SAEF

ECONOMICS 3: Westville Campus

ECON306W1

INTERNATIONAL ECONOMICS
CLASS TEST 1: 20 March 2014

DURATION: 90 MINUTES TOTAL MARKS: 60

______________________________________________________

INSTRUCTIONS TO CANDIDATES:

THIS TEST CONSISTS OF TWO SECTIONS:

Section A: Short Questions Mark Allocation: 30

Suggested Time: 45 mins
Answer EITHER question 1 OR 2.

Section B: Multiple Choice Questions Mark Allocation: 30

Suggested Time: 45 mins

Answer all 15 questions.

No negative marks will be awarded.
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 2

SECTION A: SHORT PROBLEMS

Answer ANY 1 of the following 2 questions:

Question 1

(a) The Specific Factor model supposes the world is made of two regions: South and
North. South is a small land-abundant region, while North is capital-abundant. Both
South and North produce two goods: food and manufacturers. Food is land-intensive
whilst manufactures are capital-intensive in production. Both regions have a similar
labour forces and labour is used in the production of both food and manufactures.

What is the effect of import tariffs imposed by the South on the North on the returns
to each of the South’s factors of production? Explain which factors gain and which lose
and why. (10)

(b) The fixed costs for a firm in the car industry are 5000,000,000 euros and the marginal
cost to produce an extra car is 17,000 euros. The mathematical function that relates the
price for a car to the number of firms in the industry is P=17,000+(150/n), where n
represents the number of firms. The initial size of the market in the USA is
300,000,000 cars and in the EU 534,000,000 cars.

Calculate the number of firms and the equilibrium price per car that correspond to the
integrated car market in the case that the economies trade freely with one another. (10)

(c) Unlike many resource-rich countries, South Africa has a strong base in manufacturing,
requiring strong technological knowledge. Over time, exports have been shifting
increasingly toward medium- and high-technology sectors, with corresponding demand
for high skills and capital investment. By contrast, exports have performed less well in
manufacturing sectors that are labour- and (in some cases) material-intensive. The
factor content of South Africa’s exports reveals that exports are concentrated in
products with human capital and physical capital intensity far beyond those in South
Africa’s endowment. The bad news is that this Leontief type mismatch with
endowments suggests South Africa’s export position reflects a strategic response to
domestic constraints rather than a strategy following comparative advantage. Explain
this statement with reference to the Heckscher-Ohlin theory and South Africa’s
resource and trade position. (10)

Total Marks: 30
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 3

Question 2

(a) Consider a world with two countries (Switzerland and Germany) producing two goods
(watches and cellphones) with two production factors (labour and capital). Technology
of production is the same in the two countries. The production of one watch requires 10
units of labour and 2 units of capital; however, the production of one cellphone requires
5 units of labour and 2 units of capital. Switzerland has 6000 units of labour and 2000
units of capital. Germany has 12000 units of labour and 2500 units of capital.

Determine the pattern of trade between the two countries and explain why in
Switzerland the owners of capital will be better off with trade. (10)

(b) ‘A large country has a greater incentive than a small country to use import tariffs’. True
or false. Evaluate this statement with the aid of a well-drawn partial equilibrium
framework diagram. (10)

(c) Unlike many resource-rich countries, South Africa has a strong base in manufacturing,
requiring strong technological knowledge. Over time, exports have been shifting
increasingly toward medium- and high-technology sectors, with corresponding demand
for high skills and capital investment. By contrast, exports have performed less well in
manufacturing sectors that are labour- and (in some cases) material-intensive. The factor
content of South Africa’s exports reveals that exports are concentrated in products with
human capital and physical capital intensity far beyond those in South Africa’s
endowment. Could this Leontief type finding for South Africa’s export position be
explained by either the phenomena of factor-intensity or demand reversals? Explain. (10)

Total Marks: 30
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 4

SECTION B: MULTIPLE CHOICE QUESTIONS

1. Use the equation for the gravity model and the table’s hypothetical data:

Country GDP Distance from Distance from

Angola: Botswana:
Angola $20 billion ______ 5000km
Botswana $10 billion 5000km ______
Cameroon $_____ 10000km 5000km

The predicted volume of trade between Angola and Botswana is ______. If Cameroon has
the same trading volume with Angola as does Botswana, Cameroon’s GDP must be equal to
______.

(a) $2,000 million; $500 million

(b) $1 billion; $100 million
(c) $5 billion; $250,000
(d) $10 billion; $4 million
(e) $20 billion; $40 million

2. The table below shows the unit labour requirements to produce four goods in Canada and
Colombia:

Unit Labour Requirements in Canada and Colombia

Good Canada (aL;i) Columbia (a*L;i)
Coffee 10 1
Cut Flowers 3 3
Industrial 4 20
Machinery
Timber 1 6

The wage rate in Canada (w) is US$16, whilst the wage rate in Colombia (w*) is US$4.
Assume also that transportation costs are 50% of production cost. What will the pattern of
trade be?

(a) Canada will export timber and industrial machinery and import cut flowers and coffee.
(b) Canada will export timber and import cut flowers and coffee, whilst industrial
machinery will not be traded.
(c) Canada will import industrial machinery, cut flowers and coffee, whilst timber will not
be traded.
(d) Canada will import cut flowers and coffee, whilst timber and industrial machinery will
not be traded.
(e) All goods will not be traded due to the high transport costs.
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 5

Use the following information to answer questions 3 and 4:

For two countries, Brazil and Kenya, the top row of the table shows the wages of labour, both
expressed in U.S. dollars, when they are engaged in free international trade. Below that are
shown the labour availability and quantities of labour that each requires, in a Ricardian model,
to produce two goods, coffee and tea.

Brazil Kenya
Wage $25 $10
Available labour: 2400 800
Unit labour requirements:
Coffee 3 5
Tea 2 1

3. In this free-trade equilibrium, what is the U.S. dollar price that consumers in Kenya pay for
coffee?
(a) $5
(b) $10
(c) $25
(d) $50
(e) $75

4. If the free-trade relative price of coffee to tea (Pc/Pt) is 2, what is the relative quantity of
coffee to tea (Qc/Qt) that is traded at this price?
(a) 800
(b) 400
(c) 1
(d) 0.5
(e) 0.75

5. In a study of South African international cost competitiveness and exports, the authors
Golub and Edwards (2003) find that:
(a) Relative wages are more important determinants of South African exports than relative
productivity.
(b) Relative productivity levels are more important determinants of South African exports
than relative wages.
(c) South African rapid export growth in the 1990s cannot be explained by improvements in
unit labour costs of production.
(d) South African industry level rankings of competitiveness are easily identified with
observable characteristics and do not change substantially over time.
(e) Government should favour certain industrial sectors over others since the process of
picking winners on the basis of competitive unit labour costs and industry characteristics
is an easy task.
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 6

6. Refer to the following figure:

Which of the following statements is TRUE?

(a) In the real world, national wage rates reflect differences in productivity levels and hence
provide a basis for trade between nations.
(b) In the real world, labour productivity differences do NOT provide a basis for trade
between nations as suggested by the Ricardian model.
(c) In the real world, a nation’s ability to compete internationally depends only on the level
of its wage rates relative to its productivity levels.
(d) In the real world, if national wages are exactly proportional to productivity levels then
no country has a comparative advantage and there is no basis for trade.
(e) In the real world, the cost of high wages cannot be offset by high productivity levels and
hence there is no basis for trade between nations.

Answer question 7 using the following information pertaining to the automobile industry in the
Republic of Korea (a small developing country):

World price of automobile $ 8000

Cost of imported parts $ 6000
Cost of local parts $ 10000
Tariff on automobiles 25%
Tariff on parts 10%

7. If the government of the Republic of Korea enforces a 50% local content requirement on
automobile parts, the effective rate of protection (ERPj) for the automobile industry is:
(a) 1.00
(b) 0.50
(c) 0.15
(d) 0.00
(e) -0.15
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 7

8. Suppose Australia, a land (T)-abundant country, and Sri-Lanka, a labour(L)-abundant

country, both produce labour and land intensive goods with the same technology.

T/L

According to the Heckscher-Ohlin theory, based upon the above figure, trade between the
two countries would result in _______ exporting cloth and the relative income of workers in
Australia to _______ as a result of trade.
(a) Sri Lanka; fall
(b) Sri Lanka; rise
(c) Australia; fall
(d) Australia; rise
(e) Either country; remain unchanged

9. If human capital is physically the most abundant resource in Japan, Japan’s high usage of
natural resources in the manufacture of its exports could in accordance with the Leontief
paradox be explained by?
(a) relatively high Japanese tariffs on human capital-intensive imports.
(b) relatively low Japanese tariffs on natural resource-intensive imports.
(c) Japan’s importation of goods that are unskilled labour-intensive in their production.
(d) a strong Japanese demand for relatively human capital-intensive goods, coupled with a
weak foreign demand for relatively natural resource- intensive goods.
(e) a weak Japanese demand for relatively human capital-intensive goods, coupled with a
strong foreign demand for relatively natural resource- intensive goods.
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 8

Consider the following figure and answer question 10:

10. Given the relative factor endowments of the countries shown in the figure, which of the
following is TRUE for Switzerland?
(a) Capital is the factor that Switzerland is most scarcely endowed with.
(b) Land is the factor that Switzerland is most richly endowed with.
(c) Capital-intensive goods could be either exported or imported by Switzerland depending
upon demand conditions for this factor of production.
(d) Switzerland’s exportation of land-intensive goods would be consistent with a “Leontief
type” prediction of its trade patterns.
(e) Switzerland’s importation of capital-intensive goods would be consistent with a
“Heckscher-Ohlin” prediction of its trade patterns.

11. Suppose that fixed costs for a firm in the automobile industry (start-up costs of factories,
capital equipment, and so on) are $5 billion and that variable costs are equal to $17,000 per
finished automobile. Because more firms increase competition in the market, the market
price falls as more firms enter an automobile market, or specifically P = 17,000 + (150/n),
where n represents the number of firms in a market. Assume that the initial size of the U.S.
and the European automobile markets are 300 million and 533 million people, respectively.

Now suppose that the United States decides on free trade in automobiles with Europe. The
trade agreement with the Europeans adds 533 million consumers to the automobile market,
in addition to the 300 million in the United States. How many automobile firms will there
be in the United States and in Europe combined? What will be the new equilibrium price of
automobiles?
(a) firms=2; price=$17,075.00
(b) firms=3; price=$17,050.00
(c) firms=4; price=$17,037.50
(d) firms=5; price=$17,030.00
(e) firms=6; price=$17,000.00
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 9

12. In the presence of factor-intensity reversals as depicted in the following figure:

(a) The countries will trade goods in accordance with the predictions of the Heckscher-
Ohlin theorem.
(b) The Stolper Samuelson theorem will predict gains for a country’s scarce factor and loses
for a country’s abundant factor in the presence of free trade.
(c) Free trade will equalise both relative factor prices and the absolute returns to
homogenous factors across countries.
(d) Free trade will equalise only relative factor prices but not the absolute returns to
homogenous factors across countries.
(e) A Leontief paradox scenario with respect to the pattern of trade is impossible.

13. The chart below shows the worldwide income inequality results of the Dollar & Kraay
(2001) study:

Chart 3
The globalizers and worldwide inequality
Worldwide inequality across individuals

Within countries Between countries

1.00
Mean log deviation

0.80

0.60

0.40

0.20

0.00
1960 1965 1970 1975 1980 1985 1990 1995

The results can be viewed as empirical evidence which:

(a) Supports the Stolper Samuelson theorem and disproves the Factor Price Equalisation
theorem.
(b) Supports the Factor Price Equalisation theorem and disproves the Stolper Samuelson
theorem.
(c) Supports both the Stolper Samuelson and the Factor Price Equalisation theorems.
(d) Disproves both the Stolper Samuelson and the Factor Price Equalisation theorems.
(e) Neither supports nor disproves the Stolper Samuelson and the Factor Price Equalisation
theorems.
SAEF: INTERNATIONAL ECONOMICS: ECON306W1
CLASS TEST ONE: 20 March 2014 PAGE: 10

14. The figure below shows an industry composed of a single monopolistic domestic firm. The
firm sells in two, segmented markets: a domestic market, where it faces the demand curve
DDOM and an export market, where it faces the demand curve DFOR.

According to this figure, dumping is evident since:

(a) The foreign price of R5.00 exceeds the domestic price of R4.29.
(b) The domestic price of R6.67 exceeds the foreign price of R5.00.
(c) The volume of exports exceeds domestic sales.
(d) The domestic price of R7.50 exceeds the foreign price of R5.00.
(e) The foreign price of R5.00 exceeds the domestic price of R3.33.

15. Assume the following information pertaining to a large country (like Brazil) with respect to
the commodity coffee under free trade and with a tariff in place:

domestic price of coffee under free trade $100

world price of coffee under free trade $100
domestic price of coffee with tariff in place $105
world price of coffee with tariff in place $ 90
domestic production of coffee under free trade 50 units
domestic production of coffee with tariff in place 60 units
consumption of coffee under free trade 120 units
consumption of coffee with tariff in place 80 units

What is the impact of the tariff upon the large country’s welfare?
(a) loss of $125.
(b) gain of $75.
(c) gain of $200.
(d) gain of $325.
(e) loss of $325.

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