most efficiently and to buy the goods that it produces
less efficiently from other countries, even if this means buying goods from other countries that it
could produce more efficiently itself. While this may seem counterintuitive, the logic can be
explained with a simple example. Assume that Ghana is more efficient in the production of both
cocoa and rice; that is, Ghana has an absolute advantage in the production of both products. In
Ghana it takes 10 resources to produce 1 ton of cocoa and 13.33 resources to produce 1 ton of rice.
Thus, given its 200 units of resources,
Ghana can produce 20 tons of cocoa and no rice, 15 tons of rice and no cocoa, or any combination
in between on its PPF. In South Korea, it takes 40 resources to produce 1 ton of cocoa and 20
resources to produce 1 ton of rice. Thus, South Korea can produce 5 tons of cocoa and no rice, 10
tons of rice and no cocoa, or any combination on its PPF. Again, assume that without trade, each
country uses half its resources to produce rice and half to produce cocoa. Thus, without trade,
Ghana will produce 10 tons of cocoa and 7.5 tons of rice, while South Korea will produce 2.5 tons
of cocoa and 5 tons of rice.
Bloom's: Understand
56
116) Discuss the concepts of constant returns to specialization and diminishing returns to
specialization.
Answer: The simple comparative advantage model developed above assumes constant returns to
specialization. By constant returns to specialization
we mean the units of resources required to produce a good (cocoa or rice) are assumed to remain
constant no matter where one is on a country's production possibility frontier (PPF). Thus, we
assumed that it always took Ghana 10 units of resources to produce 1 ton of cocoa. However, it is
more realistic to assume diminishing returns to specialization. Diminishing returns to
specialization occur when more units of resources are required to produce each additional unit.
While 10 units of resources may be sufficient to increase Ghana's output of cocoa from 12 tons to
13 tons, 11 units of resources may be needed to increase output from 13 to 14 tons, 12 units of
resources to increase output from 14 tons to 15 tons, and so on. Diminishing returns imply a
convex PPF for Ghana, rather than a straight line. It is more realistic to assume diminishing returns
for two reasons. First, not all resources are of the same quality. A second reason for diminishing
returns is that different goods use resources in different proportions.
Bloom's: Understand
117) Describe the Leontief paradox.
Answer: Using the Heckscher-Ohlin theory, Leontief postulated that since the United States was
relatively abundant in capital compared to other nations, the United States would be an exporter of
capital-intensive goods and an importer of labor-intensive goods. However, he found that U.S.
exports were less capital-intensive than U.S. imports. Since this result was at variance with the
predictions of the Heckscher-Ohlin theory, it has become known as the Leontief paradox.
Difficulty: 1 Easy
nations.
Bloom's: Remember
57
118) Describe the shortcomings of the product life-cycle theory in today's trading climate.
Answer: Viewed from an Asian or European perspective, the assertion of the product life-cycle
theory that most new products are developed and introduced in the United States seems
ethnocentric and increasingly dated. Although it may be true that during U.S. dominance of the
global economy (from 1945 to 1975), most new products were introduced in the United States,
there have always been important exceptions. With the increased globalization and integration of
the world economy, a growing number of new products are now introduced simultaneously in the
United States, Japan, and the advanced European nations. This may be accompanied by globally
dispersed production, with particular components of a new product being produced in those
locations around the globe where the mix of factor costs and skills is most favorable. In sum,
although Vernon's theory may be useful for explaining the pattern of international trade during the
brief period of American global dominance, its relevance in the modern world seems more limited.
nations.
Bloom's: Understand
119) Discuss the two important points of new trade theory.
Answer: The new trade theory began to emerge in the 1970s when a number of economists
pointed out that the ability of firms to attain economies of scale might have important implications
for international trade. Economies of scale are unit cost reductions associated with a large scale of
output. New trade theory makes two important points: First, through its impact on economies of
scale, trade can increase the variety of goods available to consumers and decrease the average
costs of those goods. Second, in those industries where the output required to attain economies of
scale represents a significant proportion of total world demand, the global market may be able to
support only a small number of enterprises. Thus, world trade in certain products may be
dominated by countries whose firms were first movers in their production.
nations.
Bloom's: Understand
58
120) Define economies of scale and provide an example.
Answer: Economies of scale are unit cost reductions associated with a large scale of output.
Economies of scale have a number of sources, including the ability to spread fixed costs over a
large volume and the ability of large-volume producers to utilize specialized employees and
equipment that are more productive than less specialized employees and equipment. Economies of
scale are a major source of cost reductions in many industries, from computer software to
automobiles and from pharmaceuticals to aerospace. Automobile companies realize economies of
scale by producing a high volume of automobiles from an assembly line where each employee has
a specialized task.
Bloom's: Understand
121) Identify and briefly describe the four broad attributes that constitute Porter's diamond.
Answer: Porter theorizes that four broad attributes of a nation shape the environment in which
local firms compete, and these attributes promote or impede the creation of competitive advantage.
These attributes are: (1) Factor Endowments: A nation's position in factors of production such as
skilled labor or the infrastructure necessary to compete in a given industry. (2) Demand
Conditions: The nature of home demand for the industry's product or service. (3) Related and
Supporting Industries: The presence or absence in a nation of supplier industries and related
industries that are internationally competitive. (4) Firm Strategy, Structure, and Rivalry: The
conditions in the nation governing how companies are created, organized, and managed and the
nature of domestic rivalry. Porter speaks of these four attributes as constituting the diamond. He
argues that firms are most likely to succeed in industries or industry segments where the diamond
is most favorable. He also argues that the diamond is a mutually reinforcing system. The effect of
one attribute is contingent on the state of others.
nations.
Bloom's: Understand
59
122) Explain Porter's approach to factors of production.
Answer: Factor endowments lie at the center of the Heckscher-Ohlin theory. While Porter does
not propose anything radically new, he does analyze the characteristics of factors of production.
He recognizes hierarchies among factors, distinguishing between basic factors (e.g., natural
resources, climate, location, and demographics) and advanced factors (e.g., communication
infrastructure, sophisticated and skilled labor, research facilities, and technological know-how).
He argues that advanced factors are the most significant for competitive advantage. Unlike the
naturally endowed basic factors, advanced factors are a product of investment by individuals,
companies, and governments. Thus, government investments in basic and higher education, by
improving the general skill and knowledge level of the population and by stimulating advanced
research at higher education institutions, can upgrade a nation's advanced factors. The relationship
between advanced and basic factors is complex. Basic factors can provide an initial advantage that
is subsequently reinforced and extended by investment in advanced factors. Conversely,
disadvantages in basic factors can create pressures to invest in advanced factors.
nations.
Bloom's: Understand
123) How does Porter's theory predict patterns in international trade? Do his predictions turn out to
be accurate in a real-world scenario?
Answer: According to Porter's model of international trade, countries should be exporting

products from those industries where all four components of the diamond are favorable, while
importing in those areas where the components are not favorable. However, we do not know if he
is correct. Porter's theory has not been subjected to detailed empirical testing. Much about the
theory rings true, but the same can be said for the new trade theory, the theory of comparative
advantage, and the Heckscher-Ohlin theory.
Difficulty: 3 Hard
Bloom's: Apply
60
Test Bank for Global Business Today, 11th Edition, Charles W. L. Hill, G. Tomas M. Hult, ISB
124) From a profit perspective based on the various international theories, how would a business
go about choosing locations for its various productive activities?
Answer: From a profit perspective, it makes sense for a firm to disperse its productive activities
to those countries where, according to the theory of international trade, they can be performed
most efficiently. The result is a global web of productive activities, with different activities being
performed in different locations around the globe depending on considerations of comparative
advantage, factor endowments, and the like. If the firm does not do this, it may find itself at a
competitive disadvantage relative to firms that do.
Difficulty: 3 Hard
Bloom's: Apply
125) Discuss the policy implications of Porter's theory of national competitive advantage.
Answer: Porter's theory of national competitive advantage suggests that it is in the best interest of
business for a firm to invest in upgrading advanced factors of production; for example, to invest in
better training for its employees and to increase its commitment to research and development. It is
also in the best interests of business to lobby the government to adopt policies that have a favorable
impact on each component of the national diamond. Thus, according to Porter, businesses should
urge government to increase investment in education, infrastructure, and basic research (since all
these enhance advanced factors) and to adopt policies that promote strong competition within
domestic markets (since this makes firms stronger international competitors, according to Porter's
findings).
Bloom's: Understand
61
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39) A zero-sum game occurs when

94) One of the suggestions of new trade theory is that

100) The purpose of Porter's study of national competitive advantage was to

117) Describe the Leontief paradox.

119) Discuss the two important points of new trade theory.

Answer: According to Porter's model of international trade, countries should be exporting

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