WEEK 4

Question 1

Mercantilism

Answer 1

• PROMOTES EXPORTS, discouraged imports
• focus on building NATIONAL WEALTH
• zero-sum game: one country’s gain is another’s loss

Question 2

Adam Smith

Answer 2

• free trade
• MARKET FORCES should determine imports and exports, NOT GOVERNMENT
• Positive sum game

Question 3

What are the main benefits of international trade and specialization?

Answer 3

Countries gain by specializing in goods they produce efficiently.

They import goods that other countries produce more efficiently.

This increases overall efficiency and consumer choice.

Question 4

Ricardo’s comparative advantage

Answer 4

Countries should export goods they produce more efficiently.

Question 5

Heckscher–Ohlin theory

Answer 5

Trade patterns are based on a country’s factor endowments (land, labor, capital). the theory explains why countries trade certain things—based on what resources they have more of.

Question 6

Paul Krugman’s New Trade Theory

Answer 6

Some industries have high costs, so only a few large firms can exist.

Economies of scale means the more a company produces, the cheaper it gets per unit.

A first-mover advantage happens when a company starts early and becomes hard to beat.

Countries with early, successful firms can get a lasting trade advantage, even if others have similar resources.

Question 7

absolute advantage

Answer 7

when it can produce a product more efficiently than another country.

Question 8

what said Adam smith when it comes to absolute advantages?

Answer 8

countries should specialize in goods where they have an absolute advantage and trade for others

Question 9

Production Possibility Frontiers

Answer 9

a graph that shows the maximum combinations of two goods a country can produce using all its resources efficiently

Question 10

Comparative Advantage

Answer 10

The ability to produce a good at a lower opportunity cost than another country

Question 11

What does Ricardo’s theory show about trade?

Answer 11

Even if a country has no absolute advantage, it can still benefit from trade.

Free trade increases total global output and allows countries to consume more than they could alone.

Question 12

What does the Ricardian model assume about resource mobility?

Answer 12

It assumes resources can easily switch between producing different goods.

Example: labor can move from cocoa to rice production with no problem.

Question 13

What is the reality of resource mobility in advanced economies?

Answer 13

In real life, resources are not fully mobile.
Workers in declining industries (like textiles) may face job loss or lower wages.

This creates political resistance to free trade, even if the economy benefits overall

Question 14

What does the Ricardian model assume about returns to specialization?

Answer 14

It assumes constant returns: same input always gives the same output.
Example: 10 units of input = 1 ton of cocoa, always.

Question 15

What are diminishing returns in trade theory?

Answer 15

As more resources go into one product, the extra output gets smaller.

Question 16

How does diminishing returns affect the PPF (Production Possibility Frontier)?

Answer 16

It makes the PPF curved (bowed out) instead of a straight line.

This shows that opportunity costs rise as you produce more of one good.

Question 17

so Ricardian model is wrong about two things

Answer 17

1. mobility –> is hard in real life
2. constant returns –> diminishing returns

Question 18

What do traditional trade models assume about growth?

Answer 18

They assume trade does not change a country’s resource stock or efficiency.
Trade only helps countries reallocate existing resources more efficiently.

Question 19

What are dynamic gains from trade?

Answer 19

Dynamic gains are long-term improvements from trade, including:

MORE RESOURCES (e.g., foreign investment, labor, and technology).

HIGHER EFFICIENCY in how resources are used.

Question 20

How does trade lead to economic growth over time?

Answer 20

Trade can cause a country’s PPF to shift outward, meaning it can produce more of everything.

This reflects increased potential output and long-term economic growth.

Question 21

What is the Samuelson Critique about free trade?

Answer 21

Paul Samuelson warned that free trade isn’t always good for everyone.

Especially when rich countries trade with poor countries that are quickly improving productivity.

Question 22

What’s the key insight from Samuelson’s argument?

Answer 22

If a lower-wage country catches up in productivity, it can harm workers in higher-wage countries.

So, free trade can cause wage pressure, even if it increases total output.

Question 23

What does the Heckscher–Ohlin theory say about comparative advantage?

Answer 23

Comparative advantage comes from a country’s factor endowments (natural resources like land, labor, and capital).

Countries export goods that use their abundant and cheap resources.

Question 24

What are factor endowments?

Answer 24

Factor endowments are the resources a country naturally has in large amounts:
Land (space, farmland)
Labor (workers)
Capital (machines, money, infrastructure)

Question 25

What is the logic behind Heckscher–Ohlin theory?

Answer 25

A resource that is abundant is also cheaper to use. So, a country has a cost advantage in producing goods that rely on that resource.

Question 26

What is the Leontief Paradox?

Answer 26

An unexpected finding that challenged the Heckscher–Ohlin theory. It showed that U.S. exports were more labor-intensive, not capital-intensive, despite the U.S. having more capital.

Question 27

What did Wassily Leontief expect to find?

Answer 27

He expected that the U.S., with its abundant capital, would export capital-intensive goods and import labor-intensive goods.

Question 28

What does the Leontief Paradox suggest about trade theories?

Answer 28

rade is not explained by factor endowments alone. Other factors like technology, innovation, or government policy may also shape trade patterns.

Question 29

What is the Product Life-Cycle Theory?

Answer 29

Created by Raymond Vernon in the 1960s. Explains how products move from invention to global production. Focuses on how production locations change over time.

Question 30

What are the main stages of the Product Life-Cycle Theory?

Answer 30

Innovation stage: New product is invented and made in rich countries (e.g., U.S.). Export stage: Product is exported to other countries as demand grows. Mature stage: Product becomes standardized, and production shifts to lower-cost countries.

Question 31

Why are new products usually invented in wealthy countries, according to Vernon?

Answer 31

Consumers have high incomes and want new products. Companies have advanced technology and strong research abilities.

Question 32

Example of Product Life-Cycle in action?

Answer 32

A tech product is invented in Silicon Valley, Exported globally, Later manufactured in China or India to reduce costs.

Question 33

What is a main criticism of the Product Life-Cycle Theory?

Answer 33

Assumes all innovation starts in rich countries (like the U.S.). Doesn’t reflect today’s world, where developing countries also create new products. Seen as outdated and too U.S.-focused.

Question 34

What is the New Trade Theory?

Answer 34

Explains why trade can happen even between similar countries (like France and Germany). Focuses on economies of scale and first-mover advantage.

Question 35

What are economies of scale in New Trade Theory?

Answer 35

When companies produce more, their cost per unit goes down. This is because fixed costs (like R&D or machines) are spread out. Big firms become more efficient and specialized.

Question 35

How do economies of scale lead to trade?

Answer 35

A few large firms can dominate global markets. Countries trade to benefit from specialization in products made efficiently at scale—even if they have similar resources.

Question 36

What is Porter’s Diamond Model?

Answer 36

Created by Michael Porter to explain why some countries succeed in certain industries. It identifies 4 key factors that create national competitive advantage. These factors interact to boost innovation and global success.

Question 37

What are factor endowments in Porter’s Diamond? (1)

Answer 37

Includes both BASIC (like natural resources) and ADVANCED (like skilled labor, tech, infrastructure) resources. The more specialized and advanced, the more competitive the industry.

Question 38

What are demand conditions in Porter’s Diamond? (2)

Answer 38

Refers to how demanding local customers are. High expectations force companies to innovate, improving global performance.

Question 39

What are related and supporting industries in Porter’s Diamond? (3)

Answer 39

Strong local suppliers and related sectors (like parts or tools) help firms be more efficient and innovative.

Question 40

What is firm strategy, structure, and rivalry in Porter’s Diamond? (4)

Answer 40

Describes how companies are organized and managed, and how much domestic competition exists. Intense local rivalry drives companies to improve and compete better globally.

Question 41

What is Porter’s main argument about national success?

Answer 41

Countries succeed internationally when all four elements of the Diamond Model are strong and supportive. The interaction of these factors fuels innovation, productivity, and global leadership in certain industries.

Question 42

How does government policy impact trade and business?

Answer 42

Companies may lobby governments to: Support free trade Lower tariffs Invest in innovation Or lobby for protection (tariffs, quotas) if under threat. Governments shape trade through agreements, subsidies, and regulation.