Question 1

Adam Smith's theory of absolute advantage is based on the labor theory of value.

Accepted Answer

Adam Smith believed that a country should specialize in producing goods that it can produce more efficiently or with lower opportunity costs than other countries. He believed that labor was the primary source of value and thus countries should produce goods where they possess absolute advantage in labor productivity.

Question 2

Briefly discuss the primary features of the mercantilist philosophy. Mention any two major criticisms of the mercantilist theory as put forward by Adam Smith and other economists.

Accepted Answer

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Question 3

Explain how products produced by high-wage workers in the United States can compete with the products manufactured in countries whose workers earn much lower wages.

Accepted Answer

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Question 4

In the two-country two-good model, both countries can gain from trade as long as their relative advantages and disadvantages in producing different goods are different.

Accepted Answer

If the relative advantages and disadvantages in producing different goods are the same in both countries, then there would be no incentive for trade as both countries would produce the same goods at the same cost. However, if the countries have different relative advantages and disadvantages, then they can specialize in the production of the goods that they are relatively better at producing and trade with each other. This allows both countries to consume more of both goods than if they were producing everything themselves.

Question 5

The opportunity cost of producing a good is the additional labor cost incurred to produce an extra unit of the good.

Accepted Answer

The opportunity cost of producing a good is the value of the next best alternative forgone when resources are used to produce that good. It is not necessarily just the additional labor cost.

Question 6

In a two-country two-good model, if a country has an absolute advantage in the production of a certain good, it implies that:
A)it is not possible that this country can gain by importing this good from the other country.
B)this country also has a comparative advantage in the production of this good.
C)it has greater resources than the other country.
D)this country has higher labor productivity in the production of this good.

Accepted Answer

Absolute advantage refers to a country's ability to produce a good using fewer resources (including labor) than another country. Therefore, if a country has an absolute advantage in the production of a certain good, it implies that it has higher labor productivity in the production of this good. This does not necessarily mean that the country also has a comparative advantage in the production of this good, as comparative advantage takes into account the opportunity cost of producing one good over another. Therefore, choice B is not necessarily true. Choices A and C are also incorrect, as having an absolute advantage does not necessarily mean that it is not possible or that the country has greater resources than the other country.

Question 7

Mercantilists believed that a country gains from international trade only at the expense of another country or countries.

Accepted Answer

Mercantilists believed in a zero-sum game of international trade, where one country's gain was always at the expense of another country or countries.

Question 8

Using relevant diagrams, illustrate a two-country two-good model in which one country has an absolute advantage in the production of both goods, but each has a comparative advantage in the production of only one good.

Accepted Answer

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Question 9

In a two-country two-commodity model, if a country has higher labor productivity in producing both the goods, it must produce and export both the goods to the other country.

Accepted Answer

According to the theory of comparative advantage, a country will specialize in producing and exporting the good for which it has a comparative advantage (i.e., the good it can produce at a lower opportunity cost), not necessarily every good for which it has an absolute productivity advantage.

Question 10

Arbitrage is the act of buying at one place and selling at another place in order to profit from the price differences that exist between the two places.

Accepted Answer

This statement accurately describes what arbitrage is.

Question 11

With the help of a suitable diagram, explain how in a two-country two commodity model, one of the countries may fail to specialize completely despite enjoying comparative advantage in one of the goods.

Accepted Answer

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Question 12

Explain how a mutually beneficial trade is possible in a two-country two-good model even when one of the countries has absolute advantage in the production of both the commodities.

Accepted Answer

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Question 13

The production-possibility curve shows various bundles of quantities of two goods that lead to the same level of well-being to the consumers.

Accepted Answer

The production-possibility curve shows the various combinations of two goods that a producer can produce using the same factors of production and technology. It does not necessarily indicate the level of well-being for the consumers.

Question 14

The act of buying at a low price in one place and selling at a high price in another place is called relative pricing.

Accepted Answer

The act of buying at a low price in one place and selling at a high price in another place is called arbitrage. Relative pricing refers to the comparison of prices between different goods or services.

Question 15

If country X has a higher labor productivity than the rest of the world in the production of a good, then country X has a comparative advantage in the production of the good.

Accepted Answer

Comparative advantage is determined not by absolute productivity but by the opportunity cost of producing a good relative to other goods. A country can have higher labor productivity in a good but still lack a comparative advantage if it has an even higher productivity in producing another good.

Question 16

According to the theory of comparative advantage, trade will not occur if one country is less efficient in the production of all products.

Accepted Answer

The theory of comparative advantage states that trade can still occur between two countries even if one country is less efficient in producing all products, as long as each country specializes in producing the goods for which they have the lowest opportunity cost. This allows both countries to benefit from trade by obtaining goods at a lower opportunity cost than if they were to produce everything domestically.

Question 17

In a two-country two-good model, if a country has a comparative advantage in the production of a certain good, it implies that this country:
A)also has an absolute advantage in the production of this good.
B)will start importing this good from the other country.
C)can produce this good at a lower opportunity cost than the other country.
D)uses most of its resources in the production of this good .

Accepted Answer

Comparative advantage means that a country can produce a certain good at a lower opportunity cost than another country. This does not necessarily imply absolute advantage or that the country will start importing the good from another country. It also does not mean that the country uses most of its resources in the production of this good, only that it can produce it at a lower opportunity cost.

Question 18

Straight-line production-possibility curves indicate that the opportunity cost of producing additional units of each good is constant.

Accepted Answer

Straight-line production-possibility curves show that there is a constant opportunity cost between producing each good. This means that the amount of one good that must be given up to increase production of the other good stays the same no matter how much of each good is being produced.

Question 19

If a country does not have an absolute advantage in the production of at least one commodity, then it cannot gain from free trade.

Accepted Answer

Even if a country does not have an absolute advantage in the production of any commodity, it can still benefit from free trade by specializing in the production of goods and services in which it has a comparative advantage and trading with other countries. Comparative advantage is determined by the opportunity cost of production, rather than the absolute level of productivity. Therefore, countries can still gain from free trade by focusing on producing and exporting goods and services that they can produce at a relatively lower opportunity cost.

Quiz 3: Why Everybody Trades: Comparative Advantage