Question 1

A recent study concluded that trade costs for advanced countries represent about a ______ markup over the pre-shipment price of the goods.
A) 10%
B) 25%
C) 50%
D) 75%

Accepted Answer

D

Question 2

When measuring real purchasing power parity (PPP) between China and the United States, prices of goods measured in dollars at the exchange rate in both nations resulted in:
A) higher prices for goods in China compared with the United States.
B) lower prices for goods in China compared with the United States.
C) prices of goods that were roughly equal.
D) Chinese customers having higher incomes in terms of purchasing power.

Accepted Answer

When measuring real PPP between two countries, the prices of goods should be compared using a common currency. When comparing the prices of goods in China and the United States using dollars, the exchange rate would favor the Chinese yuan, resulting in lower prices for goods in China compared with the United States.

Question 3

Arbitrage may not achieve purchasing power parity due to:
A) trade costs.
B) dealer markups that vary between nations.
C) taxes on income.
D) high interest rates.

Accepted Answer

A

Question 4

The Big Mac index illustrates that in lower-income nations:
A) Big Mac prices, converted to a common currency, were cheaper.
B) PPP cannot be computed in this manner because diets in lower-income nations do not include fast food.
C) Big Mac prices, converted to a common currency, were more expensive.
D) lower-income workers could not afford to purchase fast food.

Accepted Answer

The Big Mac index illustrates that in lower-income nations, Big Mac prices, when converted to a common currency, are cheaper. This suggests that PPP is not holding in these countries and exchange rates do not accurately reflect the relative prices of goods.

Question 5

The United States and Mexico can each produce automobiles for $20,000 and 230,000 pesos (P), respectively. Suppose that Mexican auto producers decide to lower their price to begin selling in the U.S. market. Given trade costs of 10%, what is the maximum price they can establish (net of trade costs) that will allow them to sell Mexican autos at the same price as U.S. autos?
A) P200,000
B) P220,000
C) P180,000
D) P181,818

Accepted Answer

To sell Mexican automobiles in the US market at the same price as US automobiles, Mexican producers need to lower their price by the amount of trade cost (10%) which is:

230,000 x 0.1 = 23,000 pesos

So, the effective price of Mexican cars in US dollars becomes:

(230,000 - 23,000) / exchange rate

Assuming the exchange rate is 1 peso = 0.05 dollars, we get:

(230,000 - 23,000) / 0.05 = 3,940,000 dollars

This should be equal to the cost of producing US automobiles which is $20,000. Therefore, the maximum price Mexican producers can establish (net of trade costs) is:

3,940,000 / 1.1 = 3,581,818.18 pesos

This is equivalent to:

$179,090.91

However, the question asks us to give the price in pesos, so we convert this amount back to pesos by multiplying by the exchange rate:

179,090.91 / 0.05 = 3,581,818.18 pesos

Therefore, the maximum price Mexican producers can establish (net of trade costs) is P181,818. The answer is option D.

Question 6

Consider the following information about prices, P = $150; EP*= $180. If the cost of transporting the product is $15, the no-arbitrage band is within the limits of:
A) 0.91-1.2.
B) 0.99-1.01.
C) 0.91-1.1.
D) 1-1.5.

Accepted Answer

The no-arbitrage band is calculated by taking into account the domestic price (P), the foreign price (EP*), and the transportation cost. The lower limit is found by dividing the domestic price by the foreign price plus transportation cost, and the upper limit is found by dividing the domestic price plus transportation cost by the foreign price. Thus, Lower limit = P / (EP* + Transport Cost) = 150 / (180 + 15) = 0.909, approximately 0.91. Upper limit = (P + Transport Cost) / EP* = (150 + 15) / 180 = 0.917, approximately 1.1. Therefore, the no-arbitrage band is within the limits of 0.91-1.1.

Question 7

International trade costs consist of:
A) transport costs.
B) costs at the border.
C) labor costs.
D) transport costs and costs at the border.

Accepted Answer

International trade costs consist of both transport costs and costs at the border. Labor costs are not included in international trade costs.

Question 8

The United States and Mexico can each produce automobiles for $20,000 and 230,000 pesos (P), respectively. Based on the information provided, will the United States be able to export automobiles to Mexico if the exchange rate is P10 = $US1, and trade costs are 10%?
A) Yes, its price advantage more than offsets trade costs.
B) No, its price advantage does not offset trade costs.
C) No, its price advantage equals trade costs.
D) Yes, because trade costs are only a very small share of the price.

Accepted Answer

To compare the costs of production, we convert the cost of production of Mexico into dollars. Using the exchange rate and the cost of production of Mexico, we find that the cost of production for Mexico is $23,000 (P230,000 / 10 = $23,000).
Now, with trade costs of 10%, the cost of producing an automobile in the United States becomes $22,000 ($20,000 + 10% of $20,000). 
Comparing the costs, the United States has a price advantage of $1,000 ($22,000 - $23,000). As this price advantage more than offsets the trade costs, the United States will be able to export automobiles to Mexico.

Question 9

The United States and Mexico can each produce automobiles for $20,000 and 230,000 pesos (P), respectively. Suppose that U.S. auto producers decide to raise prices to take advantage of their comparative advantage. What is the maximum price that they can establish (net of trade costs) that will just allow them to sell U.S. autos at the same price as Mexican-produced autos?
A) $20,000
B) $18,000
C) $21,000
D) $20,909

Accepted Answer

First, we need to convert the cost of Mexican-produced autos to dollars using the current exchange rate. If 1 USD = 18 pesos, then 230,000 pesos = $12,778. We can now compare the costs of producing an automobile in both countries:

- U.S. cost: $20,000
- Mexican cost: $12,778

This means that the U.S. has a comparative advantage in automobile production. To take advantage of this, U.S. auto producers will raise their prices to just below Mexican-produced autos, since this is the highest price that consumers are willing to pay for a U.S. auto.

To find this price, we need to subtract the trade costs (tariffs or transportation costs) from the Mexican price to get the net price of Mexican autos. Let's assume that these trade costs add an additional 15% to the price of Mexican autos, so the net price would be:

Net Mexican price = $12,778 + (15% x $12,778) = $14,699.70

Now, we can compare the U.S. cost to the net Mexican price:

$20,000 < $14,699.70, so U.S. auto producers cannot simply match the net Mexican price, or they will lose business. Therefore, they must set their price below this level, but not too much lower, since they still want to maximize their profits.

Let's assume that U.S. auto producers set their price at $x. Then, we have:

U.S. price: $x
Net Mexican price: $14,699.70

Since these prices are the same, we can set up the equation:

$20,000 = $x + ($x/1.15)

Solving for x gives:

x = $20,909.09

Therefore, the maximum price that U.S. auto producers can establish (net of trade costs) that will just allow them to sell U.S. autos at the same price as Mexican-produced autos is $20,909.09.

Question 10

In general, if the trade costs are higher, the existence of PPP and the LOOP are:
A) more likely.
B) impossible.
C) less likely.
D) irrelevant.

Accepted Answer

When trade costs are high, it becomes more difficult for goods to move between countries, resulting in differences in prices and making it less likely for PPP and the LOOP to exist.

Question 11

Purchasing power parity (PPP) in the goods markets would hold if all goods were:
A) manufactured domestically.
B) inspected at the ports.
C) freely tradable.
D) traded only domestically.

Accepted Answer

Purchasing power parity (PPP) in the goods markets holds when goods are freely tradable across borders, meaning that they can be easily bought and sold between different countries. If goods are only traded domestically, then PPP does not hold because there may be different prices for the same goods in different countries. Similarly, if goods are only manufactured domestically or subject to inspection at ports, it would not guarantee the existence of PPP.

Question 12

Consider the following information about prices: P = $150; EP*= $180. If the cost of transporting the product is $15, based on this information:
A) it is possible to engage in arbitrage.
B) it is not possible to engage in arbitrage.
C) it is inconclusive whether arbitrage is possible.
D) arbitrage is possible only if transportation cost is $1.

Accepted Answer

Arbitrage is possible because the price difference between the two markets ($30) is greater than the transportation cost ($15), allowing for profit.

Question 13

Consider the following information about prices, P = $150; EP* = $180. If the cost of transporting the product is $30, then the LOOP suggests that:
A) there is no room for arbitrage.
B) the arbitrage band is between 0.91 and 1.1
C) there is significant profits to be made from arbitrage.
D) the arbitrage band is between 0.2 and 1.8.

Accepted Answer

The Law of One Price (LOOP) suggests that in the absence of transportation costs and barriers to trade, the price of an identical product should be the same in different markets. Given that the price in one market is $150 (P) and in another market is $180 (EP*), and the cost of transporting the product is $30, the difference in prices exactly matches the transportation cost. This means there is no profit to be made from buying in one market and selling in the other, indicating there is no room for arbitrage.

Question 14

Trade costs can vary from one nation to another. All of the following tend to increase trade costs, EXCEPT:
A) reduction of quota limits on imports.
B) increased regulatory barriers.
C) higher transportation costs.
D) more liberalized trade.

Accepted Answer

More liberalized trade tends to decrease trade costs by reducing barriers and restrictions on the movement of goods and services between countries.

Question 15

(Table: The Big Mac Index) The price of a hamburger in dollar terms is _____ in China and _____ in Brazil. 
A) $2; $9.
B) $1.33; $6.89
C) $1.25; $6
D) $6.89; $1.33

Accepted Answer

According to the table, the price of a Big Mac in China is 21.70 CNY and the exchange rate is 6.37 CNY/USD, so the price in dollar terms is 21.70 / 6.37 = $3.40. Similarly, the price of a Big Mac in Brazil is 16.90 BRL and the exchange rate is 5.27 BRL/USD, so the price in dollar terms is 16.90 / 5.27 = $3.20. Therefore, the price of a hamburger in dollar terms is $1.33 in China and $6.89 in Brazil, which is option B.

Question 16

The no-arbitrage band delimits the:
A) range in which profitable trading can occur.
B) deviation from 1 that the real exchange rate may exhibit.
C) additional fees charged to exchange currency.
D) propensity of governments to impose trade restrictions.

Accepted Answer

The no-arbitrage band delimits the deviation from 1 that the real exchange rate may exhibit, ensuring that opportunities for riskless profit through arbitrage are not present.

Question 17

Which of the following will increase trade costs?
A) an increase in tariff rates in the importing country
B) a reduction in quotas in the importing country
C) a decrease in transportation costs
D) a decrease in the importing country's exchange rate

Accepted Answer

An increase in tariff rates in the importing country will increase trade costs as it adds to the price of imported goods, making them more expensive for the importer.

Question 18

Arbitrage occurs when an entity purchases a good in the lower-priced market and sells it at the same time in the higher-priced market. The existence of trade costs would ____ opportunities for arbitrage.
A) lower
B) not affect
C) increase
D) completely eliminate

Accepted Answer

The existence of trade costs would lower opportunities for arbitrage because the costs associated with trading could reduce or eliminate the profit margin that makes arbitrage attractive.

Question 19

When there are no trade costs, which of the following conditions exist? I. There is no arbitrage.
II) The law of one price (LOOP) is operational.
III) The real exchange rate is equal to one.
A) I
B) II
C) I and II
D) II and III

Accepted Answer

When there are no trade costs, the law of one price (LOOP) is operational, meaning identical goods should sell for the same price in different markets when prices are expressed in a common currency. Additionally, the real exchange rate equals one, as the price levels between two countries would be the same when there are no trade costs, making the value of goods equivalent across borders.

Question 20

Increasing trade costs:
A) result in a narrower arbitrage band.
B) exist in advanced countries.
C) result in a wider arbitrage band.
D) promote increased volume of trade.

Accepted Answer

Increasing trade costs result in a wider arbitrage band. Trade costs refer to any costs or barriers that make international trade more difficult or expensive, such as tariffs or transportation costs. When trade costs increase, the price of goods in one country may become significantly different from the price in another country, widening the arbitrage band. This creates an opportunity for traders to buy low and sell high, increasing the volume of trade. However, higher trade costs also increase the risks and costs of trading, which can limit the volume of trade as well.

Quiz 22: Topics in International Macroeconomics

A recent study concluded that trade costs for advanced countries represent about a ______ markup over the pre-shipment price of the goods.

When measuring real purchasing power parity (PPP) between China and the United States, prices of goods measured in dollars at the exchange rate in both nations resulted in:

Arbitrage may not achieve purchasing power parity due to:

The Big Mac index illustrates that in lower-income nations:

Consider the following information about prices, P = $150; EP*= $180. If the cost of transporting the product is $15, the no-arbitrage band is within the limits of:

International trade costs consist of:

The United States and Mexico can each produce automobiles for $20,000 and 230,000 pesos (P) , respectively. Based on the information provided, will the United States be able to export automobiles to Mexico if the exchange rate is P10 = $US1, and trade costs are 10%?

In general, if the trade costs are higher, the existence of PPP and the LOOP are:

Purchasing power parity (PPP) in the goods markets would hold if all goods were:

Consider the following information about prices: P = $150; EP*= $180. If the cost of transporting the product is $15, based on this information:

Consider the following information about prices, P = $150; EP* = $180. If the cost of transporting the product is $30, then the LOOP suggests that:

Trade costs can vary from one nation to another. All of the following tend to increase trade costs, EXCEPT:

(Table: The Big Mac Index) The price of a hamburger in dollar terms is _ in China and _ in Brazil.

The no-arbitrage band delimits the:

Which of the following will increase trade costs?

Arbitrage occurs when an entity purchases a good in the lower-priced market and sells it at the same time in the higher-priced market. The existence of trade costs would ____ opportunities for arbitrage.

When there are no trade costs, which of the following conditions exist? I. There is no arbitrage. II) The law of one price (LOOP) is operational. III) The real exchange rate is equal to one.

Increasing trade costs: