International Economics

Econ 4401
Midterm Exam
Tim Uy
Name:
Student Number:

Short Answer Questions (30 Points)

1. [5] Give five reasons (or five theories that explain) why countries trade.

2. [6] Name and define two types of foreign direct investment (FDI). For each
type of FDI, state the location(s) where such investment is usually made. Explain
why that is the case.

3. [6] Consider a 2 x 2 x 2 Heckscher-Ohlin model where country 1 is capitalabundant (country 2 capital-scarce) and the two factors (capital and labor) are
used to produce good 1, which is capital-intensive, and good 2, which is laborintensive. Following the liberalization of trade, what good(s) does country 1
export? What about country 2? Who gains and loses in country 1? What about
winners and losers in country 2? Explain.

4. [4] How does faster economic growth in developing countries like India and
China impact workers and consumers in the developed world? What are the pros
and cons to trading with these developing nations?

5. [3] What are some of the policy instruments countries use to regulate trade?
Name at least three and explain the differences between these policy tools.

6. [3] How can trade benefit an entire country and create winners and losers
within that country at the same time? In the models that weve seen in class, are
there any models for which an entire country suffers following the liberalization
of trade? Justify your answers.

7. [3] How can a 1% drop in output or income be followed by a 5% drop in

trade? What does your answer to this question mean for firms that are considering producing overseas? What other factors play a role in the location-choice
decision made by firms in an increasingly global economy?

True or False (30 Points)

1. Ricardian trade is driven by differences in factor endowments.
2. Countries that trade more also grow faster.

3. Firms are responding to protectionist measures when they draw down

their inventories during a recession, hence leading to reduced trade.
4. A country can still have comparative advantage even when it does
not have absolute advantage in the production of that good.
5. Because more and more Canadian jobs are being offshored, Canadian
unemployment has to rise over time.
6. Complex supply chains motivate firms to shift their operations abroad.
7. Intraindustry trade is not as quantitatively significant as interindustry trade in accounting for the growth of trade flows over time.
8. State-owned multinational enterprises originate primarily from the developing world, and grow in size as a result of their efficiency.
9. A greenfield investment is one wherein a multinational firm purchases
shares of a domestic company.
10. Tariffs that restrict imports to the same amount as a comparable
quota are worse for welfare.
11. A specific-factors model predicts that all workers gain when the price
of the skill-intensive good rises relative to the good made with unskilled labor.
12. All countries can gain from greater trade (i.e. it is not zero-sum).
13. In the absence of trade, the return to capital in a capital-abundant
country is lower than the same return in a capital-scarce country.
14. Trade equalizes goods prices, not factor returns, across countries.
15. FDI flows have grown more than trade flows in the last 20 years.
5

Economic Models (40 Points)

Question 1. Trade Policy.

Consider a small open economy where the market for rackets is described by the
following demand and supply equations:
QD =

2048
p

QS = 2p
(a) [5] What is the autarky price for rackets in this country?
(b) [5] Suppose that the world price of rackets is pW = 4. At this price, how much
would the country produce? How much would it demand? How much would it
import?
(c) [5] Suppose that the country imposes a tariff of t percent on all racket imports.
Find the tariff level required to limit total imports of rackets to 96.
(d) [5] What can you say about the welfare of local consumers under the three
regimes (autarky, free trade, tariff) considered above? What about local producers? Are there winners and losers?

Question 2. Comparative Advantage.

Two countries, Home and Foreign, use one factor, labor, to produce two goods,
Shipyards (S) and Nurseries (N). The Home country can produce Shipyards with
three units of labor and Nurseries with two units of labor. The Foreign country
can produce Shipyards with one unit of labor and Nurseries with four units of
labor. Home country is endowed with a labor force of 900 units, while the endowment for the foreign country is 300 units. Preferences in each country can be
described by the following utility function:
1
2
log N + log S
3
3
(a) [5] Which country has absolute advantage in producing Shipyards? Nurseries?
(b) [5] Which country has a comparative advantage in producing Shipyards? How
is this relevant in determining the pattern of production in a world where the
countries can trade? Explain.
(c) [5] How much does Home consume and produce in autarky?
(d) [5] Now consider the case where the two countries are allowed to trade. List all
the possible cases of specialization or diversification for the two countries. Justify
your answer.
U (N, S) =