CEA International Trade and Finance 2 — Questions and Answers
Question 1: The J-curve effect in international trade suggests that after a currency depreciation, the trade balance initially:
- Improves immediately due to cheaper exports
- Worsens before eventually improving (Correct answer)
- Remains unchanged for two years
- Improves then worsens permanently
Correct answer: Worsens before eventually improving
The J-curve occurs because import/export volumes adjust slowly, so the trade balance worsens in the short run before improving as quantities respond.
Question 2: Which condition must hold for a currency depreciation to improve the trade balance in the long run?
- Purchasing power parity must hold exactly
- The Marshall-Lerner condition must be satisfied (Correct answer)
- The current account must already be in surplus
- Interest rate parity must be violated
Correct answer: The Marshall-Lerner condition must be satisfied
The Marshall-Lerner condition states that the sum of the price elasticities of demand for exports and imports must exceed one for depreciation to improve the trade balance.
Question 3: A country running a persistent current account surplus is best described as:
- A net borrower from the rest of the world
- A net lender to the rest of the world (Correct answer)
- A country with a balanced capital account
- A country experiencing excessive inflation
Correct answer: A net lender to the rest of the world
A current account surplus means the country exports more than it imports, making it a net lender (capital outflow) to the rest of the world.
Question 4: Covered interest rate parity links which variables?
- Spot exchange rates and relative inflation rates
- Forward exchange rates, spot rates, and interest rate differentials (Correct answer)
- Trade balances and exchange rate movements
- Capital flows and purchasing power parity
Correct answer: Forward exchange rates, spot rates, and interest rate differentials
Covered interest parity states that the forward premium or discount on a currency equals the interest rate differential between two countries.
Question 5: A tariff-rate quota (TRQ) allows imports:
- At a high tariff rate for all quantities
- At zero tariff for all quantities above the quota
- At a low tariff up to a threshold, then a higher tariff above it (Correct answer)
- Only from countries with free trade agreements
Correct answer: At a low tariff up to a threshold, then a higher tariff above it
A TRQ charges a lower (or zero) tariff on imports up to a specified quantity and a higher tariff on any imports exceeding that threshold.
Question 6: The Stolper-Samuelson theorem predicts that free trade will:
- Benefit all factors of production equally
- Raise the real return to the scarce factor
- Lower the real return to the abundant factor
- Benefit owners of the factor used intensively in the export sector (Correct answer)
Correct answer: Benefit owners of the factor used intensively in the export sector
Stolper-Samuelson states that free trade raises the real return to factors used intensively in export industries and lowers returns to factors used intensively in import-competing industries.
Question 7: A country with a fixed exchange rate that faces a balance of payments deficit under the Bretton Woods system was expected to:
- Freely float its currency to restore equilibrium
- Borrow from the IMF and adjust domestic policies (Correct answer)
- Impose capital controls permanently
- Increase tariffs to restrict imports unilaterally
Correct answer: Borrow from the IMF and adjust domestic policies
Under Bretton Woods, deficit countries were expected to seek IMF assistance and implement policy adjustments while maintaining the fixed peg.
CEA International Trade and Finance 2
The J-curve effect in international trade suggests that after a currency depreciation, the trade balance initially: