International Economics 8th Edition

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International Economics, 8e (Husted/Melvin)
Chapter 9 Preferential Trade Arrangements

9.1 Multiple-Choice Questions

1) ________ are a form of regional integration where member countries lower internal trade
barriers but maintain existing barriers against nonmembers.
A) Customs unions
B) Free trade areas
C) Reciprocal trade agreements
D) None of the above.
Answer: B

2) ________ are a form of regional integration where member countries lower internal trade
barriers and establish a common barrier against nonmembers.
A) Customs unions
B) Free trade areas
C) Reciprocal trade agreements
D) None of the above.
Answer: A

Answer the question(s) below based upon the following diagram which depicts country A's
market for its importable.

3) Refer to the figure above. In free trade A will import

A) 700 units from country C.
B) 700 units from C and 600 units from B.
C) 600 units from C.
D) 600 units from C and 400 units from B.
Answer: C
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4) Refer to the figure above. If A imposes a per unit tariff of $10 on imports from both B and C,
it will import
A) 400 units from B.
B) 200 units from C.
C) 200 units from each.
D) 400 units from B and 200 units from C.
Answer: B

5) Refer to the figure above. If A forms a customs union with B, it will import
A) 400 units from B.
B) 200 units from C.
C) 200 units from each.
D) 400 units from B and 200 units from C.
Answer: A

6) Refer to the figure above. If A forms a customs union with C, the value of trade diversion will
be
A) $0.
B) $10,000.
C) $20,000.
D) $40,000.
Answer: A

7) The European Union (EU) is an example of a

A) customs union.
B) free trade area.
C) reciprocal trade agreement.
D) None of the above.
Answer: A

8) ________ is said to exist when the formation of a regional trading group leads to the reduction
of trade with nonmember countries in favor of member countries.
A) Trade creation
B) Trade diversion
C) Trade exclusion
D) Trade distortion
Answer: B

9) ________ is said to exist when the formation of a regional trading group leads to an expansion
of trade above pre-group levels.
A) Trade creation
B) Trade diversion
C) Trade exclusion
D) Trade distortion
Answer: A

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10) In addition to tariff lowering provisions, the NAFTA agreement includes two side
agreements on
A) Mexican exchange rate policy and Mexican foreign policy.
B) U.S. exchange rate policy and U.S. foreign policy.
C) environmental and labor market issues.
D) All of the above.
Answer: C

11) In leading the opposition to the adoption of NAFTA, H. Ross Perot argued that NAFTA
would lead to
A) a loss of U.S. competitiveness with Canada.
B) a loss of U.S. manufacturing jobs to Mexico.
C) a loss of U.S. willingness to negotiate the Uruguay Round.
D) All of the above.
Answer: B

12) One of the more unique aspects of NAFTA compared with other preferential trade
arrangements is the fact that the NAFTA countries have
A) similar cultures.
B) fixed exchange rates.
C) common borders.
D) very different standards of living.
Answer: D

13) The U.S. factor of production that is most likely to be made worse off because of NAFTA
(because its factor payment will fall) is
A) unskilled labor.
B) skilled labor
C) capital
D) All of the above will be made worse off.
Answer: A

14) The ________ is the chief executive body of the European Union (EU).
A) European Parliament
B) European Executive Branch
C) European Trade Body
D) European Commission
Answer: D

15) The goal of the Single European Act (or Europe 1992 initiative) is to
A) develop uniform product standards for all EU countries.
B) remove nontariff barriers to trade between EU countries.
C) deregulate economic activities in transportation and financial services.
D) All of the above.
Answer: D

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16) As of 2002 the European Union has announced that 10 new members will be allowed to join
the union? Which of the following countries is included in that group?
A) Poland
B) Russia
C) Turkey
D) All of the above.
Answer: A

Answer the question(s) below based upon the following diagram which depicts country A's
market for its importable.

17) Refer to the figure above. In free trade A will import

A) 70 units from country C.
B) 70 units from C and 100 units from B.
C) 120 units from B.
D) 100 units from B.
Answer: D

18) Refer to the figure above. If A imposes a per unit tariff of $10 on imports from both B and C,
it will import
A) 40 units from B.
B) 10 units from C.
C) 40 units from each.
D) 40 units from B and 10 units from C.
Answer: A

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19) Refer to the figure above. If A forms a customs union with C, it will import
A) 40 units from B.
B) 70 units from C.
C) 70 units from each.
D) 40 units from B and 70 units from C.
Answer: B

20) Refer to the figure above. If A forms a customs union with B, the value of trade diversion
will be
A) $0.
B) $10,000.
C) $20,000.
D) $40,000.
Answer: A

21) Refer to the figure above. If A forms a customs union with C, the quantity of trade creation
will be
A) 100 units.
B) 70 units.
C) 30 units.
D) None of the above.
Answer: C

22) Refer to the figure above. If A forms a customs union with C, A's welfare will change by
A) $a + $e
B) $a + $b + $c + $d + $e
C) $a + $e - $b - $c - $d
D) $a + $e - $h - $i - $j
Answer: D

23) Refer to the figure above. If A forms a customs union with C, the post agreement price will
be
A) $10
B) $15
C) $20
D) $25
Answer: B

24) Refer to the figure above. Domestic producers of this product in A would most prefer
A) a customs union with C.
B) a customs union with B.
C) a free trade agreement with both B and C.
D) no agreement with either country.
Answer: D

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25) Refer to the figure above. Domestic consumers of this product in A would most prefer
A) a customs union with C.
B) a customs union with B.
C) a free trade agreement with C.
D) no agreement with either country.
Answer: B

26) Which of the following countries is not a member of the European Union?
A) Portugal
B) Switzerland
C) Slovakia
D) Malta
Answer: B

27) Which of the following countries became the newest members of the European Union in
2007?
A) Bulgaria and Romania
B) Greece and Sweden
C) Albania and Cyprus
D) None of the above
Answer: A

28) Which of the following countries is not a member of NAFTA?

A) Canada.
B) The United States of America.
C) Mexico.
D) All three countries form part of NAFTA.
Answer: D

9.2 True or False Questions

1) Customs unions and free trade areas are identical in the manner in which member countries
treat imports from nonmember countries.
Answer: FALSE

2) If a customs union leads to a large amount of trade creation relative to trade diversion, it may
be beneficial to world welfare.
Answer: TRUE

3) A long term goal of the EU member countries is to integrate their economies into a single
economic entity with a common currency as well as common trade policies and internal factor
mobility.
Answer: TRUE

4) A long term goal of the NAFTA member countries is to integrate their economies into a single
economic entity with a common currency as well as common trade policies and internal factor
mobility.
Answer: FALSE
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5) If a customs union leads to a large amount of trade diversion relative to trade creation, it may
be beneficial to world welfare.
Answer: FALSE

6) Most economists estimate that the U.S. factor of production most likely to be hurt by the
formation of the NAFTA is unskilled U.S. labor.
Answer: TRUE

7) The political debate over joining NAFTA was especially contentious in the United States
because Mexico's standard of living (including wage rates, labor standards, and environmental
standards) is low relative to the U.S. standard of living.
Answer: TRUE

8) Prior to agreeing to join NAFTA, Mexico had followed a free trade policy for more than 30
years.
Answer: FALSE

9) The EU currently is a preferential trade agreement with no governmental institutions.

Answer: FALSE

10) An argument in favor of multilateral trade liberalization (multilateralism) over preferential

trade agreements (regionalism) is that multilateralism results in less trade diversion.
Answer: TRUE

11) NAFTA was a controversial issue in the 2008 presidential campaign, particularly in the
Democratic primaries.
Answer: TRUE

12) Russia is a member of the European Union.

Answer: FALSE

13) The ultimate purpose of the NAFTA free trade agreement is to balance trade between the
member nations.
Answer: FALSE

14) Recent studies have shown that NAFTA has had a tremendous negative impact on the
economic welfare of the U.S.
Answer: FALSE

15) The welfare impact of a preferential trade agreement depends on the difference between the
amount of new trade that takes place because of the agreement and the change in international
trade patterns that arises because of it.
Answer: TRUE

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9.3 Essay Questions

1) Membership in a customs union may be either welfare improving or welfare worsening.

Illustrate and explain.
Answer: It can be welfare worsening if trade diversion is large and trade creation is small.
Graphically, this will be more likely when the partner country's price is quite a bit higher than
the world price.

2) Compare and contrast NAFTA and the EU in terms of the types of agreements that they are,
the institutions that operate under the agreement, and the long term goals of the arrangements.
Answer: NAFTA is a FTA with a limited institutional framework that settles trade disputes
between members, and oversees the provisions of side agreements involving labor and the
environment. There are no stated long term goals to further integrate any of the three economies.
Indeed, it would take a major change of attitudes in both Canada and Mexico to convince either
country to pursue further economic integration, especially with the United States. The one long
term goal often expressed by the NAFTA countries is to expand the agreement to bring in other
countries from the Western Hemisphere such as Chile. The EU is a customs union that hopes
ultimately to transform itself into a full economic union with a single currency. The EU has an
extensive governmental structure with a parliament, an executive branch and a judiciary.

3) The push toward creating more regional trade agreements necessarily harms the multilateral
liberalization process that is at the heart of the WTO.
Answer: There are some economists, most notably Bhagwati, who would agree with this
statement. They oppose regionalism because of the trade diversion it causes and because, they
argue, regional agreements distract countries from the multilateral process. Others, including
Krugman, argue that regionalism is a natural process, owing to regional cultural similarities and
the economics of transportation costs. These agreements do not divert much trade, they contend,
because trade tends to be regional anyway and because external barriers are low. Moreover,
success in negotiating regional agreements may spur on multilateral talks.

4) Summarize the type of agreement that NAFTA is, its history, the process by which it has been
implemented in the last 15 years.
Answer: The North American Free Trade Agreement between the U.S., Canada, and Mexico
went into effect on January 1st, 1994. In many ways, it is an expansion of the agreement that
previously existed between Canada and the U.S. to include Mexico. It is broader than this
previous agreement in that it includes accords to enforce environmental and labor laws. By now,
tariffs on virtually all trade among these three countries have fallen to zero, with trade in services
substantially liberalized and restrictions on investment flows relaxed. Although the agreement
remains controversial, the amount of trade that has been created between the three countries
ranks NAFTA as the second largest preferential trade agreement in the world, only behind the
European Union.

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5) Why is NAFTA controversial? Briefly describe both sides of this controversy.
Answer: Opponents of the agreement argue that increased trade with low-wage countries such as
Mexico threatens American jobs, particularly in the manufacturing sector, where Mexican
factories have a comparative advantage. American jobs are lost every time U.S. factories decide
to relocate in Mexico. On the other hand, those in favor of the agreement generally make
reference to the advantages of trade, such as lower costs of final goods to consumers, and the
expansion of markets to sell American products.

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