Question 1

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 2

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's theory of reciprocal demand explains how the equilibrium terms of trade are determined by the relative domestic demand for goods in each trading country, implying that knowing these demands allows for the determination of equilibrium terms of trade.

Question 3

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 statement accurately describes the limitations of the Ricardian theory of comparative advantage.

Question 4

When testing the Ricardian theory of comparative advantage in 1951, MacDougall found that nations tend to export goods in which their labor productivity is relatively high.

Accepted Answer

This statement is true according to MacDougall's findings when testing the Ricardian theory of comparative advantage in 1951.

Question 5

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 6

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

When the international terms of trade coincide with one country's cost ratio, it does not mean that this country realizes all the gains from trade. Both countries can still benefit from trade due to the principle of comparative advantage, which allows for gains to be shared between trading partners, even if the terms of trade are more favorable to one side.

Question 7

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

Accepted Answer

If a country's terms of trade worsen, it means the country must exchange more exports for a given amount of imports, indicating a decrease in the value of its exports relative to its imports.

Question 8

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 9

A nation realizes maximum gains from trade at the point where the international terms-of-trade line is tangent to its community indifference curve.

Accepted Answer

This statement is true because when the international terms-of-trade line is tangent to the community indifference curve, the nation is able to specialize in the production of goods and services that it has a comparative advantage in and trade with other nations for goods and services that it lacks a comparative advantage in, thereby maximizing gains from trade.

Question 10

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 11

The Ricardian theory of comparative advantage could fully explain the distribution of the gains from trade among trading partners.

Accepted Answer

The Ricardian theory of comparative advantage explains why trade happens but does not fully account for the distribution of gains from trade among partners, as it simplifies many real-world factors such as technology differences, factor endowments, and trade barriers.

Question 12

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

If the international terms of trade align with Canada's cost ratio, it means that the trade terms are equivalent to Canada's opportunity cost. Therefore, the U.S. benefits by trading at Canada's cost, capturing all potential gains from trade.

Question 13

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

Accepted Answer

The theory of reciprocal demand suggests that as the U.S. demand for Canadian wheat rises, the equilibrium terms of trade would actually improve for Canada, not the United States, because the U.S. would be willing to offer more for the wheat, reflecting a higher demand.

Question 14

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

An improvement in a nation's terms of trade is defined as an increase in the ratio of export prices to import prices. This means that if the prices of exports rise relative to imports, the nation's terms of trade have improved.

Question 15

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 16

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 assumes that two countries are of equal economic size and have a noticeable impact on market prices.

Question 17

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 18

A nation benefits from international trade if it can achieve a higher indifference curve than it can in autarky.

Accepted Answer

By engaging in international trade, a nation can consume goods from other countries that it cannot produce domestically or can produce at a higher cost. This allows the nation to move to a higher indifference curve, meaning it can achieve a higher level of satisfaction or well-being.

Question 19

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

Accepted Answer

The production possibilities frontier shows the maximum amount of goods that a country can produce with its limited resources. The domestic cost ratios, which refer to the opportunity cost of producing one good in terms of another, determine the relative prices of goods and services in the economy. The terms of trade, or the ratio of export prices to import prices, will tend to settle between the opportunity costs of the two trading partners. Therefore, the domestic cost ratios set the outer limits to the equilibrium terms of trade.

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 statement is true according to the theory of comparative advantage, which states that countries can benefit from trading with each other if they specialize in producing the goods they have a comparative advantage in and trade with other countries for goods they don't produce as efficiently. The equilibrium terms of trade should reflect the relative domestic costs of production for each country, as this ensures that both parties benefit from the trade.

Quiz 2: Foundations of Modern Trade Theory Comparative Advantage