Question 1

Assume 1990 to be the base year. If by the end of 2004 a country's export price index rose from 100 to 130 while its import price index rose from 100 to 115, its terms of trade would equal 113.

Accepted Answer

Terms of trade is calculated by dividing the export price index by the import price index and multiplying by 100.

In this case, (130/115) x 100 = 113.

Thus, the statement is true.

Question 2

The expression "importance of being unimportant" suggests that if one nation is much larger than the other, the larger nation realizes most of the gains from trade while the smaller nation realizes fewer gains from trade.

Accepted Answer

The expression "importance of being unimportant" actually suggests that smaller nations have more to gain from trade, as they can specialize in producing the goods and services in which they have a comparative advantage and trade with larger nations that may not have a comparative advantage in those areas. Therefore, the statement in the question is incorrect.

Question 3

If two nations of approximately the same size and with similar taste patterns participate in international trade, the gains from trade tend to be shared about equally between them.

Accepted Answer

According to the law of comparative advantage, when two countries specialize in producing the goods that they can produce at a lower opportunity cost and trade with each other, both countries can benefit and gain from the trade. Therefore, the gains from trade are likely to be shared about equally between them.

Question 4

An improvement in a nation's terms of trade occurs if the prices of its exports rise relative to the prices of its imports over a given time period.

Accepted Answer

This is the correct definition of an improvement in a nation's terms of trade.

Question 5

Assume that the United States and Canada engage in trade. If the international terms of trade coincides with the Canadian cost ratio, the United States realizes all of the gains from trade with Canada.

Accepted Answer

The answer of Assume that the United States and Canada...

Question 6

If the international terms of trade lies beneath (inside) the Mexican cost ratio, Mexico is worse off with trade than without trade.

Accepted Answer

If the terms of trade are less favorable than the Mexican cost ratio, Mexico would have to give up more of their own production to obtain the same amount of another country's production. This would lead to a net loss for Mexico in terms of their own production and welfare.

Question 7

Assume that Canada has a comparative advantage in wheat and a comparative disadvantage in autos. As the Canadian demand for wheat increases, Canada's equilibrium terms of trade improves.

Accepted Answer

An increase in domestic demand for wheat in Canada would likely lead to an increase in domestic prices for wheat, making Canadian wheat more expensive on the international market. This could worsen Canada's terms of trade, as it would have to give up more of its wheat (or other goods) to obtain the same amount of autos (or other imports) from abroad. Comparative advantage affects production decisions, not terms of trade directly in this context.

Question 8

Although J. S. Mill recognized that the region of mutually beneficial trade is bounded by the cost ratios of two countries, it was not until David Ricardo developed the theory of reciprocal demand that the equilibrium terms of trade could be determined.

Accepted Answer

David Ricardo is known for developing the theory of comparative advantage, not the theory of reciprocal demand, which was indeed developed by J.S. Mill. Ricardo's theory explains how countries benefit from trade even if one can produce everything more efficiently than the other, while Mill's theory of reciprocal demand deals with determining the equilibrium terms of trade between countries.

Question 9

The domestic cost ratios of nations set the outer limits to the equilibrium terms of trade.

Accepted Answer

The domestic cost ratios determine the opportunity cost of producing one good in terms of another for each nation, which sets the limits for mutually beneficial trade. This, in turn, determines the equilibrium terms of trade between the two nations.

Question 10

The theory of reciprocal demand asserts that as the U.S. demand for Canadian wheat rises, the equilibrium terms of trade improve for the United States.

Accepted Answer

The theory of reciprocal demand asserts that as the demand for a good in country A rises, the terms of trade will improve for the country that produces that good (country B). Therefore, if the U.S. demand for Canadian wheat rises, the equilibrium terms of trade would actually improve for Canada, not the United States.

Question 11

Because the Ricardian theory of comparative advantage was based only on a nation's supply conditions, it could only determine the outer limits within which the equilibrium terms of trade would lie.

Accepted Answer

The Ricardian theory of comparative advantage only takes into consideration a nation's supply conditions and does not account for other factors that may affect the equilibrium terms of trade. Thus, it can only provide a range of possible outcomes, rather than a precise prediction of the terms of trade.

Question 12

The terms of trade represents the rate of exchange between a country's exports and imports.

Accepted Answer

The terms of trade is the ratio of the price of exports to the price of imports. It represents the exchange rate between a country's exports and imports.

Question 13

Assume 1990 to be the base year. If by the end of 2004 a country's export price index rose from 100 to 140 while its import price index rose from 100 to 160, its terms of trade would equal 120.

Accepted Answer

The terms of trade are calculated as the ratio of the export price index to the import price index, multiplied by 100. In this case, it would be (140 / 160) * 100 = 87.5, not 120.

Question 14

The theory of reciprocal demand best applies when two countries are of equal economic size, so that the demand conditions of each nation have a noticeable impact on market prices.

Accepted Answer

The theory of reciprocal demand is based on the assumption that two countries are of equal size, so that the demand conditions of each country can have a significant impact on the prices in the market. Therefore, the statement is true.

Question 15

The theory of reciprocal demand best applies when one country has a "large" economy and the other country has a "small" economy.

Accepted Answer

The theory of reciprocal demand applies to trade between any two countries, regardless of their economic size, and focuses on how the mutual demand for each other's goods determines the terms of trade.

Question 16

Assume that the United States and Canada engage in trade. If the international terms of trade coincides with the U.S. cost ratio, the United States realizes all of the gains from trade with Canada.

Accepted Answer

The statement is false. When the international terms of trade coincides with the U.S. cost ratio, it means that the prices at which Canada is willing to trade with the U.S. are the same as the U.S. production costs. In such a scenario, both countries can benefit from trade as they can obtain goods at a lower cost than producing them themselves. Canada, in this case, gains by exporting goods to the U.S. at a price higher than their production costs, and the U.S. gains by importing these goods at a price lower than what it would cost to produce them domestically.

Question 17

According to J. S. Mill, if we know the domestic demand expressed by both trading partners for both products, the equilibrium terms of trade can be defined.

Accepted Answer

J. S. Mill believed that the equilibrium terms of trade can be determined by knowing the domestic demand expressed by both trading partners for both products. This is because the terms of trade represent the ratio of export prices to import prices, and these prices are determined by the demand and supply conditions of the products in both countries. Therefore, by knowing the demand for both products in both countries, we can determine the equilibrium terms of trade that benefit both countries.

Question 18

If a country's terms of trade improve, it must exchange more exports for a given amount of imports.

Accepted Answer

If a country's terms of trade improve, it means that the prices of its exports have increased relative to the prices of its imports. This means that the country can purchase the same amount of imports with fewer exports or can purchase more imports with the same amount of exports. Therefore, the country does not have to exchange more exports for a given amount of imports.

Question 19

If a country's terms of trade worsen, it must exchange fewer exports for a given amount of imports.

Accepted Answer

The answer of If a country's terms of trade worsen,...

Question 20

Mutually beneficial trade for two countries occurs if the equilibrium terms of trade lies between the two countries' domestic cost ratios.

Accepted Answer

This is the principle of comparative advantage. If one country has a lower domestic cost ratio for a certain product and the other country has a lower domestic cost ratio for another product, then they can trade goods at a mutually beneficial price that falls between their respective domestic cost ratios.

Quiz 2: Foundations of Modern Trade Theory: Comparative Advantage