Chapter 4:

Trade: Factor Availability and Factor Proportions are Key

Multiple Choice Questions

1. Constant cost production possibility curves lead to __________ specialization. Increasing

cost production possibility curves lead to __________ specialization.
a. no; partial
b. complete; no
c. complete; partial
d. partial; complete
ANSWER: C

2. Which of the following statements is true about production possibility curves?

I. Constant cost production possibility curves are straight lines and lead to complete
specialization.
II. Bowed-out production possibility curves are associated with partial specialization, but
the opportunity cost of producing each good is constant along the curve.

a. I
b. II
c. I and II
d. None of the above.
ANSWER: A

3. Which of the following are reasons why increasing marginal costs of production arise?

I. Different products use inputs to production in different proportions.

II. Different inputs are better utilized in the production of different products.
III. Different countries have different endowments of the different factors of production.

a. III
b. II and III
c. I and II and III
d. I and II
ANSWER: D

4. Assume that Country X produces two goods—sugar and shoes—and that the country’s
production possibility curve is “bowed-out”. As the country produces more sugar:
a. The opportunity cost of sugar in terms of shoes foregone will increase.
b. The opportunity cost of sugar in terms of shoes foregone will decrease.
c. The opportunity cost of shoes in terms of sugar foregone will increase.
d. The opportunity cost of sugar in terms of shoes foregone will be the same.
ANSWER: A
5. In the two-country, two-good model with an increasing-cost production-possibility curve, the
amount of both goods that are produced in the economy in autarky is determined by:
a. Relative prices.
b. Factor endowments.
c. Community indifference curves.
d. Labor productivity.
ANSWER: A

Figure 4.1

Wheat

.
. .
I2
I1
80
S1 C1
60 C0
50 International
S0
Price = 0.25W/C
Price = 1W/C
25 65 Cloth
Canada

6. Refer to Figure 4.1. In autarky Canada will produce at point __________ and consume at
point __________.
a. S1; C1
b. S0; C0
c. S1; C0
d. S0; C1
ANSWER: B

7. Refer to Figure 4.1. After the opening up of international trade, Canada will produce at point
__________ and consume at point __________.
a. S1; C1
b. S0; C0
c. S1; C0
d. S0; C1
ANSWER: A

8. Refer to Figure 4.1. Canada has a comparative advantage in which good?

a. Wheat.
b. Cloth.
 c. Both wheat and cloth.
d. Neither wheat nor cloth.
ANSWER: A

9. Refer to Figure 4.1. After the opening up of international trade, Canada will export
__________ units of wheat and import __________ units of cloth.
a. 0; 0
b. 20; 80
c. 20; 5
d. 60; 15
ANSWER: B

10. Refer to Figure 4.1. After the opening up of international trade, Canada will import
__________ units of wheat and export __________ units of cloth.
a. 0; 0
b. 25; 25
c. 30; 65
d. 65; 65
ANSWER: A

11. Refer to Figure 4.1. Before the opening up of international trade, 1 unit of wheat will trade
for __________ units of cloth. After the opening up of international trade 1 unit of wheat will
trade for __________ units of cloth.
a. 1; 0.25
b. 4; 1.
c. 1; 4.
d. 0; 2.5.
ANSWER: C

12. Refer to Figure 4.2. Before trade opens, the Rest of the World produces __________ yards of
cloth and __________ units of wheat; while consuming __________ yards of cloth and
__________ units of wheat.
a. 10; 8; 8; 10
b. 4; 16; 8; 10
c. 8; 10; 12; 8
d. 8; 10; 8; 10
ANSWER: D

13. Refer to Figure 4.2. After trade, Canada produces __________ yards of cloth and
__________ units of wheat and consumes __________ yards of cloth and __________ units
of wheat.
a. 20; 3; 12; 11
b. 12; 11; 12; 11
c. 20; 3; 20; 3
d. 16; 6; 12; 11
ANSWER: A
14. Refer to Figure 4.2. In autarky, the Rest of the World produces and consumes __________
yards of cloth and __________ units of wheat. In autarky Canada produces and consumes
__________ yards of cloth and __________ units of wheat.
a. 8; 10; 20; 3
b. 8; 10; 16; 6
c. 4; 16; 20; 3
d. 12; 8; 12; 11
ANSWER: B

Figure 4.2
W heat
W heat
I1
I2

I2
I1 16
S1

C 10 S 2
11 1

C
8 1
T
6 S0
P r ic e =
3 1 u n it
T S1 P r ic e =
0 .6 7 u n it per yard
per yard 0 4 8 12
0 C lo th
C lo th 12 16 2 0 1 u n it
2 u n its
per yard R e s t o f th e W o r ld
C anada per yard

15. Refer to Figure 4.2. Before trade, the total amount of cloth produced in the world was
__________ yards and the total amount of wheat produced in the world was __________.
a. 24; 19
b. 24; 16
c. 19; 24
d. 16; 24
ANSWER: B

16. Refer to Figure 4.2. As a result of specialization and trade, cloth production in the world is
increased by __________ yards and wheat production is increased by __________ units.
a. 0; 3
b. 0; 0
c. 24; 19
d. 3; 0
ANSWER: A
17. Which of the following can explain why product prices in two countries will differ in a world
with no trade?

I. Production conditions in the two countries are different and therefore the
production-possibility curves in the two countries are different.
II. Consumption conditions are different in the two countries and therefore the
community indifference curves in the two countries are different.
III. Trade would not be possible because the international price ratio would be the
same in the two countries.
a. I and III
b. II
c. I and II
d. I and II and III
ANSWER: C

18. A country whose ratio of capital to other factors of production is greater than the rest of the
world’s ratio of capital to other factors of production is:
a. Relatively capital-intensive.
b. Relatively capital-abundant.
c. Running a trade deficit.
d. Operating at a point inside its production possibilities curve.
ANSWER: B

19. The United States is relatively capital-abundant because:

a. Capital costs more in the United States than in the rest of the world.
b. The United States has more capital than the rest of the world.
c. The United States produces more high-tech goods than the rest of the world.
d. The ratio of capital to other factors of production is greater in the United States than
the rest of the world’s ratio of capital to other factors of production.
ANSWER: D

20. Which of the following theories predicts that a country will export those goods that use the
country’s abundant factor(s) intensively in production and import those goods that use the
country’s scarce factor(s) intensively in production?
a. Absolute advantage.
b. Comparative advantage.
c. Heckscher-Ohlin theory.
d. The production differentiation model.
ANSWER: C

21. If Country A is labor-abundant and capital-scarce, Country B is labor-scarce and capital-

abundant, Good X is produced in a labor-intensive process, and Good Y is produced in a
capital-intensive process, we would expect that:
a. Country A would export Good X.
 b. Country B would import Good Y.
c. Country A would import Good X.
d. Country B would import both Good X and Good Y.
ANSWER: A

22. China has 20% of the world’s population but only 10% of the world’s farmable land. The
Heckscher-Ohlin theory of trade would predict which of the following for China following
the opening of trade?
a. China will export land-intensive goods like wheat and import labor-intensive goods
like clothing.
b. China will shift resources into the production of agricultural goods and away from
manufactured goods.
c. China will shift resources out of the production of agricultural goods and into the
production of labor-intensive goods.
d. China will export capital-intensive goods like automobiles and import labor-intensive
goods like clothing.
ANSWER: C

23. A product is relatively __________ if labor costs are a greater proportion of the product’s
value than they are the value of other products.
a. Capital-abundant
b. Labor-abundant
c. Capital-intensive
d. Labor-intensive
ANSWER: D

24. If Country A has a relatively higher ratio of labor to the other factors of production than does
Country B, then:
a. Country A is labor-abundant.
b. Country A is labor-scarce.
c. Country A is labor-intensive.
d. Country B is labor-intensive.
ANSWER: A

25. Given the following relationship:

(U.K. land supply) < (Rest of the world’s land supply)
(U.K. labor supply) > (Rest of the world’s labor supply)
One can conclude that:
a. The U.K is labor abundant.
b. The U.K. is labor intensive.
c. The Rest of the World is labor abundant.
d. The Rest of the World is land intensive.
ANSWER: A

26. Which of the following economists proposed an international trade model that explains
international trade patterns using factor proportions?
 a. Adam Smith
b. David Ricardo
c. Eli Heckscher and Bertil Ohlin
d. Joseph Stiglitz
ANSWER: C

27. Assume a two-country, two-good, two-factor of production world with the countries being
the United States and the Rest of the World, the two goods being steel and wheat, and the two
factors of production being capital and land. If the United States was capital-abundant and
steel production was capital-intensive, the Heckscher-Ohlin model would predict that the
United States would export __________ and import __________.
a. Steel; wheat
b. Wheat; steel
c. Steel; steel
d. Wheat; wheat
ANSWER: A

28. Assume a two-country, two-good, two-factor of production world with the countries being
the United States and the Rest of the World, the two goods being steel and wheat, and the two
factors of production being capital and land. If the United States was capital-abundant and
steel production was capital-intensive, the Heckscher-Ohlin model would predict that the
Rest of the World would export __________ and import __________.
a. Steel; wheat
b. Wheat; steel
c. Steel; steel
d. Wheat; wheat
ANSWER: B

Use the following information to answer questions 29 thru 35.

Assume a two-country, two-good, two-factor of production world where the following

relationships hold:

(K/L)US > (K/L)ROW

(K/L)automobiles > (K/L)shoes

Where (K/L)US is the capital-labor ratio in the United States, (K/L)ROW is the capital-labor ratio in
the Rest of the World, (K/L)automobiles is the capital-labor ratio in the production of automobiles,
and (K/L)shoes is the capital-labor ratio in the production of shoes. Assume further that technology
and tastes are the same in the United States and the Rest of the World.

29. The relationships shown above indicate that the United States is:
a. A capital-intensive country.
b. Scarce in land.
c. A labor-abundant country.
d. A capital-abundant country.
 ANSWER: D

30. The relationships shown above indicate that the production of shoes is:
a. Capital-intensive.
b. Labor-intensive.
c. Labor-abundant.
d. Capital-abundant.
ANSWER: B

31. The relationships shown above indicate that in the United States the price of automobiles
relative to shoes is:
a. Higher than in the Rest of the World.
b. Lower than in the Rest of the World.
c. The same as in the Rest of the World.
d. It is impossible to compare the prices with the information provided.
ANSWER: B

32. The relationships shown above indicate that the United States has a comparative advantage in
the production of __________ while the Rest of the World has a comparative advantage in
the production of __________.
a. Both goods; neither good
b. Shoes; automobiles
c. Automobiles; shoes
d. Neither good; both goods
ANSWER: C

33. According to the Heckscher-Ohlin model, the opening of trade between the United States and
the Rest of the World should cause the United States to export __________ and import
__________.
a. Both goods; neither good
b. Shoes; automobiles
c. Automobiles; shoes
d. Neither good; both goods
ANSWER: C

34. According to the Heckscher-Ohlin model, the opening of trade between the United States and
the Rest of the World should cause the Rest of the World to export __________ and import
__________.
a. Both goods; neither good
b. Shoes; automobiles
c. Automobiles; shoes
d. Neither good; both goods
ANSWER: B

35. Trade between the United States and the Rest of the World would lead to:
 a. An improvement in economic well-being in the United States but deterioration in
economic well-being in the Rest of the World.
b. No change in economic well-being in the United States but an improvement in
economic well-being in the Rest of the World.
c. An improvement in economic well-being in both the United States and in the Rest of
the World.
d. Deterioration in economic well-being in the United States but an improvement in
economic well-being in the Rest of the World.
ANSWER: C

Use the information below to answer questions 36 thru 38.

The following cost data is for the mythical land of Painduvin where they produce nothing but
bread and wine using only land and labor as inputs.

1 unit of Bread 1 unit of Cheese

Labor Input 5 dollars 20 dollars
Land Input 4 dollars 10 dollars

36. In Painduvin, bread is __________ and cheese is __________.

a. Labor-intensive; land-intensive
b. Land-intensive; labor-intensive
c. Labor-abundant; land-abundant
d. Land-abundant; labor-abundant
ANSWER: B

37. If Painduvin were land-abundant, the opening up of free trade would cause the price of bread
relative to cheese to:
a. Rise.
b. Fall.
c. Stay the same.
d. Unable to answer with the information provided.
ANSWER: A

38. If Painduvin were land-abundant, the opening up of free trade would cause the production of
bread to __________ and the production of cheese to __________.
a. Rise; rise
b. Rise; fall
c. Fall; fall
d. Fall; rise
ANSWER: B

Use the following information to answer questions 39 and 40.

Puglia has 15 thousand acres of land and 45 thousand laborers, whereas the Rest of the World has
100 thousand acres of land 200 thousand laborers. These countries produce the labor intensive
good A, and the land intensive good B.

39. Based on the above information, Pugelovia is relatively:

a. Labor-abundant.
b. Labor-intensive.
c. Land-abundant.
d. Land-intensive.
ANSWER: A

40. Based on the above information, Pugelovia will:

a. Not trade with the Rest of the World.
b. Export good B, and import good A.
c. Export good A, and import good B.
d. Import both good A and good B.
ANSWER: C

Figure 4.2

Cheese

120

80 . S1

C1
I1

40 90 Wine
International Price =
Pugelovia 1 C/W

41. Figure 4.2 illustrates the production possibilities curve of Pugelovia. This country can
produce only wine and cheese, and trade these products with the rest of the world.
Pugelovia’s production possibilities curve indicates that this country has __________
marginal costs of production.
a. Constant
b. Increasing
c. Decreasing
 d. Progressive
ANSWER: B

42. Refer to Figure 4.2. Pugelovia imports:

a. 20 units of wine.
b. 20 units of cheese.
c. 50 units of wine.
d. 80 units of cheese.
ANSWER: B

43. Refer to Figure 4.2. Pugelovia exports:

a. 50 units of wine.
b. 50 units of cheese.
c. 30 units of wine.
d. 80 units of cheese.
ANSWER: B

True/False Questions

44. Increasing-cost production-possibility curves are bowed out from the origin.
ANSWER: TRUE

45. Increasing-cost production-possibility curves lead to partial specialization.

ANSWER: TRUE

46. In the two-country, two-good model, the opening of trade will necessarily lead to complete
specialization in the production of one good by one country and complete specialization in
the production of the other good by the other country.
ANSWER: FALSE

47. Increasing marginal costs of production arise as a result of the fact that different inputs to
production are used in different proportions in the production of different goods.
ANSWER: TRUE

48. As a country moves up along its “bowed-out” production possibility curve, the opportunity
cost of producing more of the good on the y-axis decreases.
ANSWER: FALSE

49. The production-possibility curve does not provide enough information to determine the
amount of each good produced by the economy.
ANSWER: TRUE

50. The comparison of the production-possibility curves of the two countries in the two-country,
two-good model with constant-cost production-possibility curves is sufficient to determine
 the specialization point, but insufficient to determine the specialization point with increasing-
cost production-possibility curves.
ANSWER: TRUE

51. Indifference curves show the various bundles of consumption quantities that lead to the same
level of well-being.
ANSWER: TRUE

52. Heckscher-Ohlin theory relies upon the factor proportions used in the production of different
goods and differences in the endowments of different factors in different countries to explain
international trade patterns.
ANSWER: TRUE

53. If the proportion of labor to capital in a country is greater than the proportion of labor to
capital in the rest of the world, we can conclude that the country is labor abundant and will
have a comparative advantage in the production of goods that use capital intensively.
ANSWER: FALSE

54. If Country A is relatively abundant in labor and Country B is relatively abundant in capital,
Heckscher-Ohlin’s theory predicts that Country A will export relatively labor-intensive goods
and Country B will export relatively capital-intensive goods.
ANSWER: TRUE

55. If Country A is relatively land-abundant and Country B is relatively labor-abundant,

Heckscher-Ohlin theory predicts that Country A will export textiles (a relatively labor-
intensive good) and Country B will export corn (a relatively land-intensive good).
ANSWER: FALSE

56. The Heckscher-Ohlin theory of trade differs from the Ricardian model by
assuming that there are only two goods.
ANSWER: FALSE

57. In contrast to the Ricardian model, the Heckscher-Ohlin model assumes

that production has increasing marginal costs.
ANSWER: TRUE

58. The community indifference curves illustrate the technological capabilities of a country.
ANSWER: FALSE

59. The production possibilities curve illustrates the consumption preferences of a country’s
population, and explains why all people prefer to be employed rather than unemployed.
ANSWER: FALSE

60. According to the Heckscher-Ohlin model, countries will engage in trade only if they have
different production technologies.
ANSWER: FALSE
Essay Questions

61. Explain the differences between the two-country two-good model with constant costs of
production and the model with increasing costs of production. Adequately describe the
production possibilities curves for each country in each case. Describe production,
consumption, and the degree of specialization in each country under both cost situations.
POSSIBLE RESPONSE: If the cost of production of each good is constant, the opportunity
cost of production of one good (in terms of production foregone of the other good) is also
constant. In an economy with constant cost of production, the production possibilities curve
(ppc) is a straight line. In such a situation it is beneficial for a country to fully specialize in
the production of one good, and export this good in exchange for imports of the other good.
The good that will be produced is the good with an opportunity cost that is lower than the
relative international price of this good (the price of the good expressed in units of the other
good). Conversely, the good with an opportunity cost higher than the international price will
be imported. The result is complete specialization.
This reasoning is behind Ricardo’s idea of comparative advantage and complete
specialization. Ricardo assumed that all goods are produced with one factor of production –
labor, and in order to double the production of a product, a producer just needs to double the
amount of the input factor –the labor hours. Realistically, however, production requires a
variety of factor inputs: land, skilled labor, unskilled labor, capital, etc., and different
products use factor inputs in different proportions. The basic variation of these inputs leads to
an increasing cost of production. That means the production possibilities curve is bowed out.
In other words, the opportunity cost of production of one good is not constant but rather
increasing with the increased production of this good. When a country is opened to trade only
a partial specialization will be observed.

62. Explain why constant costs of production result in complete specialization and why
increasing costs of production result in partial specialization.
POSSIBLE RESPONSE: Constant cost of production implies constant opportunity cost,
which is the amount of the other good that must be foregone to increase the production of a
certain good with one unit. If a good has a higher opportunity cost compared to the relative
international price of this good, then it is beneficial for a country to produce the other good
and export it in exchange for imports of this good. Because the opportunity cost does not
change with the increased production of the other good, it will be beneficial for the country
to completely specialize in the good with opportunity cost lower than the international price,
and import the other good.
With increasing cost of production, the opportunity cost of a good is increasing with the
increased production. Optimally, the country will produce the two goods in such a
proportion, that the opportunity cost is equal to the international price ratio. With increasing
opportunity cost this implies a partial specialization.
63. Is the following statement true or false and why? “In the two-good, two-country model with
increasing costs, the degree of specialization is determined only by considering society’s
preferences as illustrated with indifference curves. However, in the same model, it is possible
to determine the post-trade consumption point in each country without indifference curves.”
POSSIBLE RESPONSE: The community indifference curves reflect the preferences of the
country’s consumers for consumption of both goods. With or without trade, the production
decision of a country will depend on the technology and the available factors of production
(production possibilities curve), on the one hand, and the preferences of the consumers
toward the consumption of the two goods (indifference curves) on the other hand.
Without a free trade the consumption point coincides with the production. When international
trade is allowed, the consumption point does not coincide with the production point anymore,
but reflects both production and trade. It is not possible to determine post-trade consumption
in each country without indifference curves as we will not know which consumption point is
preferred by the consumers in the country.

64. Assume a two-country, two-good, two-factor of production world with the countries being
the United States and the Rest of the World, the two goods being steel and wheat, and the two
factors of production being capital and land. Further assume that the United States is capital-
abundant and steel production is capital-intensive. Suppose that in autarky the United States
operates at a point on its production possibilities curve where it produces 20 units of wheat
and 20 units of steel. Once international trade opens, the international price of one unit of
steel is two units of wheat. In response to the opening of trade the United States moves along
its production possibilities curve to a new point where it produces 30 units of steel and 10
units of wheat. Is the United States better-off following the opening of trade? Provide a
logical proof of your answer.
POSSIBLE RESPONSE: The opening of trade allows the United States to (partially)
specialize in the production of steel because steel is capital intensive and the United States is
capital abundant. We need to compare the well-being of the United States in the case of
autarky to the case of free trade. In autarky the United States would consume 20 units of steel
and 20 units of wheat.
When free trade is allowed, the United States can extend the production of steel to 30 units,
that is, by 10 units. The foregone wheat is also 10 units; the production of wheat goes down
from 20 to 10 units. But the United States can exchange steel for wheat in the proportion 1
unit of steel for 2 units of wheat. If the United States would sell the 10 more units of steel
produced for 20 units of wheat, the United States would end up in a situation in which it
consumes 30 units of wheat and 20 units of steel. This is better than the autarky situation of
only 20 units of wheat and 20 units of steel. The country is thus better off in the case of free
trade.

65. As a result of the North American Free Trade Agreement (NAFTA), trade restrictions
between Canada, the United States, and Mexico were eased and cross-border trade increased.
What predictions would the Heckscher-Ohlin model make concerning the changes in labor-
intensive industries such as textiles in both Mexico and the United States and in capital-
 intensive-industries such as steel production in both Mexico and the United States as a result
of NAFTA?
POSSIBLE RESPONSE: The Heckscher-Ohlin model predicts that free trade will allow
countries to specialize in the production of goods that intensively use their relatively
abundant factors of production. Applied to NAFTA, the Heckscher-Ohlin model implies that
Mexico will extend its production in industries such as textiles as they require the intensive
use of labor. The United States, on the other hand, will expand its production of steel, which
is a capital-intensive industry.

66. Explain how tastes or preferences can reverse the predictions made by the Heckscher-Ohlin
trade model so that, for example, labor-abundant countries import labor-intensive goods.
POSSIBLE RESPONSE: The production decision of a country depends not only on the
available factors of production, but also on the technology of the country, and the preferences
of the consumers within the country. The preferences of consumers of this country as well as
other countries define the international demand for a product. Conversely, factor availability,
and technology define the international supply of a product. If consumers within a country
value labor-intensive goods so much that the marginal satisfaction of this product is higher
than the opportunity cost of production, then it possible that this country consumes more than
their own production of labor-intensive goods, which means the country is importing these
goods from other countries.

67. Using the concepts of community indifference curves and production possibilities frontier,
explain how the international price of a good is determined in the Heckscher-Ohlin two
goods model. What is the unit of measurement for the price of a good in this model?
POSSIBLE RESPONSE: The production possibilities curve (ppc) illustrates the maximal
quantities of two goods that a country can produce with full employment of its resources.
What combination of quantities along the ppc producers will eventually decide to produce
depends on the relative price of the good (the price is expressed in units of the other good). A
community indifference curve indicates all combinations of quantities of the two goods,
which provide the same satisfaction to the community. The ppc can be used to derive the
marginal cost of a product (expressed in units of the other product to be given up), which
defines the supply of this product. The system of indifference curves can be used to derive
the demand of the product. The international price of a good in the Hecksher-Olin model is
determined in such a way, that the excess supply in one of the countries is matched by the
shortage (excess demand) in the other country. The first country exports the good in
exchange for importing the other good.

68. Explain why the Heckscher-Olin model predicts only partial specialization in the production
of two goods, while Ricardo’s comparative advantage model predicts full specialization.
POSSIBLE RESPONSE: Ricardo considered only labor as a production resource and
believed that production has constant costs. That is, to double production, the producer just
needs to employ twice as much labor. The opportunity cost in Ricardo’s model is constant,
which implies that the production possibilities curve is a straight line. Assume that a country
faces a relative international price of a product that is, let’s say, lower than the opportunity
cost of production of that product. That means, it is cheaper to buy that product at
international market in exchange for the other product rather than use their own labor for
producing it. Their own labor will be more efficiently employed in the production of the
other product. Because the marginal cost is the same no matter how much of both products is
produced, the country specializes fully in the production of the product that has a lower
opportunity cost compared to the international price, and exchanges it for the other at the
international market.
This is the major difference to the Heckscher-Ohlin model. In this model, opportunity cost is
increasing, so there will be a certain quantity combination of the two goods along the
production possibilities curve, for which opportunity cost matches the relative (international)
price. This is the optimal combination of production quantities for the country.