economics
beginner
10 sample questions
Trade Theory MCQ Practice Test
Comparative advantage and specialization
Q1. A firm in a small open economy is considering exporting a product to a larger economy. The firm's production costs are £10 per unit, and the price it can sell the product for in the larger economy is £13 per unit. However, due to transportation costs and other trade barriers, the firm must pay a £0.50 per unit tariff to export the product. What is the maximum amount that the firm can afford to pay for the tariff per unit and still export the product profitably?
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A. £0.50 ✓
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B. £1.00
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C. £1.50
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D. £2.00
Explanation: The firm can export the product profitably as long as the price it receives in the larger economy (£13) is greater than the production cost (£10) plus the tariff (£0.50). Therefore, the maximum amount the firm can afford to pay for the tariff per unit is £0.50.
Q2. A firm in a small open economy is considering producing a good with a high import content. Which of the following trade theories best explains the firm's decision to import intermediate goods rather than produce them domestically?
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A. The firm should import the intermediate goods when the domestic price exceeds the world price, since the country then lacks a comparative advantage in producing them. ✓
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B. The firm should import the intermediate goods when the domestic price is below the world price, since foreign goods are then relatively expensive.
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C. The firm should produce the intermediate goods domestically whenever the domestic wage rate is below the foreign wage rate.
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D. The firm should never import intermediate goods, because trade theory always favors domestic vertical integration.
Explanation: A country imports goods whose domestic (autarky) price exceeds the world price — that price gap is the signal of comparative disadvantage in producing them, the core of Ricardian/H-O trade logic. The old key inverted the price comparison.
Q3. In the Heckscher–Ohlin model, what is the fundamental source of comparative advantage between countries?
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A. Differences in relative factor endowments such as labor, capital, and land ✓
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B. Differences in currency exchange rates
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C. Differences in national tax systems
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D. Differences in the age of the population
Explanation: Heckscher–Ohlin locates comparative advantage in factor endowments: countries relatively abundant in a factor export goods that use that factor intensively. Exchange rates, taxes, and demographics are not the model's source of comparative advantage.
Q4. A firm in a small open economy is considering exporting a product that has a comparative advantage. However, the product is also subject to a specific tariff imposed by the importing country. Which of the following trade theories best explains the firm's decision to export the product?
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A. The firm is engaging in strategic trade policy to gain a competitive advantage over rival firms.
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B. The firm is exploiting its comparative advantage to increase its exports and gain economies of scale. ✓
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C. The firm is using the product as a diversification strategy to reduce its dependence on a single market.
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D. The firm is subject to a binding constraint of the Heckscher-Ohlin theorem, which is forcing it to export the product.
Explanation: This question requires the application of the Heckscher-Ohlin theorem and the concept of comparative advantage. The correct answer is based on the idea that a firm will export a product in which it has a comparative advantage, even if it is subject to a tariff. The other options are incorrect because they do not accurately reflect the trade theory that best explains the firm's decision to export the product.
Q5. A country's comparative advantage in producing a good is determined by which of the following?
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A. The difference in the opportunity cost of producing the good between the two countries. ✓
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B. The difference in the fixed costs of production between the two countries.
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C. The difference in the wage rate between the two countries.
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D. The difference in the absolute output per worker between the two countries.
Explanation: Comparative advantage is defined by relative opportunity costs: the country with the lower opportunity cost of a good should specialize in it. Absolute productivity differences determine absolute, not comparative, advantage.
Q6. A firm in a small open economy is considering exporting a good that is produced using a combination of labor and capital. The firm can produce the good more efficiently using labor, but the country's labor market is not perfectly competitive. Which of the following trade theories best explains the firm's decision to export the good?
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A. The firm is taking advantage of comparative advantage due to its superior labor productivity. ✓
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B. The firm is exploiting the country's factor endowments to produce the good at a lower opportunity cost.
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C. The firm is engaging in intra-industry trade due to the country's specialization in labor-intensive production.
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D. The firm is participating in export-led growth due to the country's labor market distortions.
Explanation: This question requires the application of the Heckscher-Ohlin model, which predicts that countries will export goods in which they have a comparative advantage due to their factor endowments. In this case, the firm's superior labor productivity gives it a comparative advantage in producing the good, despite the country's labor market distortions.
Q7. A country imports a good that is produced using a technology that is not available domestically. If the country imposes a tariff on the imported good, what effect will this have on the "technology gap" between the domestic and foreign producers?
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A. The technology gap will widen as the tariff makes the foreign technology more expensive. ✓
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B. The technology gap will narrow as the tariff encourages domestic producers to adopt more efficient technologies.
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C. The technology gap will remain unchanged as the tariff only affects the price of the good, not the technology used to produce it.
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D. The technology gap will increase as the tariff creates an incentive for domestic producers to invest in research and development to close the technology gap.
Explanation: This question requires an understanding of the technology gap concept in international trade theory. The correct answer, "The technology gap will widen as the tariff makes the foreign technology more expensive," is based on the idea that tariffs can increase the relative price of imported goods, making foreign technologies more expensive for domestic producers to adopt. This can widen the technology gap between domestic and foreign producers.
Q8. A firm in a country with a comparative advantage in producing a good is considering exporting it to a country with an absolute advantage in the same good. However, the exporting country has a tariff on the good, which increases the firm’s cost of production. What is the impact of the tariff on the firm’s export decision?
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A. The firm will increase exports to the tariff-imposing country to take advantage of the tariff
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B. The firm will decrease exports to the tariff-imposing country to avoid the tariff ✓
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C. The firm will maintain its export level to the tariff-imposing country as the tariff is a one-time cost
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D. The firm will switch to producing a different good that is not subject to the tariff
Explanation: The tariff increases the firm’s cost of production, making it less competitive in the tariff-imposing country. As a result, the firm will decrease its exports to avoid the tariff and maintain its profit margins.
Q9. A firm in a small open economy produces a differentiated good with increasing returns to scale, but faces a downward-sloping demand curve due to the presence of a larger rival firm in the same market. Which of the following trade policies would be most likely to increase the firm's exports?
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A. Implementing a quota on imports of the differentiated good to reduce competition
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B. Providing a subsidy to the firm to increase its productivity and competitiveness
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C. Imposing a tariff on imports of the differentiated good to increase its price and shift the demand curve to the right
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D. Removing all trade barriers to increase the firm's access to foreign markets ✓
Explanation: The firm's exports are limited by the downward-sloping demand curve, which is a result of the presence of the larger rival firm. Removing all trade barriers would increase the firm's access to foreign markets, allowing it to serve a larger market with a more elastic demand curve, and thus increasing its exports.
Q10. A firm in a small open economy exports a differentiated product to a large country with a relatively small market size. The firm's production costs are affected by the exchange rate, but the price of the product in the large country is determined by the firm's markup over marginal cost. Suppose the exchange rate appreciates, causing the firm's production costs to increase. Which of the following best describes the effect of the exchange rate appreciation on the firm's export price in the large country?
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A. The firm's export price in the large country will increase due to the higher production costs.
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B. The firm's export price in the large country will decrease due to the higher production costs.
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C. The firm's export price in the large country will remain unchanged due to the firm's markup over marginal cost. ✓
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D. The firm's export price in the large country will increase due to the firm's markup over marginal cost.
Explanation: In a small country model, the firm's export price is determined by the firm's markup over marginal cost, not by the production costs. Therefore, an appreciation of the exchange rate, which increases production costs, will not affect the firm's export price in the large country.
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