International Trade and Finance Flashcards

Country A can produce 10 tons of wheat or 5 tons of steel using the same amount of resources. Country B can produce 6 tons of wheat or 4 tons of steel with the same resources. According to the principle of comparative advantage, which of the following is true?

Answer: Country B has a comparative advantage in producing steel.

To determine comparative advantage, we calculate the opportunity cost. For Country A, the opportunity cost of 1 ton of steel is 2 tons of wheat (10/5). For Country B, the opportunity cost of 1 ton of steel is 1.5 tons of wheat (6/4). Since Country B has a lower opportunity cost for producing steel, it has a comparative advantage in steel production. Conversely, Country A's opportunity cost for 1 ton of wheat is 0.5 tons of steel (5/10), while Country B's is 0.67 tons of steel (4/6), giving Country A the comparative advantage in wheat. Therefore, Country B should specialize in steel and Country A in wheat for mutual gains from trade.

Which of the following transactions would be recorded as a credit in a country's Current Account component of the Balance of Payments?

Answer: A foreign tourist paying for a hotel stay within the country.

The Current Account records the flow of goods, services, income, and unilateral transfers. A credit entry represents money flowing into the country. A foreign tourist paying for a hotel is an export of a service, resulting in a credit to the Current Account. Purchasing a factory abroad and buying foreign bonds are debits to the Financial Account. The central bank's reserve changes are also recorded in the Financial Account.

A government imposes a limit on the quantity of a specific good that can be imported per year. This type of trade barrier is known as a(n):

Answer: Quota

A quota is a direct quantitative limit on the amount of a specific good that can be imported into a country during a certain period. This contrasts with a tariff, which is a tax on imports, a subsidy, which is a payment to domestic producers, and a VER, where the exporting country 'voluntarily' limits its exports.

According to the theory of Purchasing Power Parity (PPP), if a basket of goods costs $150 in the United States and €120 in the Eurozone, what should the nominal exchange rate (USD per EUR) be?

Answer: 1.25

The theory of Purchasing Power Parity (PPP) suggests that the exchange rate between two currencies should equalize the prices of an identical basket of goods and services in each country. To find the PPP exchange rate, you divide the price of the basket in one currency by the price in the other. In this case, the exchange rate (USD/EUR) = Price in USD / Price in EUR = $150 / €120 = 1.25.

Within the Mundell-Fleming model for a small open economy with perfect capital mobility, under a floating exchange rate regime, an expansionary fiscal policy will lead to:

Answer: No change in output as the currency appreciation crowds out net exports.

In the Mundell-Fleming model with a floating exchange rate and perfect capital mobility, an expansionary fiscal policy (e.g., increased government spending) shifts the IS curve to the right. This puts upward pressure on the domestic interest rate, attracting capital inflows. These inflows cause the domestic currency to appreciate. The currency appreciation makes exports more expensive and imports cheaper, thus reducing net exports. This reduction in net exports completely offsets the initial fiscal expansion, shifting the IS curve back to its original position, resulting in no change in output.

Which international institution primarily focuses on providing long-term development assistance and poverty reduction through financing projects like infrastructure and education in developing countries?

Answer: The World Bank

The World Bank's primary mission is long-term economic development and poverty reduction. It provides financial and technical assistance to developing countries for specific projects in areas like infrastructure, health, and education. The IMF, by contrast, focuses on maintaining global financial stability and providing short-to-medium-term loans to countries with balance of payments problems. The WTO deals with the rules of trade between nations, and the BIS is an institution for central banks.