Global Business Today 7th Edition By Charles W. L. Hill - Test Bank

Global Business Today 7th Edition By Charles W. L. Hill – Test Bank

 

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Sample Questions Are Posted Below

 

Chapter 05

International Trade Theory

 

True / False Questions

1. Mercantilism, as advocated in the 16^th and 17^th centuries, believed that countries should simultaneously encourage both imports and exports.
   True    False

 

2. Largely discredited and primitive, mercantilism still influences the trade policies of many countries.
   True    False

 

3. Free trade refers to a situation where a government, through quotas or duties, attempts to influence what its citizens can buy from another country, or what they can produce and sell to another country.
   True    False

 

4. David Ricardo’s theory of comparative advantage was the first to explain why unrestricted free trade is beneficial to a country.
   True    False

 

5. According to Adam Smith, market mechanism, rather than government policy, should determine a country’s imports and exports.
   True    False

 

6. The theories of Smith, Ricardo, and Heckscher-Ohlin failed to identify the specific benefits of international trade.
   True    False

 

 

7. Smith, Ricardo, and Heckscher-Ohlin suggest that a country’s economy would gain only if its citizens buy products that are made in that country.
   True    False

 

8. Limits on imports are often in the interests of domestic consumers, but not domestic producers.
   True    False

 

9. During the 1980s, economists such as Paul Krugman developed what has come to be known as the new trade theory.
   True    False

 

10. The first theory of international trade that emerged in England asserted that gold and silver were the mainstays of national wealth and essential to vigorous commerce.
    True    False

 

11. The main tenet of mercantilism was that it was in a country’s best interests to maintain a trade surplus.
    True    False

 

12. Zero-sum game refers to a situation in which an economic gain by one country results in an economic loss by another.
    True    False

 

13. If a country is more efficient than any other country in the production of a product, it has what is known as relative advantage in the production of that product.
    True    False

 

 

14. In his book, “The Wealth of Nations,” Adam Smith supported the mercantilist assumption that trade is a zero-sum game.
    True    False

 

15. According to Adam Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries.
    True    False

 

16. Ricardo’s theory of comparative advantage says that it is logical for a country to specialize in the production of goods that it produces most efficiently and to export goods that it produces less efficiently.
    True    False

 

17. The basic message of the theory of comparative advantage is that potential world production is greater with unrestricted free trade than it is with restricted trade.
    True    False

 

18. Advocates of free trade rely on Ricardo’s theory of comparative advantage as a major intellectual weapon.
    True    False

 

19. Paul Samuelson argued that contrary to the standard interpretation, in certain circumstances, the theory of comparative advantage predicts that a rich country might actually be worse off by switching to a free trade regime with a poor country.
    True    False

 

 

20. Embracing a free trade regime for an advanced economy often implies that the country will produce less of some labor-intensive goods and more of some knowledge-intensive goods.
    True    False

 

21. The simplistic model of the comparative advantage theory used in the text assumes that trade changes a country’s stock of resources and the efficiency with which it utilizes those resources.
    True    False

 

22. Ricardo’s theory leads us to expect that despite the short-term adjustment costs associated with adopting a free trade regime, trade would seem to produce a greater economic growth and higher living standards in the long run.
    True    False

 

23. Factor endowments refer to the extent to which free trade impacts the national wealth of a country.
    True    False

 

24. 24.When the impact of differences of technology on productivity is controlled for, Heckscher-Ohlin theory gains predictive power.
    True    False

 

25. Most economists prefer Ricardo’s theory to the Heckscher-Ohlin theory because it makes fewer simplifying assumptions.
    True    False

 

 

26. Raymond Vernon’s theory of the product life-cycle was based on the observation that for most of the 20th century, a very large proportion of the world’s new products were developed by foreign nations and sold first in the U.S. market.
    True    False

 

27. According to the product life cycle theory, as demand for a product starts to grow in other advanced countries, potential for exports from the U.S. will gradually be limited.
    True    False

 

28. Viewed from an Asian or European perspective, Vernon’s argument that most new products are developed and introduced in the United States seems ethnocentric.
    True    False

 

29. The new trade theory began to emerge in the 1970s when a number of economists pointed out that the ability of firms to attain economies of scale might have important implications for international trade.
    True    False

 

30. The new trade theory suggests that a country may predominate in the export of a good simply because it was lucky enough to have one or more pioneering firms to produce that good.
    True    False

 

31. Porter argues that an absence of domestic rivalry is vital to the creation and persistence of international competitive advantage in an industry.
    True    False

 

32. According to Porter, both advanced factors and basic factors are equally significant for competitive advantage.
    True    False

 

 

33. According to Michael Porter, factor endowments can be affected by subsidies, policies toward capital markets, and policies toward education.
    True    False

 

34. The individual firm should invest substantial financial resources in trying to build a first-mover advantage, even if that means several years of losses before a new venture becomes profitable.
    True    False

 

35. According to Porter’s theory of national competitive advantage, a firm should invest in upgrading advanced factors of production because it is in the best interest of business for a firm to do so.
    True    False

 

 

Multiple Choice Questions

36. Which of the following is best identified as the absence of government-imposed barriers to the free flow of goods and services between countries?
    A. Free trade
    B. Mercantilism
    C. Socialism
    D. Absolute advantage

 

37. David Ricardo advanced the:
    A. new trade theory.
    B. product life-cycle theory.
    C. comparative advantage theory.
    D. absolute advantage theory.

 

 

38. David Ricardo’s theory of comparative advantage attempts to rationalize why some countries export automobiles, consumer electronics, and machine tools, while other countries export chemicals, watches, and jewelry. This rationalization is best explained in terms of:
    A. absolute advantage with reference to natural resources.
    B. international differences in labor productivity.
    C. the proportions in which the factors of production are available.
    D. the cultural histories of the exporting nations.

 

39. Climate and natural resource endowments explain all of the following happening, EXCEPT:
    A. Brazil exporting coffee.
    B. Switzerland exporting watches.
    C. China exporting crawfish.
    D. Saudi Arabia exporting oil.

 

40. The argument for _____ is that both import controls and export incentives are self-defeating and result in wasted resources.
    A. protectionism
    B. subsidies
    C. mercantilism
    D. unrestricted free trade

 

41. Propagated in the 16th and 17th centuries, _____ advocated that countries should simultaneously encourage exports and discourage imports.
    A. ethnocentrism
    B. capitalism
    C. collectivism
    D. mercantilism

 

 

42. Which of the following statements most accurately captures the main tenet of mercantilism?
    A. It is in a country’s best interests to not export products to less developed countries.
    B. It is in a country’s best interests to import products even if they are most efficiently produced at home.
    C. It is in a country’s best interests to import less specialized goods than to attempt to make them at home.
    D. It is in a country’s best interests to maintain a trade surplus.

 

43. Considered to be the first theory of international trade, the principal assertion of _____ was that gold and silver were the mainstays of national wealth and essential to vigorous commerce.
    A. collectivism
    B. mercantilism
    C. capitalism
    D. open market system

 

44. Which of the following is NOT consistent with the central beliefs of mercantilism?
    A. Government should intervene to achieve a surplus in the balance of trade.
    B. Policies should be put in place to minimize exports and maximize imports.
    C. Imports should be limited by tariffs and quotas.
    D. Exports should be subsidized.

 

45. Mercantilists saw no virtue in _____.
    A. a large volume of trade
    B. protectionism
    C. tariffs and quotas
    D. subsidizing exports

 

 

46. An inconsistency in the mercantilist doctrine, as pointed out by David Hume, is that:
    A. it indirectly helped increase volume of a country’s imports.
    B. it presented a crude case for exclusion of government in matters pertaining to exports and imports.
    C. no country could sustain a surplus on the balance of trade.
    D. it was not backed by either sound political principles or social ideologies.

 

47. The flaw with mercantilism was that it viewed trade as a:
    A. zero-sum game.
    B. mutually beneficial activity.
    C. positive-sum game.
    D. threat to a nation’s sovereignty.

 

48. A situation in which gains by all parties can be achieved is called a:
    A. level playing field.
    B. zero-sum game.
    C. positive-sum game.
    D. trade surplus.

 

49. Neo-mercantilists equate _____ with economic power and economic power with
    _____.
    A. international trade; corruption
    B. political power; balance-of-trade surplus
    C. imports; regional dominance
    D. absolute advantage; trade monopoly

 

50. A country intentionally keeps its currency value low against the currency of another in order to sell more goods to the latter. This can be viewed as a(n) _____ policy.
    A. inflationist
    B. totalitarian
    C. neo-mercantilist
    D. capitalist

 

 

51. Which of the following theories of international trade was advanced by Adam Smith?
    A. Theory of absolute advantage
    B. Theory of comparative advantage
    C. New trade theory
    D. Product life-cycle theory

 

52. A country is said to have a(n) _____ in the production of a product when it is more efficient than any other country in producing that product.
    A. comparative advantage
    B. relative advantage
    C. consumer advantage
    D. absolute advantage

 

53. According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then:
    A. retain these goods for strict domestic sales.
    B. trade these goods for goods produced by other countries.
    C. sell these goods to maintain a trade surplus.
    D. prohibit the import of these goods from other countries.

 

54. The different combinations of goods that a country, say Ghana, could produce are represented by the line GG’ in Figure 5.1. This is referred to as Ghana’s _____.
    A. production possibility frontier
    B. hypothetical trade barrier
    C. import-export differentiator
    D. resource conversion indicator

 

55. According to Adam Smith’s theory of absolute advantage, a country that has an absolute advantage in the production of all goods:
    A. enjoys the greatest benefits of international trade.
    B. might go on to become the dominant country in the production of those goods.
    C. will grow to be the biggest economic power.
    D. might derive no benefits from international trade.

 

 

56. In his 1817 book entitled “Principles of Political Economy,” _____ introduced the theory of comparative advantage.
    A. Adam Smith
    B. David Ricardo
    C. Raymond Vernon
    D. Max Weber

 

57. Country “A” specializes in producing beef more efficiently than any other country. It buys wheat, which it produces less efficiently than beef, from country “B,” even though it produces wheat more efficiently itself. This situation is referred to as:
    A. comprehensive advantage.
    B. first advantage.
    C. comparative advantage.
    D. absolute advantage.

 

58. To an even greater degree than the theory of absolute advantage, _____ suggests that trade is a positive-sum game in which all participating countries fetch economic gains.
    A. the Heckscher-Ohlin theory
    B. mercantilism
    C. the theory of comparative advantage
    D. Leontief’s paradox

 

59. _____ theory suggests that consumers in all nations can consume more if there are no restrictions on trade.
    A. Porter’s
    B. Vernon’s
    C. Samuelson’s
    D. Ricardo’s

 

 

60. Which of the following is one of the unrealistic assumptions that the simple Ricardian model of comparative advantage used in the text is based on?
    A. There are many countries and many more goods in the world.
    B. Each country has a fixed stock of resources.
    C. Free trade changes the efficiency with which a country uses its resources.
    D. Differences in the prices of resources in different countries exist.

 

61. The simple model of comparative advantage used in the text is based on assuming away:
    A. the effects of trade on income distribution within a country.
    B. constant returns to scale.
    C. that all resources can move freely from the production of one good to another.
    D. that free trade does not change the efficiency with which the countries use their resources.

 

62. _____ argued that contrary to the standard interpretation, in certain circumstances, the theory of comparative advantage predicts that a rich country might actually be worse off by switching to a free trade regime with a poor nation.
    A. Raymond Vernon
    B. Andrew Warner
    C. Paul Samuelson
    D. Jeffery Sachs

 

63. In comparative advantage, the assumption is that resources can move freely from production of one good to another. Why is this assumption unrealistic?
    A. The process of shifting resources from one good to another eliminates human suffering.
    B. The benefit of free trade is much lesser compared to the cost of shifting resources.
    C. The process of moving resources causes friction and human suffering.
    D. There are regulations that prohibit such movement.

 

64. The units of resources required to produce a good are assumed to remain unchanged no matter where one is on a country’s production possibility frontier. This is known as:
    A. zero-sum game.
    B. positive-sum game.
    C. constant returns to specialization.
    D. diminishing returns to specialization.

 

 

65. Diminishing returns to specialization occurs when:
    A. natural resources begin to run out owing to pollution.
    B. more units of resources are required to produce each additional unit.
    C. the cost of producing goods reduces substantially with increase in number of goods produced.
    D. the quality of resources comes down as a result of producing more goods.

 

66. It is more realistic to assume diminishing returns to specialization when evaluating the theory of comparative advantage. This is because:
    A. there exist differences in the prices of resources in different countries.
    B. resources can move freely from the production of one good to another within a country.
    C. not all resources are of the same quality.
    D. different goods use resources in the same proportions.

 

67. The comparative advantage theory is considered to have ignored which of the following statements?
    A. Constant returns to specialization implies a concave Production Possibility Frontier.
    B. Constant returns to specialization suggests that the gains from specialization are likely to be exhausted before specialization is complete.
    C. It is feasible for a country to specialize to a point where the resulting gains from trade are outweighed by diminishing returns.
    D. Different goods use different resources in different proportions.

 

68. Dynamic gains in both the stock of a country’s resources and the efficiency with which resources are utilized will:
    A. cause the country’s PPF to be in a bell-shaped curve.
    B. enable the country to produce more goods than it did before the introduction of free trade.
    C. cause a country’s PPF to shift inward.
    D. enable the country to achieve constant returns to specialization.

 

 

69. What was Samuelson’s criticism of free trade?
    A. He argued that dynamic gains lead to a universally beneficial outcome for all countries.
    B. He argued that offshoring service jobs that were traditionally mobile will increase the market clearing wage rate.
    C. He argued that free trade has historically been beneficial only to third world countries.
    D. A rich country importing cheap goods from a poor country may not make up for the wage losses in the rich country.

 

70. According to Samuelson, the ability to offshore service jobs that traditionally were not internationally mobile, coupled with rapid advances in communications technology and the productivity of foreign labor due to better education have an effect on middle-class wages in the United States that can be similar to:
    A. mass inward migration into the United States.
    B. improvement in the standard of living in the United States.
    C. better employability of United States labor.
    D. a substantial hike in the market clearing wage rate.

 

71. One of the rebuttals of Samuelson’s critique of the free trade model is that:
    A. the United States’ ability to achieve constant returns to specialization is unparalleled.
    B. the strict immigration policies of the United States help insulate the economy from inward migration.
    C. introducing trade barriers may in fact be beneficial for the United States to some extent.
    D. developing nations are unlikely to upgrade the skill level of their workforce rapidly enough.

 

72. _____ and _____ created a measure of how “open” to international trade an economy was and then looked at the relationship between “openness” and economic growth for a sample of more than 100 countries from 1970 to 1990.
    A. Ricardo; Smith
    B. Warner; Sachs
    C. Porter; Vernon
    D. Samuelson; Ohlin

 

 

73. In general, economic studies on the relationship between trade and economic growth suggest that:
    A. countries open to international trade display higher growth rates than those that close their economies to trade.
    B. comparative advantage theory does not hold much relevance in the modern world of international trade and open economies.
    C. modern economic trends tend to be influenced more by the absolute advantage theory than the comparative advantage theory.
    D. with the onset of free trade, rich countries are showing better dynamic gains in the efficiency with which resources are used.

 

74. According to the Heckscher-Ohlin theory, the pattern of international trade is determined by differences in:
    A. labor productivity.
    B. efficiency.
    C. factor endowments.
    D. management practices.

 

75. The United States has an abundance of arable land, but faces a shortage of low-cost labor. In contrast, China excels in the production of labor-intensive goods, such as footwear and textiles. According to the Heckscher-Ohlin theory:
    A. United States will import textiles and footwear from China and export agricultural goods.
    B. China will invest more than United States in the production of agricultural goods to exploit its population advantage.
    C. United States and China will import agricultural goods and textiles respectively to exploit the comparative advantage.
    D. the migration of Chinese laborers to United States will increase exponentially to bridge the shortage in cheap labor.

 

76. Nations have varying factor endowments, and different factor endowments explain differences in _____.
    A. labor productivity
    B. efficiency of processes
    C. factor mobility
    D. factor costs

 

 

77. The difference between Ricardo’s theory and the Heckscher-Ohlin theory is that they attributed the rise of comparative advantage to differences in _____ and _____, respectively.
    A. abundance of resources; education
    B. economic systems; political ideologies
    C. availability of labor; efficiency of production
    D. productivity; factor endowments

 

78. Which theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce?
    A. Warner-Sachs
    B. Wacziarg-Welch
    C. Heckscher-Ohlin
    D. Frankel-Romer

 

79. According to the text, most economists prefer the Heckscher-Ohlin theory to Ricardo’s theory because:
    A. it makes fewer simplifying assumptions.
    B. it predicts real-world international trade patterns with greater accuracy.
    C. Ricardo’s theory is less accurate due to the Leontief paradox.
    D. Ricardo’s theory is too complicated to be applied to real-world scenarios.

 

80. U.S. exports were less capital-intensive than U.S. imports, despite the relative abundance of capital in the country. This phenomenon runs contrary to what the Heckscher-Ohlin theory would predict and is termed the _____ paradox.
    A. Zeno
    B. Leontief
    C. Russell
    D. Simpson

 

 

81. What is a possible explanation for the Leontief paradox?
    A. U.S. imports goods that heavily use skilled labor and innovative entrepreneurship.
    B. U.S. has a special advantage in producing new products made with innovative technologies.
    C. U.S. exports heavy manufacturing products that use large amounts of capital.
    D. U.S. has a strong absolute advantage over all other foreign nations because of its advantageous factor endowments.

 

82. 82.One of the drawbacks of the Heckscher-Ohlin theory, even though it makes sound theoretical sense, is that:
    A. it does not explain the differences in national factor endowments.
    B. it argues that comparative advantage arises from differences in the countries’ labor productivity.
    C. it lacks common sense appeal.
    D. it is a relatively poor predictor of real-world international trade patterns.

 

83. One of the key assumptions of the Heckscher-Ohlin theory is that:
    A. technologies are the same across countries.
    B. differences in the prices of resources in different countries do not exist.
    C. resources can move freely from the production of one good to another within a country.
    D. trade has no effect on income distribution in a country.

 

84. Raymond Vernon proposed the product life cycle in the mid-1960s. Vernon argued that two factors gave U.S. firms a strong incentive to develop new consumer products. These two factors were _____ and _____.
    A. innovation; number of industries
    B. size of the U.S. market; lack of competition
    C. wealth; size of the U.S. market
    D. entrepreneurial spirit; low-cost U.S. labor

 

 

85. Vernon’s product life-cycle theory was based on the observation that for most of the 20^th century, a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the _____ market.
    A. Asian
    B. Western European
    C. U.S.
    D. global

 

86. According to the product life-cycle theory, the high cost of U.S. labor gave U.S. firms an incentive to:
    A. lower costs of services to offset a fall in demand.
    B. develop cost-saving process innovations.
    C. invite foreign direct investment in domestic industries.
    D. embrace and promote open market capitalism.

 

87. Vernon argues that pioneering firms kept production facilities closer to the market and centers of decision making because:
    A. of the uncertainty and risks inherent in introducing new products.
    B. they believed that foreign production facilities were inferior in technical skills.
    C. they believed that U.S. labor costs were much lower than those in foreign markets.
    D. earlier U.S. governments were critical of outsourcing production to other countries.

 

88. According to Vernon, which of the following factors obviates the need for pioneering U.S. firms to look for low-cost production sites in other countries?
    A. There is less uncertainty and risks inherent in introducing new products.
    B. The demand for most new products tends to be based mainly on price.
    C. U.S. labor costs were relatively low compared to global standards.
    D. Firms can charge relatively high prices for new products.

 

 

89. Vernon argues that early in the life cycle of a typical new product, while demand is starting to grow rapidly in the United States, demand in other advanced countries:
    A. remains limited to high income groups.
    B. necessitates imports to the United States.
    C. necessitates outsourcing of production to low-cost locations.
    D. raises costs of production in the United States.

 

90. Vernon predicts that as the demand for a new product starts to grow in other advanced countries:
    A. it becomes worthwhile for firms to invest in low-cost domestic labor in the United States.
    B. they deem it worthwhile to invest in production facilities in the United States.
    C. it is not worthwhile for firms in those countries to start producing the new product.
    D. the potential for exports from the U.S. begins to get limited.

 

91. Vernon theorizes that as the market in the U.S. and other advanced nations matures, the product becomes more standardized and price becomes:
    A. governmentally regulated.
    B. higher.
    C. unimportant.
    D. the main competitive weapon.

 

92. Historically, the product life-cycle theory seems to be an accurate explanation of:
    A. international trade patterns.
    B. the growth of innovation in U.S. firms.
    C. the Leontief paradox.
    D. the current labor advantages in the U.S.

 

93. The relevance of the product life-cycle theory in the modern world seems more limited because:
    A. many countries have increasingly invested in the U.S. labor market over the past century.
    B. with the diminishing strength of the U.S. dollar, it loses the ability to generalize trade globally.
    C. it holds true only for the brief U.S. dominance of the global economy.
    D. historically, it has provided inaccurate explanations of international trade patterns.

 

 

94. Compared to the comparative advantage theory, the product life-cycle theory:
    A. fails to predict the possibility of globally dispersed production.
    B. is increasingly relevant to explaining trade patterns in the modern world.
    C. makes a lot of simplifying assumptions.
    D. explains the current labor advantages in the U.S.

 

95. The _____ theory began to emerge in the 1970s when some economists pointed out that the ability of firms to attain economies of scale might have important implications for international trade.
    A. balanced trade
    B. Heckscher-Ohlin
    C. new trade
    D. product life-cycle

 

96. _____ are unit cost reductions associated with a large scale of output.
    A. Comparative advantages
    B. Factor endowments
    C. Economies of scale
    D. Diminishing returns

 

97. Because of substantial economies of scale, the new trade theory argues that trade can:
    A. increase the variety of goods available to consumers.
    B. increase the average costs of goods.
    C. enable the global market to support a wide range of enterprises.
    D. inhibit first-mover advantages in all products.

 

98. The _____ theory states that in those industries where the output required to attain economies of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of enterprises.
    A. Heckscher-Ohlin
    B. comparative advantage
    C. product life-cycle
    D. new trade

 

 

99. The ability to spread fixed costs over a large volume, and the ability of large-volume producers to utilize specialized employees and equipment that are more productive than less-specialized employees and equipment, are both sources of:
    A. first-mover disadvantages.
    B. economies of scale.
    C. conflict in international trade.
    D. rising production costs.

 

100. The new trade theory points out that through its impact on economies of scale, trade can:
     A. reduce the volume of the goods produced.
     B. decrease the variety of goods available to consumers.
     C. decrease the average costs of goods.
     D. inhibit first-mover advantages in all industries.

 

101. Assuming a world without trade, in industries where economies of scale are important, both the variety of goods that a country can produce and the scale of production are limited by the _____.
     A. size of the market
     B. monetary system
     C. purchasing power parity
     D. strength of the currency

 

102. If a national market is small, there may not be enough demand to enable producers to realize _____ for certain products.
     A. adequate supply
     B. economies of scale
     C. cheap labor
     D. low volumes

 

 

103. According to new trade theory, which of the following could be a result of the economies of scale that may be achieved by individual firms as the size of the market expands due to trade?
     A. Each nation can produce a wider variety of goods, minimizing its imports.
     B. Each nation can simultaneously decrease the variety of goods available to its consumers and raise the costs of those goods.
     C. Each nation may specialize in producing a narrower range of products, importing goods that it does not make.
     D. Each nation can attain self-sufficiency in most products and eliminate exports.

 

104. According to the new trade theory, how does trade offer an opportunity for mutual gain even when countries do not differ in their resource endowments or technology?
     A. Trade results in a contraction of the size of the markets of individual firms.
     B. Trade allows for production of products at higher prices.
     C. Trade affords realization of scale economies.
     D. Trade allows countries to attain self-sufficiency in the production of all goods.

 

105. One of the themes in new trade theory is that the pattern of trade we observe in the world economy may be the result of _____ and _____.
     A. competitive advantage; technological advancement
     B. heterogeneous world market; globalization
     C. economies of scale; first-mover advantages
     D. liberal immigration policies; better standards of living

 

106. The economic and strategic advantages that accrue to early entrants in an industry are called:
     A. first-mover advantages.
     B. comparative advantages.
     C. pioneering advantages.
     D. early-bird advantages.

 

 

107. Which of the following is an advantage that first-movers enjoy?
     A. Increasing returns to specialization
     B. A positive-sum game due to lack of competition
     C. Capture scale economies ahead of later entrants
     D. Absolute advantage and higher efficiency

 

108. According to the new trade theory, countries whose firms establish a(n) _____ advantage with regard to the production of a particular new product may subsequently dominate global trade in that product.
     A. comparative
     B. absolute
     C. first-mover
     D. constant return

 

109. One of the implications of the new trade theory is that:
     A. it predicts the U.S. dominating the world market for consumer goods.
     B. nations may benefit from trade irrespective of resource endowments or technology.
     C. U.S. switches from being an importer of products to an exporter owing to lowering of labor costs.
     D. it accurately predicts the evolution of globally dispersed production.

 

110. According to the new trade theory, the dominance of America and Europe in the trade of mid-sized and large aircraft is largely a product of:
     A. the nascent world market for private jets owned by individuals.
     B. lack of technological advancement elsewhere to compete with the leaders.
     C. the unpredictability of supply and demand patterns endemic to the aviation industry.
     D. first-mover advantages afforded by the industry.

 

 

111. The new trade theory is at variance with the _____ theory, which suggests that a country will predominate in the export of a product when it is particularly well endowed with those factors used intensively in its manufacture.
     A. Heckscher-Ohlin
     B. product life-cycle
     C. comparative advantage
     D. Ricardo-Sraffa

 

112. With regard to first-mover advantages and international trade, a study by Harvard business historian Alfred Chandler suggests the existence of first-mover advantages is an important factor in explaining:
     A. the dominance of firms from certain nations in specific industries.
     B. the economic hardships faced by former colonies of the West.
     C. the superiority enjoyed by developing countries like India and China in producing goods that require highly-skilled labor.
     D. the decline of United States’ share in world output.

 

113. The most contentious implication of the new trade theory is perhaps the argument that it generates for _____ and _____.
     A. free trade; laissez faire
     B. entrepreneurship; innovation
     C. luck; entrepreneurship
     D. government intervention; strategic trade policy

 

114. The new trade theory diverts from its advocacy of free trade by:
     A. suggesting that first-mover advantages influence domination of certain countries in specific industries.
     B. suggesting that nations benefit even in absence of resource endowments and technology.
     C. indirectly suggesting an economic rationale for a proactive trade policy.
     D. stressing the role of luck, entrepreneurship, and innovation in giving a firm first-mover advantages.

 

 

115. Which of the following theorists published the results of an intensive research effort that attempted to determine why some nations succeed and others fail in international competition, in addition to, proposing an explanation in the form of a “diamond” of four national attributes?
     A. Alfred Chandler
     B. Raymond Vernon
     C. Andrew Warner
     D. Michael Porter

 

116. Which of the following best describes the essential task of Porter’s 1990 study of national competitive advantage?
     A. How do nations leverage their resources efficiently to gain absolute advantage?
     B. Why does a nation achieve international success in a particular industry?
     C. How do countries gain first-mover advantages?
     D. What are the international trade patterns in evidence in the modern world?

 

117. Porter suggested four attributes making up the “diamond” consist of factor endowments, relating and supporting industries, firm strategy, structure, and rivalry, and:
     A. nature of competition.
     B. first-mover advantages.
     C. constant returns to specialization.
     D. demand conditions.

 

118. According to Porter’s diamond, a nation’s position in elements of production such as skilled labor or the infrastructure necessary to compete in a given industry is best referred to as:
     A. capitalization.
     B. demand conditions.
     C. factor endowments.
     D. optimization.

 

 

119. Porter’s thesis was that four broad attributes of a nation shape the environment in which local firms compete, and that these attributes promote or impede the creation of competitive advantage. All of the following are attributes EXCEPT:
     A. factor endowments.
     B. first-mover advantages.
     C. firm strategy, structure, and rivalry.
     D. relating and supporting industries.

 

120. Porter maintains that two additional variables can influence the “diamond” of attributes in important ways. These two variables are _____ and ______.
     A. entrepreneurship; strategic trade policies
     B. innovation; entrepreneurship
     C. absolute advantage; PPF
     D. chance; government

 

121. Which of the following factor endowments would be classified as a basic factor by Michael Porter?
     A. Communication
     B. Research facilities
     C. Natural resources
     D. Skilled labor

 

122. Which of the following factor endowments would be classified as an advanced factor by Michael Porter?
     A. Demographics
     B. Climate and location
     C. Natural resources
     D. Skilled labor

 

 

123. Porter argued that in terms of factor endowments, _____ factors are the most significant for competitive advantage.
     A. constant
     B. basic
     C. advanced
     D. complementary

 

124. Japan is a country that is at a disadvantage in terms of natural resources but it has achieved economic success by investing in education, thereby building a vital pool of skilled labor and technological know-how. This reflects Porter’s argument that:
     A. competitive advantage is largely a product of basic factors.
     B. basic factors can be upgraded by nations, while advanced factors are endowed by nature.
     C. an initial advantage in basic factors is vital to competitive advantage.
     D. advanced factors are the most significant for competitive advantage.

 

125. According to Porter, the characteristics of _____ are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality.
     A. international customers
     B. the U.S. market
     C. foreign investment
     D. home demand

 

126. Porter argues that a nation’s firms gain competitive advantage if their domestic consumers are:
     A. sophisticated and demanding.
     B. price insensitive and trusting.
     C. accommodating and flexible.
     D. nationalist and protective of their domestic industries.

 

 

127. Sophisticated and demanding local customers in Scandinavia helped push Nokia of Finland and Ericsson of Sweden to invest in cellular phone technology long before demand for cellular phones took off in other developed nations. This underscores Porter’s point about how:
     A. home demand plays an important role in upgrading competitive advantage.
     B. upgrading basic factors can help countries gain competitive advantage.
     C. basic factors are the most significant for competitive advantage.
     D. international trade can help firms gain competitive advantage.

 

128. Technological leadership in the U.S. semiconductor industry provided the basis for U.S. success in personal computers and several other technically advanced electronic products. Similarly, Switzerland’s success in pharmaceuticals is closely related to its previous international success in the technologically related dye industry. These instances illustrate the attribute of national competitive advantage identified by Porter as:
     A. national investment in basic factors of production.
     B. the presence of sophisticated and knowledgeable local customers.
     C. the presence of suppliers or related industries that are internationally competitive.
     D. the international demand for a locally produced product.

 

129. _____ occurs when employees move between firms within a region and when national industry associations bring employees from different companies together for regular conferences or workshops.
     A. Domestic competition
     B. Organizational restructuring
     C. Management friction
     D. Knowledge flow

 

130. Porter noted the predominance of engineers in top management at German and Japanese firms and a predominance of people with finance backgrounds leading many U.S. firms. He argued that the dominance of finance in U.S. firms led to a relative loss of U.S. competitiveness in some engineering-based industries. Thus, Porter illustrates how different nations _____, which are instrumental in their building national competitive advantage.
     A. upgrade their basic factors
     B. have different trade policies
     C. are characterized by different management ideologies
     D. have varying levels of government interference

 

 

131. Porter, in his model of competitive advantage, suggested that there is a strong association between _____ and the creation and persistence of competitive advantage in an industry.
     A. investment
     B. vigorous domestic rivalry
     C. eliminating competition
     D. the availability of a captive market

 

132. Who argued that successful industries within a country tend to be grouped into “clusters” of related industries?
     A. Michael Porter
     B. Raymond Vernon
     C. David Ricardo
     D. Eli Heckscher

 

133. Porter argues that the presence of _____ component(s) is usually required for “Porter’s diamond” to boost national competitive advantage.
     A. at least two
     B. all four
     C. at least three
     D. at least one

 

134. Does Porter’s model of competitive advantage predict the pattern of international trade that we observe in the real world?
     A. Yes, Porter’s model has been supported by detailed empirical testing.
     B. We do not know because Porter’s theory has not been subjected to detailed empirical testing.
     C. No, Porter’s model has failed to stand the test of time and is dated.
     D. Yes, Porter’s model stands out as the one single theory that best predicts international trade.

 

 

135. If a company were to draw from the ideas proposed in the various theories of international trade, from a profit perspective, how would it go about selecting locations for its businesses?
     A. It would concentrate its productive activities mostly in developing countries.
     B. It would concentrate its productive activities in its home country.
     C. It would disperse its productive activities to those countries where they can be performed most efficiently.
     D. It would disperse its productive activities across all countries that serve as its market.

 

136. Preempting the available demand, gaining cost advantages related to volume, building an enduring brand ahead of later competitors, and, consequently, establishing a long-term sustainable competitive advantage, are all examples of:
     A. monopolistic practices.
     B. comparative advantages.
     C. absolute advantages.
     D. first-mover advantages.

 

 

Essay Questions

137. What is meant by the term “free trade”? Is free trade compatible with the concept of mercantilism?

 

 

 

 

138. Mercantilism viewed trade as a zero-sum game. Discuss Adam Smith’s and David Ricardo’s stand on the issue. Also discuss the phenomenon of neo-mercantilism.

 

 

 

 

 

139. Describe Adam Smith’s concept of absolute advantage.

 

 

 

 

140. How does the theory of comparative advantage suggest that trade is a positive-sum game to an even greater degree than does the theory of absolute advantage does?

 

 

 

 

141. Discuss Paul Samuelson’s critique of free trade, where he argued that in some circumstances, dynamic gains can lead to an outcome that is not so beneficial.

 

 

 

 

142. Describe the Leontief paradox.

 

 

 

 

 

143. In his product life-cycle theory, Raymond Vernon argued that for most of the twentieth century a very large proportion of the world’s new products had been developed by U.S. firms, produced in the U.S., and sold first in the U.S. market. What reasons does he cite for U.S. firms basing initial production at home and not at some low-cost foreign location?

 

 

 

 

144. Describe briefly the shortcomings of the product life-cycle theory.

 

 

 

 

145. Briefly describe the new trade theory.

 

 

 

 

146. What are first-mover advantages? Outline the relationship between economies of scale, first-mover advantages and the pattern of trade as indicated by new trade theory.

 

 

 

 

 

147. Identify and briefly describe the four broad attributes of a nation identified by Michael Porter as shaping the environment in which local firms compete, and promote or impede the creation of competitive advantage. Also, outline Porter’s conclusions from his analysis.

 

 

 

 

148. Porter’s theory counts demand conditions as one of the four broad attributes of a nation, shaping the environment in which local firms compete. Briefly explain how it is so and mention at least two examples to support the explanation.

 

 

 

 

149. How does Porter’s theory predict patterns in international trade? Do his predictions hold up in a real-world scenario?

 

 

 

 

150. From a profit perspective based on the various international theories, how would a business go about choosing locations for its various productive activities?

 

 

 

 

 

151. Discuss the policy implications of Porter’s theory of national competitive advantage.

 

 

 

 

 

 

Chapter 05 International Trade Theory Answer Key
 

True / False Questions

1. (p. 163)Mercantilism, as advocated in the 16^th and 17^th centuries, believed that countries should simultaneously encourage both imports and exports.
   FALSE

Propagated in the sixteenth and seventeenth centuries, mercantilism advocated that countries should simultaneously encourage exports and discourage imports.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

2. (p. 163)Largely discredited and primitive, mercantilism still influences the trade policies of many countries.
   TRUE

Although mercantilism is an old and largely discredited doctrine, its echoes remain in modern political debate and in the trade policies of many countries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

 

3. (p. 163)Free trade refers to a situation where a government, through quotas or duties, attempts to influence what its citizens can buy from another country, or what they can produce and sell to another country.
   FALSE

Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

4. (p. 163)David Ricardo’s theory of comparative advantage was the first to explain why unrestricted free trade is beneficial to a country.
   FALSE

Proposed in 1776, Adam Smith’s theory of absolute advantage was the first to explain why free trade is beneficial to a country.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

5. (p. 163)According to Adam Smith, market mechanism, rather than government policy, should determine a country’s imports and exports.
   TRUE

Adam Smith argued that the invisible hand of the market mechanism, rather than government policy, should determine what a country imports and what it exports.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

 

6. (p. 163)The theories of Smith, Ricardo, and Heckscher-Ohlin failed to identify the specific benefits of international trade.
   FALSE

The great strength of the theories of Smith, Ricardo, and Heckscher-Ohlin is that they identify with precision the specific benefits of international trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

7. (p. 164)Smith, Ricardo, and Heckscher-Ohlin suggest that a country’s economy would gain only if its citizens buy products that are made in that country.
   FALSE

The theories of Smith, Ricardo, and Heckscher-Ohlin tell us that a country’s economy may gain if its citizens buy certain products from other nations that could be produced at home.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

8. (p. 164)Limits on imports are often in the interests of domestic consumers, but not domestic producers.
   FALSE

Limits on imports are often in the interests of domestic producers, but not domestic consumers.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

 

9. (p. 165)During the 1980s, economists such as Paul Krugman developed what has come to be known as the new trade theory.
   TRUE

During the 1980s economists such as Nobel Prize winner Paul Krugman developed what has come to be known as the new trade theory. This theory stresses that in some cases countries specialize in the production and export of particular products not because of underlying differences in factor endowments, but because in certain industries the world market can support only a limited number of firms.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

10. (p. 165)The first theory of international trade that emerged in England asserted that gold and silver were the mainstays of national wealth and essential to vigorous commerce.
    TRUE

The first theory of international trade, mercantilism that emerged in England in the mid-sixteenth century asserted that gold and silver were the mainstays of national wealth and essential to vigorous commerce.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

 

11. (p. 165)The main tenet of mercantilism was that it was in a country’s best interests to maintain a trade surplus.
    TRUE

The main tenet of mercantilism was that it was in a country’s best interests to maintain a trade surplus (to export more than it imported), thereby accumulating gold and silver and, consequently, increasing its national wealth, prestige, and power.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

12. (p. 167)Zero-sum game refers to a situation in which an economic gain by one country results in an economic loss by another.
    TRUE

A zero-sum game is one in which a gain by one country results in a loss by another. Mercantilism views trade as a zero-sum game.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

13. (p. 167)If a country is more efficient than any other country in the production of a product, it has what is known as relative advantage in the production of that product.
    FALSE

A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Absolute Advantage

 

14. (p. 167)In his book, “The Wealth of Nations,” Adam Smith supported the mercantilist assumption that trade is a zero-sum game.
    FALSE

In his 1776 landmark book “The Wealth of Nations,” Adam Smith attacked the mercantilist assumption that trade is a zero-sum game, with the argument that countries differ in their ability to produce goods efficiently.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Absolute Advantage

15. (p. 167)According to Adam Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries.
    TRUE

According to Smith’s theory of absolute advantage, countries should specialize in the production of goods they are most efficient in, compared to others, and then trade these for goods produced by other countries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Absolute Advantage

 

16. (p. 169)Ricardo’s theory of comparative advantage says that it is logical for a country to specialize in the production of goods that it produces most efficiently and to export goods that it produces less efficiently.
    FALSE

According to Ricardo’s theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Comparative Advantage

17. (p. 172)The basic message of the theory of comparative advantage is that potential world production is greater with unrestricted free trade than it is with restricted trade.
    TRUE

The basic message of the theory of comparative advantage is that potential world production is greater with unrestricted free trade than it is with restricted trade as consumers in all nations can consume more if there are no restrictions on trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

 

18. (p. 172)Advocates of free trade rely on Ricardo’s theory of comparative advantage as a major intellectual weapon.
    TRUE

Ricardo’s theory of comparative advantage provides a strong rationale for encouraging free trade and is powerful enough to remain a major intellectual weapon for those who argue for free trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

19. (p. 172)Paul Samuelson argued that contrary to the standard interpretation, in certain circumstances, the theory of comparative advantage predicts that a rich country might actually be worse off by switching to a free trade regime with a poor country.
    TRUE

Once all the assumptions are dropped, the case for unrestricted free trade, while still positive, has been argued by some economists associated with the “new trade theory” to lose some of its strength. Nobel Prize winning economist Paul Samuelson argued that in certain circumstances, the theory of comparative advantage predicts that a rich country might be worse off by switching to a free trade regime with a poor nation.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

 

20. (p. 173)Embracing a free trade regime for an advanced economy often implies that the country will produce less of some labor-intensive goods and more of some knowledge-intensive goods.
    TRUE

Resources do not always shift quite easily from producing one good to another. A certain amount of friction is involved in cases where embracing a free trade regime for an advanced economy often implies that the country will produce less of some labor-intensive goods and more of some knowledge-intensive goods.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

21. (p. 172)The simplistic model of the comparative advantage theory used in the text assumes that trade changes a country’s stock of resources and the efficiency with which it utilizes those resources.
    FALSE

A simplistic model of the comparative advantage theory assumes that each country has a fixed stock of resources and that free trade does not change the efficiency with which a country uses its resources. This static assumption makes no allowances for the dynamic changes in a country’s stock of resources and in the efficiency with which the country uses its resources that might result from free trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

 

22. (p. 177)Ricardo’s theory leads us to expect that despite the short-term adjustment costs associated with adopting a free trade regime, trade would seem to produce a greater economic growth and higher living standards in the long run.
    TRUE

Despite the short-term adjustment costs associated with adopting a free trade regime, trade would seem to produce greater economic growth and higher living standards in the long run, just as the theory of Ricardo would lead us to expect.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

23. (p. 178)Factor endowments refer to the extent to which free trade impacts the national wealth of a country.
    FALSE

Factor endowments refer to the extent to which a country is endowed with such resources as land, labor, and capital.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

 

24. (p. 179)24.When the impact of differences of technology on productivity is controlled for, Heckscher-Ohlin theory gains predictive power.
    TRUE

New research shows that once differences in technology across countries are controlled for, countries do indeed export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. In other words, once the impact of differences of technology on productivity is controlled for, the Heckscher-Ohlin theory seems to gain predictive power.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

25. (p. 178)Most economists prefer Ricardo’s theory to the Heckscher-Ohlin theory because it makes fewer simplifying assumptions.
    FALSE

The Heckscher-Ohlin theory has been one of the most influential theoretical ideas in international economics. Most economists prefer the Heckscher-Ohlin theory to Ricardo’s theory because it makes fewer simplifying assumptions.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

 

26. (p. 179)Raymond Vernon’s theory of the product life-cycle was based on the observation that for most of the 20th century, a very large proportion of the world’s new products were developed by foreign nations and sold first in the U.S. market.
    FALSE

Raymond Vernon’s product life-cycle theory was based on the observation that for most of the twentieth century a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the U.S. market.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

27. (p. 179)According to the product life cycle theory, as demand for a product starts to grow in other advanced countries, potential for exports from the U.S. will gradually be limited.
    TRUE

Over time, as demand for a new product starts to grow in other advanced countries, it becomes worthwhile for foreign producers to begin producing for their home markets. In addition, U.S. firms might set up production facilities in those advanced countries where demand is growing. Consequently, production within other advanced countries begins to limit the potential for exports from the United States.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

 

28. (p. 180)Viewed from an Asian or European perspective, Vernon’s argument that most new products are developed and introduced in the United States seems ethnocentric.
    TRUE

Viewed from an Asian or European perspective, Vernon’s argument that most new products are developed and introduced in the United States seems ethnocentric and increasingly dated.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

29. (p. 182)The new trade theory began to emerge in the 1970s when a number of economists pointed out that the ability of firms to attain economies of scale might have important implications for international trade.
    TRUE

The new trade theory began to emerge in the 1970s when a number of economists pointed out that the ability of firms to attain economies of scale might have important implications for international trade. Economies of scale are unit cost reductions associated with a large scale of output.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: New Trade Theory

 

30. (p. 184)The new trade theory suggests that a country may predominate in the export of a good simply because it was lucky enough to have one or more pioneering firms to produce that good.
    TRUE

The new trade theory suggests that a country may predominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good. Because they are able to gain economies of scale, the first movers in an industry may get a lock on the world market that discourages subsequent entry.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: New Trade Theory

31. (p. 189)Porter argues that an absence of domestic rivalry is vital to the creation and persistence of international competitive advantage in an industry.
    FALSE

Porter argues that there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry induces firms to look for ways to improve efficiency, which makes them better international competitors.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

32. (p. 187)According to Porter, both advanced factors and basic factors are equally significant for competitive advantage.
    FALSE

Michael Porter argues that advanced factors are the most significant for competitive advantage. The benefits of investments in advanced factors of production by related and supporting industries can spill over into an industry, thereby helping it achieve a strong competitive position internationally. Unlike the naturally endowed basic factors, advanced factors are a product of investment by individuals, companies, and governments.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

33. (p. 189, 190)According to Michael Porter, factor endowments can be affected by subsidies, policies toward capital markets, and policies toward education.
    TRUE

Porter contends that government can influence each of the four components of Porter’s diamond—either positively or negatively. Factor endowments can be affected by subsidies, policies toward capital markets, policies toward education, and so on.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-04
Topic: National Competitive Advantage: Porter’s Diamond

 

34. (p. 191)The individual firm should invest substantial financial resources in trying to build a first-mover advantage, even if that means several years of losses before a new venture becomes profitable.
    TRUE

Individual firms should realize that it pays to invest substantial financial resources in trying to build a first-mover or early-mover advantage even if that means several years of losses before a new venture becomes profitable. The idea is to preempt the available demand, gain cost advantages related to volume, build an enduring brand ahead of later competitors, and, consequently, establish a long-term sustainable competitive advantage.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-05
Topic: Focus on Managerial Implications

35. (p. 192)According to Porter’s theory of national competitive advantage, a firm should invest in upgrading advanced factors of production because it is in the best interest of business for a firm to do so.
    TRUE

Porter’s theory suggests that it is in the best interest of business for a firm to invest in upgrading advanced factors of production; for example, to invest in better training for its employees and to increase its commitment to research and development.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-05
Topic: Focus on Managerial Implications

 

 

Multiple Choice Questions

36. (p. 163)Which of the following is best identified as the absence of government-imposed barriers to the free flow of goods and services between countries?
    A. Free trade
    B. Mercantilism
    C. Socialism
    D. Absolute advantage

Free trade is said to be the absence of government barriers to the free flow of goods and services between countries. Alternatively, free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

37. (p. 163)David Ricardo advanced the:
    A. new trade theory.
    B. product life-cycle theory.
    C. comparative advantage theory.
    D. absolute advantage theory.

The theory of comparative advantage, advanced by the nineteenth century English economist David Ricardo, is the intellectual basis of the modern argument for unrestricted free trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

 

38. (p. 164)David Ricardo’s theory of comparative advantage attempts to rationalize why some countries export automobiles, consumer electronics, and machine tools, while other countries export chemicals, watches, and jewelry. This rationalization is best explained in terms of:
    A. absolute advantage with reference to natural resources.
    B. international differences in labor productivity.
    C. the proportions in which the factors of production are available.
    D. the cultural histories of the exporting nations.

Much of the observed pattern of international trade, like why Switzerland exports chemicals, pharmaceuticals, watches, and jewelry and why Bangladesh exports garments, is difficult to explain. David Ricardo’s theory of comparative advantage offers an explanation in terms of international differences in labor productivity.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-01
Topic: An Overview of Trade Theory

39. (p. 164)Climate and natural resource endowments explain all of the following happening, EXCEPT:
    A. Brazil exporting coffee.
    B. Switzerland exporting watches.
    C. China exporting crawfish.
    D. Saudi Arabia exporting oil.

Climate and natural resource endowments explain why Ghana exports cocoa, Brazil exports coffee, Saudi Arabia exports oil, and China exports crawfish. However, climate and natural resources do not explain why Switzerland exports chemicals, pharmaceuticals, watches, and jewelry and why Bangladesh exports garments.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

 

40. (p. 165)The argument for _____ is that both import controls and export incentives are self-defeating and result in wasted resources.
    A. protectionism
    B. subsidies
    C. mercantilism
    D. unrestricted free trade

The theories of Smith, Ricardo, and Heckscher-Ohlin form part of the case for unrestricted free trade. The argument for unrestricted free trade is that both import controls and export incentives (such as subsidies) are self-defeating and result in wasted resources.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-01
Topic: An Overview of Trade Theory

41. (p. 165)Propagated in the 16th and 17th centuries, _____ advocated that countries should simultaneously encourage exports and discourage imports.
    A. ethnocentrism
    B. capitalism
    C. collectivism
    D. mercantilism

Propagated in the sixteenth and seventeenth centuries, mercantilism advocated that countries should simultaneously encourage exports and discourage imports.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

 

42. (p. 165)Which of the following statements most accurately captures the main tenet of mercantilism?
    A. It is in a country’s best interests to not export products to less developed countries.
    B. It is in a country’s best interests to import products even if they are most efficiently produced at home.
    C. It is in a country’s best interests to import less specialized goods than to attempt to make them at home.
    D. It is in a country’s best interests to maintain a trade surplus.

The main tenet of mercantilism was that it was in a country’s best interests to maintain a trade surplus, to export more than it imported. By doing so, a country would accumulate gold and silver and, consequently, increase its national wealth, prestige, and power.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

43. (p. 165)Considered to be the first theory of international trade, the principal assertion of _____ was that gold and silver were the mainstays of national wealth and essential to vigorous commerce.
    A. collectivism
    B. mercantilism
    C. capitalism
    D. open market system

The principle assertion of mercantilism was that gold and silver were the mainstays of national wealth and essential to vigorous commerce. Gold and silver were the currency of trade between countries; a country could earn gold and silver by exporting goods and importing goods from other countries would result in an outflow of gold and silver to those countries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

 

44. (p. 165)Which of the following is NOT consistent with the central beliefs of mercantilism?
    A. Government should intervene to achieve a surplus in the balance of trade.
    B. Policies should be put in place to minimize exports and maximize imports.
    C. Imports should be limited by tariffs and quotas.
    D. Exports should be subsidized.

Mercantilism is an economic philosophy advocating that countries should simultaneously encourage exports and discourage imports.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: Mercantilism

45. (p. 166)Mercantilists saw no virtue in _____.
    A. a large volume of trade
    B. protectionism
    C. tariffs and quotas
    D. subsidizing exports

The mercantilists saw no virtue in a large volume of trade. Rather, they recommended policies to maximize exports and minimize imports. To achieve this, imports were limited by tariffs and quotas, while exports were subsidized.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

 

46. (p. 166, 167)An inconsistency in the mercantilist doctrine, as pointed out by David Hume, is that:
    A. it indirectly helped increase volume of a country’s imports.
    B. it presented a crude case for exclusion of government in matters pertaining to exports and imports.
    C. no country could sustain a surplus on the balance of trade.
    D. it was not backed by either sound political principles or social ideologies.

The classical economist David Hume pointed out an inherent inconsistency in the mercantilist doctrine in 1752. According to Hume, in the long run no country could sustain a surplus on the balance of trade and so accumulate gold and silver as the mercantilists had envisaged.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: Mercantilism

47. (p. 167)The flaw with mercantilism was that it viewed trade as a:
    A. zero-sum game.
    B. mutually beneficial activity.
    C. positive-sum game.
    D. threat to a nation’s sovereignty.

The flaw with mercantilism was that it viewed trade as a zero-sum game in which a gain by one country results in a loss by another.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

 

48. (p. 167)A situation in which gains by all parties can be achieved is called a:
    A. level playing field.
    B. zero-sum game.
    C. positive-sum game.
    D. trade surplus.

A situation in which all countries can benefit is called a positive-sum game. This is in contrast to a zero-sum game where gain by one of the parties results in loss by another.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

49. (p. 167)Neo-mercantilists equate _____ with economic power and economic power with
    _____.
    A. international trade; corruption
    B. political power; balance-of-trade surplus
    C. imports; regional dominance
    D. absolute advantage; trade monopoly

The mercantilist doctrine is by no means dead in the modern world. Neo-mercantilists equate political power with economic power and economic power with a balance-of-trade surplus.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Mercantilism

 

50. (p. 167)A country intentionally keeps its currency value low against the currency of another in order to sell more goods to the latter. This can be viewed as a(n) _____ policy.
    A. inflationist
    B. totalitarian
    C. neo-mercantilist
    D. capitalist

Critics argue that many nations have adopted a neo-mercantilist strategy that is designed to simultaneously boost exports and limit imports. For example, critics charge that China is pursuing a neo-mercantilist policy, deliberately keeping its currency value low against the U.S. dollar in order to sell more goods to the United States, and thus amass a trade surplus and foreign exchange reserves.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: Mercantilism

51. (p. 167)Which of the following theories of international trade was advanced by Adam Smith?
    A. Theory of absolute advantage
    B. Theory of comparative advantage
    C. New trade theory
    D. Product life-cycle theory

In his 1776 landmark book “The Wealth of Nations,” Adam Smith attacked the mercantilist assumption that trade is a zero-sum game. This led Smith to propose the theory of absolute advantage.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Absolute Advantage

 

52. (p. 167)A country is said to have a(n) _____ in the production of a product when it is more efficient than any other country in producing that product.
    A. comparative advantage
    B. relative advantage
    C. consumer advantage
    D. absolute advantage

According to Adam Smith, countries differ in their ability to produce goods efficiently. A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Absolute Advantage

53. (p. 167)According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then:
    A. retain these goods for strict domestic sales.
    B. trade these goods for goods produced by other countries.
    C. sell these goods to maintain a trade surplus.
    D. prohibit the import of these goods from other countries.

According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade these for goods produced by other countries. Smith’s basic argument, therefore, is that a country should never produce goods at home that it can buy at a lower cost from other countries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Absolute Advantage

 

54. (p. 167, 168)The different combinations of goods that a country, say Ghana, could produce are represented by the line GG’ in Figure 5.1. This is referred to as Ghana’s _____.
    A. production possibility frontier
    B. hypothetical trade barrier
    C. import-export differentiator
    D. resource conversion indicator

The different combinations of goods that a country could produce is referred to as a production possibility frontier (PPF).

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: Absolute Advantage

55. (p. 169)According to Adam Smith’s theory of absolute advantage, a country that has an absolute advantage in the production of all goods:
    A. enjoys the greatest benefits of international trade.
    B. might go on to become the dominant country in the production of those goods.
    C. will grow to be the biggest economic power.
    D. might derive no benefits from international trade.

Adam Smith’s theory of absolute advantage suggests that a country that has an absolute advantage in the production of all goods might derive no benefits from international trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Comparative Advantage

 

56. (p. 169)In his 1817 book entitled “Principles of Political Economy,” _____ introduced the theory of comparative advantage.
    A. Adam Smith
    B. David Ricardo
    C. Raymond Vernon
    D. Max Weber

David Ricardo took Adam Smith’s theory one step further by exploring what might happen when one country has an absolute advantage in the production of all goods. In his 1817 book entitled “Principles of Political Economy,” he introduced the theory of comparative advantage.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Comparative Advantage

57. (p. 169)Country “A” specializes in producing beef more efficiently than any other country. It buys wheat, which it produces less efficiently than beef, from country “B,” even though it produces wheat more efficiently itself. This situation is referred to as:
    A. comprehensive advantage.
    B. first advantage.
    C. comparative advantage.
    D. absolute advantage.

According to Ricardo’s theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself.

 

AACSB: Reflective Thinking
Bloom’s: Apply
Difficulty: Hard
Learning Objective: 05-02
Topic: Comparative Advantage

 

58. (p. 172)To an even greater degree than the theory of absolute advantage, _____ suggests that trade is a positive-sum game in which all participating countries fetch economic gains.
    A. the Heckscher-Ohlin theory
    B. mercantilism
    C. the theory of comparative advantage
    D. Leontief’s paradox

Ricardo’s theory suggests that consumers in all nations can consume more if there are no restrictions on trade even if they lack an absolute advantage in the production of any goods. In other words, to an even greater degree than the theory of absolute advantage, the theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

59. (p. 172)_____ theory suggests that consumers in all nations can consume more if there are no restrictions on trade.
    A. Porter’s
    B. Vernon’s
    C. Samuelson’s
    D. Ricardo’s

Ricardo’s theory suggests that consumers in all nations can consume more if there are no restrictions on trade. This occurs even in countries that lack an absolute advantage in the production of any goods.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

 

60. (p. 172)Which of the following is one of the unrealistic assumptions that the simple Ricardian model of comparative advantage used in the text is based on?
    A. There are many countries and many more goods in the world.
    B. Each country has a fixed stock of resources.
    C. Free trade changes the efficiency with which a country uses its resources.
    D. Differences in the prices of resources in different countries exist.

The conclusion that free trade is universally beneficial is a rather bold one to draw from the simple Ricardian model used in the text. This model includes many unrealistic assumptions, including the assumption that each country has a fixed stock of resources and that free trade does not change the efficiency with which a country uses its resources. This static assumption makes no allowances for the dynamic changes in a country’s stock of resources and in the efficiency with which the country uses its resources that might result from free trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

61. (p. 172)The simple model of comparative advantage used in the text is based on assuming away:
    A. the effects of trade on income distribution within a country.
    B. constant returns to scale.
    C. that all resources can move freely from the production of one good to another.
    D. that free trade does not change the efficiency with which the countries use their resources.

The conclusion that free trade is universally beneficial is a rather bold one to draw from such a simple model as comparative advantage as it assumes away the effects of trade on income distribution within a country.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

 

62. (p. 172)_____ argued that contrary to the standard interpretation, in certain circumstances, the theory of comparative advantage predicts that a rich country might actually be worse off by switching to a free trade regime with a poor nation.
    A. Raymond Vernon
    B. Andrew Warner
    C. Paul Samuelson
    D. Jeffery Sachs

Nobel Prize winning economist Paul Samuelson argued that contrary to the standard interpretation, in certain circumstances the theory of comparative advantage predicts that a rich country might actually be worse off by switching to a free trade regime with a poor nation.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

63. (p. 173)In comparative advantage, the assumption is that resources can move freely from production of one good to another. Why is this assumption unrealistic?
    A. The process of shifting resources from one good to another eliminates human suffering.
    B. The benefit of free trade is much lesser compared to the cost of shifting resources.
    C. The process of moving resources causes friction and human suffering.
    D. There are regulations that prohibit such movement.

Resources do not always move easily from one economic activity to another. The process creates friction and human suffering too. While the comparative advantage theory predicts that the benefits of free trade outweigh the costs by a significant margin, this is of cold comfort to those who bear the costs.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

 

64. (p. 173)The units of resources required to produce a good are assumed to remain unchanged no matter where one is on a country’s production possibility frontier. This is known as:
    A. zero-sum game.
    B. positive-sum game.
    C. constant returns to specialization.
    D. diminishing returns to specialization.

Constant returns to specialization means that the units of resources required to produce a good are assumed to remain constant no matter where one is on a country’s production possibility frontier (PPF).

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

65. (p. 173)Diminishing returns to specialization occurs when:
    A. natural resources begin to run out owing to pollution.
    B. more units of resources are required to produce each additional unit.
    C. the cost of producing goods reduces substantially with increase in number of goods produced.
    D. the quality of resources comes down as a result of producing more goods.

Diminishing returns to specialization occurs when more units of resources are required to produce each additional unit.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

 

66. (p. 173)It is more realistic to assume diminishing returns to specialization when evaluating the theory of comparative advantage. This is because:
    A. there exist differences in the prices of resources in different countries.
    B. resources can move freely from the production of one good to another within a country.
    C. not all resources are of the same quality.
    D. different goods use resources in the same proportions.

While applying the Ricardian theory of comparative advantage to a simplified model with two nations, it is more realistic to assume diminishing returns for two reasons. First, not all resources are of the same quality. A second reason for diminishing returns is that different goods use resources in different proportions.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

67. (p. 173, 174)The comparative advantage theory is considered to have ignored which of the following statements?
    A. Constant returns to specialization implies a concave Production Possibility Frontier.
    B. Constant returns to specialization suggests that the gains from specialization are likely to be exhausted before specialization is complete.
    C. It is feasible for a country to specialize to a point where the resulting gains from trade are outweighed by diminishing returns.
    D. Different goods use different resources in different proportions.

Constant returns to specialization means the units of resources required to produce a good are assumed to remain constant no matter where one is on a country’s production possibility frontier (PPF). It is more realistic to assume diminishing returns to specialization as not all resources are of the same quality and different goods use resources in different proportions.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

 

68. (p. 175)Dynamic gains in both the stock of a country’s resources and the efficiency with which resources are utilized will:
    A. cause the country’s PPF to be in a bell-shaped curve.
    B. enable the country to produce more goods than it did before the introduction of free trade.
    C. cause a country’s PPF to shift inward.
    D. enable the country to achieve constant returns to specialization.

Dynamic gains in both the stock of a country’s resources and the efficiency with which resources are utilized will cause a country’s PPF to shift outward. As a consequence of this outward shift, the country can produce more of both goods than it did before introduction of free trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

69. (p. 175)What was Samuelson’s criticism of free trade?
    A. He argued that dynamic gains lead to a universally beneficial outcome for all countries.
    B. He argued that offshoring service jobs that were traditionally mobile will increase the market clearing wage rate.
    C. He argued that free trade has historically been beneficial only to third world countries.
    D. A rich country importing cheap goods from a poor country may not make up for the wage losses in the rich country.

Paul Samuelson’s model suggests that in certain cases, the lower prices that consumers in rich countries pay for goods imported from poor countries following the introduction of a free trade regime may not be enough to produce a net gain for the richer economy if the dynamic effect of free trade is to lower real wage rates in the rich country.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

 

70. (p. 176)According to Samuelson, the ability to offshore service jobs that traditionally were not internationally mobile, coupled with rapid advances in communications technology and the productivity of foreign labor due to better education have an effect on middle-class wages in the United States that can be similar to:
    A. mass inward migration into the United States.
    B. improvement in the standard of living in the United States.
    C. better employability of United States labor.
    D. a substantial hike in the market clearing wage rate.

When coupled with rapid advances in the productivity of foreign labor due to better education, the effect on middle-class wages in the United States, according to Samuelson, may be similar to mass inward migration into the United States—it will lower the market clearing wage rate, perhaps by enough to outweigh the positive benefits of international trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

71. (p. 177)One of the rebuttals of Samuelson’s critique of the free trade model is that:
    A. the United States’ ability to achieve constant returns to specialization is unparalleled.
    B. the strict immigration policies of the United States help insulate the economy from inward migration.
    C. introducing trade barriers may in fact be beneficial for the United States to some extent.
    D. developing nations are unlikely to upgrade the skill level of their workforce rapidly enough.

While not questioning Samuelson’s analysis, some economists note that developing nations are unlikely to be able to upgrade the skill level of their workforce rapidly enough to give rise to the situation in Samuelson’s model. In other words, the countries will quickly run into diminishing returns.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

 

72. (p. 177)_____ and _____ created a measure of how “open” to international trade an economy was and then looked at the relationship between “openness” and economic growth for a sample of more than 100 countries from 1970 to 1990.
    A. Ricardo; Smith
    B. Warner; Sachs
    C. Porter; Vernon
    D. Samuelson; Ohlin

Many economic studies have looked at the relationship between trade and economic growth. Jeffrey Sachs and Andrew Warner created a measure of how “open” to international trade an economy was and then looked at the relationship between “openness” and economic growth for a sample of more than 100 countries from 1970 to 1990.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: Comparative Advantage

73. (p. 177)In general, economic studies on the relationship between trade and economic growth suggest that:
    A. countries open to international trade display higher growth rates than those that close their economies to trade.
    B. comparative advantage theory does not hold much relevance in the modern world of international trade and open economies.
    C. modern economic trends tend to be influenced more by the absolute advantage theory than the comparative advantage theory.
    D. with the onset of free trade, rich countries are showing better dynamic gains in the efficiency with which resources are used.

Many economic studies have looked at the relationship between trade and economic growth. In general, these studies suggest that, as predicted by the standard theory of comparative advantage, countries that adopt a more open stance toward international trade enjoy higher growth rates than those that close their economies to trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

 

74. (p. 178)According to the Heckscher-Ohlin theory, the pattern of international trade is determined by differences in:
    A. labor productivity.
    B. efficiency.
    C. factor endowments.
    D. management practices.

Unlike Ricardo’s theory, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments, rather than differences in productivity.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

75. (p. 178)The United States has an abundance of arable land, but faces a shortage of low-cost labor. In contrast, China excels in the production of labor-intensive goods, such as footwear and textiles. According to the Heckscher-Ohlin theory:
    A. United States will import textiles and footwear from China and export agricultural goods.
    B. China will invest more than United States in the production of agricultural goods to exploit its population advantage.
    C. United States and China will import agricultural goods and textiles respectively to exploit the comparative advantage.
    D. the migration of Chinese laborers to United States will increase exponentially to bridge the shortage in cheap labor.

Heckscher and Ohlin argued that comparative advantage arises from differences in national factor endowments. Their theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

 

76. (p. 178)Nations have varying factor endowments, and different factor endowments explain differences in _____.
    A. labor productivity
    B. efficiency of processes
    C. factor mobility
    D. factor costs

Nations have varying factor endowments, and different factor endowments explain differences in factor costs; specifically, the more abundant a factor, the lower its cost.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

77. (p. 178)The difference between Ricardo’s theory and the Heckscher-Ohlin theory is that they attributed the rise of comparative advantage to differences in _____ and _____, respectively.
    A. abundance of resources; education
    B. economic systems; political ideologies
    C. availability of labor; efficiency of production
    D. productivity; factor endowments

Unlike Ricardo’s theory, the Heckscher-Ohlin theory argues that the pattern of international trade is determined by differences in factor endowments, rather than differences in productivity.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

 

78. (p. 178)Which theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce?
    A. Warner-Sachs
    B. Wacziarg-Welch
    C. Heckscher-Ohlin
    D. Frankel-Romer

The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce. Thus, the Heckscher-Ohlin theory attempts to explain the pattern of international trade that we observe in the world economy.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

79. (p. 178)According to the text, most economists prefer the Heckscher-Ohlin theory to Ricardo’s theory because:
    A. it makes fewer simplifying assumptions.
    B. it predicts real-world international trade patterns with greater accuracy.
    C. Ricardo’s theory is less accurate due to the Leontief paradox.
    D. Ricardo’s theory is too complicated to be applied to real-world scenarios.

The Heckscher-Ohlin theory has been one of the most influential theoretical ideas in international economics. Most economists prefer the Heckscher-Ohlin theory to Ricardo’s theory because it makes fewer simplifying assumptions.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

 

80. (p. 178)U.S. exports were less capital-intensive than U.S. imports, despite the relative abundance of capital in the country. This phenomenon runs contrary to what the Heckscher-Ohlin theory would predict and is termed the _____ paradox.
    A. Zeno
    B. Leontief
    C. Russell
    D. Simpson

Using the Heckscher-Ohlin theory, Wassily Leontief postulated that since the United States was relatively abundant in capital compared to other nations, the United States would be an exporter of capital-intensive goods and an importer of labor-intensive goods. However, he found that U.S. exports were less capital intensive than U.S. imports and this has become known as the Leontief paradox.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

81. (p. 178)What is a possible explanation for the Leontief paradox?
    A. U.S. imports goods that heavily use skilled labor and innovative entrepreneurship.
    B. U.S. has a special advantage in producing new products made with innovative technologies.
    C. U.S. exports heavy manufacturing products that use large amounts of capital.
    D. U.S. has a strong absolute advantage over all other foreign nations because of its advantageous factor endowments.

One possible explanation of the Leontief paradox is that the United States has a special advantage in producing new products or goods made with innovative technologies.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

 

82. (p. 178)82.One of the drawbacks of the Heckscher-Ohlin theory, even though it makes sound theoretical sense, is that:
    A. it does not explain the differences in national factor endowments.
    B. it argues that comparative advantage arises from differences in the countries’ labor productivity.
    C. it lacks common sense appeal.
    D. it is a relatively poor predictor of real-world international trade patterns.

Economists are faced with a difficult dilemma as they prefer the Heckscher-Ohlin theory on theoretical grounds, but it is a relatively poor predictor of real-world international trade patterns.

 

AACSB: Analytic
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

83. (p. 179)One of the key assumptions of the Heckscher-Ohlin theory is that:
    A. technologies are the same across countries.
    B. differences in the prices of resources in different countries do not exist.
    C. resources can move freely from the production of one good to another within a country.
    D. trade has no effect on income distribution in a country.

A key assumption in the Heckscher-Ohlin theory is that technologies are the same across countries. This may not be the case. Differences in technology may lead to differences in productivity, which in turn, drives international trade patterns.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

 

84. (p. 179)Raymond Vernon proposed the product life cycle in the mid-1960s. Vernon argued that two factors gave U.S. firms a strong incentive to develop new consumer products. These two factors were _____ and _____.
    A. innovation; number of industries
    B. size of the U.S. market; lack of competition
    C. wealth; size of the U.S. market
    D. entrepreneurial spirit; low-cost U.S. labor

Vernon’s theory was based on the observation that for most of the 20^th century a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the U.S. market. To explain this, Vernon argued that the wealth and size of the U.S. market gave U.S. firms a strong incentive to develop new consumer products.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

85. (p. 179)Vernon’s product life-cycle theory was based on the observation that for most of the 20^th century, a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the _____ market.
    A. Asian
    B. Western European
    C. U.S.
    D. global

Vernon’s theory was based on the observation that for most of the 20^th century, a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the U.S. market.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

 

86. (p. 179)According to the product life-cycle theory, the high cost of U.S. labor gave U.S. firms an incentive to:
    A. lower costs of services to offset a fall in demand.
    B. develop cost-saving process innovations.
    C. invite foreign direct investment in domestic industries.
    D. embrace and promote open market capitalism.

Vernon’s theory was based on the observation that for most of the twentieth century a very large proportion of the world’s new products had been developed by U.S. firms and sold first in the U.S. market. In addition, the high cost of U.S. labor gave U.S. firms an incentive to develop cost-saving process innovations.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

87. (p. 179)Vernon argues that pioneering firms kept production facilities closer to the market and centers of decision making because:
    A. of the uncertainty and risks inherent in introducing new products.
    B. they believed that foreign production facilities were inferior in technical skills.
    C. they believed that U.S. labor costs were much lower than those in foreign markets.
    D. earlier U.S. governments were critical of outsourcing production to other countries.

Just because a new product is developed by a U.S. firm and first sold in the U.S. market, it does not follow that the product must be produced in the United States. It could be produced abroad at some low-cost location and then exported back into the United States. Apparently, pioneering firms believed it was better to keep production facilities close to the market and to the firm’s center of decision making, given the uncertainty and risks inherent in introducing new products.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

 

88. (p. 179)According to Vernon, which of the following factors obviates the need for pioneering U.S. firms to look for low-cost production sites in other countries?
    A. There is less uncertainty and risks inherent in introducing new products.
    B. The demand for most new products tends to be based mainly on price.
    C. U.S. labor costs were relatively low compared to global standards.
    D. Firms can charge relatively high prices for new products.

The demand for most new products tends to be based on non-price factors. Consequently, firms can charge relatively high prices for new products, which obviates the need to look for low-cost production sites in other countries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

89. (p. 179)Vernon argues that early in the life cycle of a typical new product, while demand is starting to grow rapidly in the United States, demand in other advanced countries:
    A. remains limited to high income groups.
    B. necessitates imports to the United States.
    C. necessitates outsourcing of production to low-cost locations.
    D. raises costs of production in the United States.

Vernon went on to argue that early in the life cycle of a typical new product, while demand is growing rapidly in the United States, demand in other advanced countries is limited to high-income groups. The limited initial demand in other advanced countries does not make it worthwhile for firms in those countries to start producing the new product, but it does necessitate some exports from the United States to those countries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

 

90. (p. 179)Vernon predicts that as the demand for a new product starts to grow in other advanced countries:
    A. it becomes worthwhile for firms to invest in low-cost domestic labor in the United States.
    B. they deem it worthwhile to invest in production facilities in the United States.
    C. it is not worthwhile for firms in those countries to start producing the new product.
    D. the potential for exports from the U.S. begins to get limited.

Over time, demand for a new product starts to grow in other advanced countries. As it does, it becomes worthwhile for foreign producers to begin producing for their home markets. Consequently, production within other advanced countries begins to limit the potential for exports from the United States.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

91. (p. 179)Vernon theorizes that as the market in the U.S. and other advanced nations matures, the product becomes more standardized and price becomes:
    A. governmentally regulated.
    B. higher.
    C. unimportant.
    D. the main competitive weapon.

As the market in the United States and other advanced nations matures, the product becomes more standardized, and price becomes the main competitive weapon.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

 

92. (p. 180)Historically, the product life-cycle theory seems to be an accurate explanation of:
    A. international trade patterns.
    B. the growth of innovation in U.S. firms.
    C. the Leontief paradox.
    D. the current labor advantages in the U.S.

The evolution in the pattern of international trade is consistent with the predictions of the product life-cycle theory that mature industries tend to go out of the United States and into low-cost assembly locations. Hence, historically the product life-cycle theory has been noted as being an accurate explanation for international trade patterns.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

93. (p. 180)The relevance of the product life-cycle theory in the modern world seems more limited because:
    A. many countries have increasingly invested in the U.S. labor market over the past century.
    B. with the diminishing strength of the U.S. dollar, it loses the ability to generalize trade globally.
    C. it holds true only for the brief U.S. dominance of the global economy.
    D. historically, it has provided inaccurate explanations of international trade patterns.

Although Vernon’s theory may be useful for explaining the pattern of international trade during the brief period of American global dominance, its relevance in the modern world seems more limited.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

 

94. (p. 180)Compared to the comparative advantage theory, the product life-cycle theory:
    A. fails to predict the possibility of globally dispersed production.
    B. is increasingly relevant to explaining trade patterns in the modern world.
    C. makes a lot of simplifying assumptions.
    D. explains the current labor advantages in the U.S.

The product life-cycle theory fails to account for globalization and integration of world economy, which are accompanied by globally dispersed production, with particular components of a new product being produced in those locations around the globe where the mix of factor costs and skills is most favorable (as predicted by the theory of comparative advantage).

 

AACSB: Analytic
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

95. (p. 182)The _____ theory began to emerge in the 1970s when some economists pointed out that the ability of firms to attain economies of scale might have important implications for international trade.
    A. balanced trade
    B. Heckscher-Ohlin
    C. new trade
    D. product life-cycle

The new trade theory began to emerge in the 1970s when a number of economists pointed out that the ability of firms to attain economies of scale might have important implications for international trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: New Trade Theory

 

96. (p. 182)_____ are unit cost reductions associated with a large scale of output.
    A. Comparative advantages
    B. Factor endowments
    C. Economies of scale
    D. Diminishing returns

Economies of scale are unit cost reductions or cost advantages associated with a large scale of output.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: New Trade Theory

97. (p. 182)Because of substantial economies of scale, the new trade theory argues that trade can:
    A. increase the variety of goods available to consumers.
    B. increase the average costs of goods.
    C. enable the global market to support a wide range of enterprises.
    D. inhibit first-mover advantages in all products.

New trade theory argues that, through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average costs of those goods.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: New Trade Theory

 

98. (p. 182)The _____ theory states that in those industries where the output required to attain economies of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of enterprises.
    A. Heckscher-Ohlin
    B. comparative advantage
    C. product life-cycle
    D. new trade

The new trade theory states that in those industries where the output required to attain economies of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of enterprises.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: New Trade Theory

99. (p. 182)The ability to spread fixed costs over a large volume, and the ability of large-volume producers to utilize specialized employees and equipment that are more productive than less-specialized employees and equipment, are both sources of:
    A. first-mover disadvantages.
    B. economies of scale.
    C. conflict in international trade.
    D. rising production costs.

Economies of scale are unit cost reductions associated with a large scale of output. Economies of scale have a number of sources, including the ability to spread fixed costs over a large volume, and the ability of large-volume producers to utilize specialized employees and equipment that are more productive than less-specialized employees and equipment.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: New Trade Theory

 

100. (p. 182)The new trade theory points out that through its impact on economies of scale, trade can:
     A. reduce the volume of the goods produced.
     B. decrease the variety of goods available to consumers.
     C. decrease the average costs of goods.
     D. inhibit first-mover advantages in all industries.

New trade theory argues that, through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average costs of those goods.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: New Trade Theory

101. (p. 182)Assuming a world without trade, in industries where economies of scale are important, both the variety of goods that a country can produce and the scale of production are limited by the _____.
     A. size of the market
     B. monetary system
     C. purchasing power parity
     D. strength of the currency

In a world without trade, and in industries where economies of scale are important, both the variety of goods that a country can produce and the scale of production are limited by the size of the market.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: New Trade Theory

 

102. (p. 182)If a national market is small, there may not be enough demand to enable producers to realize _____ for certain products.
     A. adequate supply
     B. economies of scale
     C. cheap labor
     D. low volumes

In the absence of trade, if a national market is small, there may not be enough demand to enable producers to realize economies of scale for certain products.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: New Trade Theory

103. (p. 182)According to new trade theory, which of the following could be a result of the economies of scale that may be achieved by individual firms as the size of the market expands due to trade?
     A. Each nation can produce a wider variety of goods, minimizing its imports.
     B. Each nation can simultaneously decrease the variety of goods available to its consumers and raise the costs of those goods.
     C. Each nation may specialize in producing a narrower range of products, importing goods that it does not make.
     D. Each nation can attain self-sufficiency in most products and eliminate exports.

As the size of the market expands due to trade, individual firms may be able to better attain economies of scale. The implication is that each nation may be able to specialize in producing a narrower range of products than it would in the absence of trade, yet by buying goods that it does not make from other countries, each nation can simultaneously increase the variety of goods available to its consumers and lower the costs of those goods.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-03
Topic: New Trade Theory

 

104. (p. 182, 183)According to the new trade theory, how does trade offer an opportunity for mutual gain even when countries do not differ in their resource endowments or technology?
     A. Trade results in a contraction of the size of the markets of individual firms.
     B. Trade allows for production of products at higher prices.
     C. Trade affords realization of scale economies.
     D. Trade allows countries to attain self-sufficiency in the production of all goods.

As the size of the market expands due to trade, individual firms may be able to better attain economies of scale. The implication, according to new trade theory, is that each nation may be able to specialize in producing a narrower range of products, buying goods that it does not make from other countries. Thus, each nation can simultaneously increase the variety of goods available to its consumers and lower the costs of those goods—thus trade offers an opportunity for mutual gain even when countries do not differ in their resource endowments or technology.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: New Trade Theory

105. (p. 183)One of the themes in new trade theory is that the pattern of trade we observe in the world economy may be the result of _____ and _____.
     A. competitive advantage; technological advancement
     B. heterogeneous world market; globalization
     C. economies of scale; first-mover advantages
     D. liberal immigration policies; better standards of living

A theme in new trade theory is that the pattern of trade we observe in the world economy may be the result of economies of scale and first-mover advantages. For those products where economies of scale are significant and represent a substantial proportion of world demand, the first movers in an industry can gain a scale-based cost advantage that later entrants find almost impossible to match.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: New Trade Theory

 

106. (p. 183)The economic and strategic advantages that accrue to early entrants in an industry are called:
     A. first-mover advantages.
     B. comparative advantages.
     C. pioneering advantages.
     D. early-bird advantages.

First-mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. The ability to capture scale economies ahead of later entrants, and thus benefit from a lower cost structure, is an important first-mover advantage.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: New Trade Theory

107. (p. 183)Which of the following is an advantage that first-movers enjoy?
     A. Increasing returns to specialization
     B. A positive-sum game due to lack of competition
     C. Capture scale economies ahead of later entrants
     D. Absolute advantage and higher efficiency

First-mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. The ability to capture scale economies ahead of later entrants, and thus benefit from a lower cost structure, is an important first-mover advantage.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-03
Topic: New Trade Theory

 

108. (p. 191)According to the new trade theory, countries whose firms establish a(n) _____ advantage with regard to the production of a particular new product may subsequently dominate global trade in that product.
     A. comparative
     B. absolute
     C. first-mover
     D. constant return

Countries may dominate in the export of certain goods because economies of scale are important in their production and because firms located in those countries were the first to capture scale economies, giving them a first-mover advantage.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-05
Topic: Focus on Managerial Implications

109. (p. 183)One of the implications of the new trade theory is that:
     A. it predicts the U.S. dominating the world market for consumer goods.
     B. nations may benefit from trade irrespective of resource endowments or technology.
     C. U.S. switches from being an importer of products to an exporter owing to lowering of labor costs.
     D. it accurately predicts the evolution of globally dispersed production.

The new trade theory suggests that nations may benefit from trade even when they do not differ in resource endowments or technology.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: New Trade Theory

 

110. (p. 184)According to the new trade theory, the dominance of America and Europe in the trade of mid-sized and large aircraft is largely a product of:
     A. the nascent world market for private jets owned by individuals.
     B. lack of technological advancement elsewhere to compete with the leaders.
     C. the unpredictability of supply and demand patterns endemic to the aviation industry.
     D. first-mover advantages afforded by the industry.

In the commercial aircraft industry, the fact that Boeing and Airbus are already in the industry and have the benefits of economies of scale discourages new entry and reinforces the dominance of America and Europe in the trade of midsized and large jet aircraft. This dominance is further reinforced because global demand may not be sufficient to profitably support another producer of midsized and large jet aircraft in the industry.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Hard
Learning Objective: 05-03
Topic: New Trade Theory

111. (p. 184)The new trade theory is at variance with the _____ theory, which suggests that a country will predominate in the export of a product when it is particularly well endowed with those factors used intensively in its manufacture.
     A. Heckscher-Ohlin
     B. product life-cycle
     C. comparative advantage
     D. Ricardo-Sraffa

New trade theory is at variance with the Heckscher-Ohlin theory, which suggests that a country will predominate in the export of a product when it is particularly well endowed with those factors used intensively in its manufacture.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-03
Topic: New Trade Theory

 

112. (p. 185)With regard to first-mover advantages and international trade, a study by Harvard business historian Alfred Chandler suggests the existence of first-mover advantages is an important factor in explaining:
     A. the dominance of firms from certain nations in specific industries.
     B. the economic hardships faced by former colonies of the West.
     C. the superiority enjoyed by developing countries like India and China in producing goods that require highly-skilled labor.
     D. the decline of United States’ share in world output.

With regard to first-mover advantages and international trade, a study by Harvard business historian Alfred Chandler suggests the existence of first-mover advantages is an important factor in explaining the dominance of firms from certain nations in specific industries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-04
Topic: New Trade Theory

113. (p. 185)The most contentious implication of the new trade theory is perhaps the argument that it generates for _____ and _____.
     A. free trade; laissez faire
     B. entrepreneurship; innovation
     C. luck; entrepreneurship
     D. government intervention; strategic trade policy

Perhaps the most contentious implication of the new trade theory is the argument that it generates for government intervention and strategic trade policy.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-04
Topic: New Trade Theory

 

114. (p. 185)The new trade theory diverts from its advocacy of free trade by:
     A. suggesting that first-mover advantages influence domination of certain countries in specific industries.
     B. suggesting that nations benefit even in absence of resource endowments and technology.
     C. indirectly suggesting an economic rationale for a proactive trade policy.
     D. stressing the role of luck, entrepreneurship, and innovation in giving a firm first-mover advantages.

By stressing first mover advantages in certain industries, new trade theory provides a rationale for government intervention to increase the chances of its domestic firms becoming first movers in newly emerging industries, as the U.S. government apparently did with Boeing.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-03
Topic: New Trade Theory

115. (p. 185)Which of the following theorists published the results of an intensive research effort that attempted to determine why some nations succeed and others fail in international competition, in addition to, proposing an explanation in the form of a “diamond” of four national attributes?
     A. Alfred Chandler
     B. Raymond Vernon
     C. Andrew Warner
     D. Michael Porter

In 1990 Michael Porter of the Harvard Business School published the results of an intensive research effort that attempted to determine why some nations succeed and others fail in international competition.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

116. (p. 185)Which of the following best describes the essential task of Porter’s 1990 study of national competitive advantage?
     A. How do nations leverage their resources efficiently to gain absolute advantage?
     B. Why does a nation achieve international success in a particular industry?
     C. How do countries gain first-mover advantages?
     D. What are the international trade patterns in evidence in the modern world?

Like the work of the new trade theorists, Porter’s work was driven by a belief that existing theories of international trade told only part of the story. For Porter, the essential task was to explain why a nation achieves international success in a particular industry.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

117. (p. 186)Porter suggested four attributes making up the “diamond” consist of factor endowments, relating and supporting industries, firm strategy, structure, and rivalry, and:
     A. nature of competition.
     B. first-mover advantages.
     C. constant returns to specialization.
     D. demand conditions.

Porter theorizes that four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage, namely factor endowments, related and supporting industries, firm strategy, structure, and rivalry, and demand conditions.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

118. (p. 186)According to Porter’s diamond, a nation’s position in elements of production such as skilled labor or the infrastructure necessary to compete in a given industry is best referred to as:
     A. capitalization.
     B. demand conditions.
     C. factor endowments.
     D. optimization.

Porter defines factor endowments, one of the four attributes of a nation that shape the environment in which local firms compete, as a nation’s position in factors of production such as skilled labor or the infrastructure necessary to compete in a given industry.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

119. (p. 186)Porter’s thesis was that four broad attributes of a nation shape the environment in which local firms compete, and that these attributes promote or impede the creation of competitive advantage. All of the following are attributes EXCEPT:
     A. factor endowments.
     B. first-mover advantages.
     C. firm strategy, structure, and rivalry.
     D. relating and supporting industries.

Porter theorizes that four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage, namely factor endowments, related and supporting industries, firm strategy, structure, and rivalry, and demand conditions.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

120. (p. 186)Porter maintains that two additional variables can influence the “diamond” of attributes in important ways. These two variables are _____ and ______.
     A. entrepreneurship; strategic trade policies
     B. innovation; entrepreneurship
     C. absolute advantage; PPF
     D. chance; government

In addition to the four attributes that constitute the national diamond, Porter maintains that two variables can influence the national diamond in important ways: chance and government.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

121. (p. 187)Which of the following factor endowments would be classified as a basic factor by Michael Porter?
     A. Communication
     B. Research facilities
     C. Natural resources
     D. Skilled labor

Porter recognizes hierarchies among factors, distinguishing between basic factors (e.g., natural resources, climate, location, and demographics) and advanced factors (e.g., communication infrastructure, sophisticated and skilled labor, research facilities, and technological know-how).

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

122. (p. 187)Which of the following factor endowments would be classified as an advanced factor by Michael Porter?
     A. Demographics
     B. Climate and location
     C. Natural resources
     D. Skilled labor

Porter recognizes hierarchies among factors, distinguishing between basic factors (e.g., natural resources, climate, location, and demographics) and advanced factors (e.g., communication infrastructure, sophisticated and skilled labor, research facilities, and technological know-how).

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

123. (p. 187)Porter argued that in terms of factor endowments, _____ factors are the most significant for competitive advantage.
     A. constant
     B. basic
     C. advanced
     D. complementary

Porter argues that advanced factors are the most significant for competitive advantage. Unlike naturally endowed basic factors, advanced factors are products of investment by individuals, companies, and governments. Thus, government investments in basic and higher education, by improving the general skill and knowledge level of the population and by stimulating advanced research at higher education institutions, can upgrade a nation’s advanced factors.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

124. (p. 187)Japan is a country that is at a disadvantage in terms of natural resources but it has achieved economic success by investing in education, thereby building a vital pool of skilled labor and technological know-how. This reflects Porter’s argument that:
     A. competitive advantage is largely a product of basic factors.
     B. basic factors can be upgraded by nations, while advanced factors are endowed by nature.
     C. an initial advantage in basic factors is vital to competitive advantage.
     D. advanced factors are the most significant for competitive advantage.

Porter argues that advanced factors are the most significant for competitive advantage. Unlike the naturally endowed basic factors, advanced factors are a product of investment by individuals, companies, and governments. Thus, government investments in basic and higher education, by improving the general skill and knowledge level of the population and by stimulating advanced research at higher education institutions, can upgrade a nation’s advanced factors.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

125. (p. 187)According to Porter, the characteristics of _____ are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality.
     A. international customers
     B. the U.S. market
     C. foreign investment
     D. home demand

The characteristics of home demand are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality. Porter argues that a nation’s firms gain competitive advantage if their domestic consumers are sophisticated and demanding and pressure local firms to meet high standards of product quality and to produce innovative products.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

126. (p. 187)Porter argues that a nation’s firms gain competitive advantage if their domestic consumers are:
     A. sophisticated and demanding.
     B. price insensitive and trusting.
     C. accommodating and flexible.
     D. nationalist and protective of their domestic industries.

Porter argues that a nation’s firms gain competitive advantage if their domestic consumers are sophisticated and demanding. Such consumers pressure local firms to meet high standards of product quality and to produce innovative products.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

127. (p. 187)Sophisticated and demanding local customers in Scandinavia helped push Nokia of Finland and Ericsson of Sweden to invest in cellular phone technology long before demand for cellular phones took off in other developed nations. This underscores Porter’s point about how:
     A. home demand plays an important role in upgrading competitive advantage.
     B. upgrading basic factors can help countries gain competitive advantage.
     C. basic factors are the most significant for competitive advantage.
     D. international trade can help firms gain competitive advantage.

Porter emphasizes the role home demand plays in upgrading competitive advantage. The characteristics of home demand are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality. Porter argues that a nation’s firms gain competitive advantage if their domestic consumers are sophisticated and demanding. Such consumers pressure local firms to meet high standards of product quality and to produce innovative products.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

128. (p. 187, 188)Technological leadership in the U.S. semiconductor industry provided the basis for U.S. success in personal computers and several other technically advanced electronic products. Similarly, Switzerland’s success in pharmaceuticals is closely related to its previous international success in the technologically related dye industry. These instances illustrate the attribute of national competitive advantage identified by Porter as:
     A. national investment in basic factors of production.
     B. the presence of sophisticated and knowledgeable local customers.
     C. the presence of suppliers or related industries that are internationally competitive.
     D. the international demand for a locally produced product.

The third broad attribute of national advantage in an industry is the presence of suppliers or related industries that are internationally competitive. The benefits of investments in advanced factors of production by related and supporting industries can spill over into an industry, thereby helping it achieve a strong competitive position internationally.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

129. (p. 189)_____ occurs when employees move between firms within a region and when national industry associations bring employees from different companies together for regular conferences or workshops.
     A. Domestic competition
     B. Organizational restructuring
     C. Management friction
     D. Knowledge flow

Clusters of related industries are important because valuable knowledge can flow between the firms within a geographic cluster when employees move between firms within a region and when national industry associations bring employees from different companies together for regular conferences or workshops, benefiting all within that cluster.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

130. (p. 189)Porter noted the predominance of engineers in top management at German and Japanese firms and a predominance of people with finance backgrounds leading many U.S. firms. He argued that the dominance of finance in U.S. firms led to a relative loss of U.S. competitiveness in some engineering-based industries. Thus, Porter illustrates how different nations _____, which are instrumental in their building national competitive advantage.
     A. upgrade their basic factors
     B. have different trade policies
     C. are characterized by different management ideologies
     D. have varying levels of government interference

The fourth broad attribute of national competitive advantage in Porter’s model is the strategy, structure, and rivalry of firms within a nation. Porter makes two important points here, of which one is that different nations are characterized by different management ideologies, which either help them or do not help them to build national competitive advantage.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

131. (p. 189)Porter, in his model of competitive advantage, suggested that there is a strong association between _____ and the creation and persistence of competitive advantage in an industry.
     A. investment
     B. vigorous domestic rivalry
     C. eliminating competition
     D. the availability of a captive market

Porter asserts that there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage in an industry. Vigorous domestic rivalry induces firms to look for ways to improve efficiency, which makes them better international competitors.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

132. (p. 189)Who argued that successful industries within a country tend to be grouped into “clusters” of related industries?
     A. Michael Porter
     B. Raymond Vernon
     C. David Ricardo
     D. Eli Heckscher

One of the most pervasive findings of Porter’s study was that successful industries within a country tend to be grouped into clusters of related industries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

133. (p. 189)Porter argues that the presence of _____ component(s) is usually required for “Porter’s diamond” to boost national competitive advantage.
     A. at least two
     B. all four
     C. at least three
     D. at least one

Porter contends that the degree to which a nation is likely to achieve international success in a certain industry is a function of the combined impact of factor endowments, domestic demand conditions, related and supporting industries, and domestic rivalry. He argues that the presence of all four components is usually required for this diamond to boost competitive performance (although there are exceptions).

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-04
Topic: National Competitive Advantage: Porter’s Diamond

 

134. (p. 190)Does Porter’s model of competitive advantage predict the pattern of international trade that we observe in the real world?
     A. Yes, Porter’s model has been supported by detailed empirical testing.
     B. We do not know because Porter’s theory has not been subjected to detailed empirical testing.
     C. No, Porter’s model has failed to stand the test of time and is dated.
     D. Yes, Porter’s model stands out as the one single theory that best predicts international trade.

It is not yet known if Porter’s model of competitive advantage is true. Porter’s theory has not been subjected to detailed empirical testing. Much about the theory rings true, but the same can be said for the new trade theory, the theory of comparative advantage, and the Heckscher-Ohlin theory.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-04
Topic: National Competitive Advantage: Porter’s Diamond

135. (p. 190)If a company were to draw from the ideas proposed in the various theories of international trade, from a profit perspective, how would it go about selecting locations for its businesses?
     A. It would concentrate its productive activities mostly in developing countries.
     B. It would concentrate its productive activities in its home country.
     C. It would disperse its productive activities to those countries where they can be performed most efficiently.
     D. It would disperse its productive activities across all countries that serve as its market.

Underlying most of the theories is the notion that different countries have particular advantages in different productive activities. Thus, from a profit perspective, it makes sense for a firm to disperse its productive activities to those countries where, according to the theory of international trade, they can be performed most efficiently.

 

AACSB: Reflective Thinking
Bloom’s: Apply
Difficulty: Hard
Learning Objective: 05-05
Topic: Focus on Managerial Implications

 

136. (p. 191)Preempting the available demand, gaining cost advantages related to volume, building an enduring brand ahead of later competitors, and, consequently, establishing a long-term sustainable competitive advantage, are all examples of:
     A. monopolistic practices.
     B. comparative advantages.
     C. absolute advantages.
     D. first-mover advantages.

For the individual firm, the clear message is that it pays to invest substantial financial resources in trying to build a first-mover or early-mover advantage even if that means several years of losses before a new venture becomes profitable. The idea is to preempt the available demand, gain cost advantages related to volume, build an enduring brand ahead of later competitors, and, consequently, establish a long-term sustainable competitive advantage.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-05
Topic: Focus on Managerial Implications

 

Essay Questions

137. (p. 163, 165, 166)What is meant by the term “free trade”? Is free trade compatible with the concept of mercantilism?

Free trade refers to the absence of government barriers to the free flow of goods and services between countries. Free trade refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country. The concept of mercantilism is not compatible with the concept of free trade. The main tenet of mercantilism is that it is in a country’s best interests to maintain a trade surplus by exporting more than it imports. Consistent with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade through policies to maximize exports and minimize imports. To achieve this, imports were limited by tariffs and quotas, while exports were subsidized.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-01
Learning Objective: 05-02
Topic: An Overview of Trade Theory; Mercantilism

 

138. (p. 167)Mercantilism viewed trade as a zero-sum game. Discuss Adam Smith’s and David Ricardo’s stand on the issue. Also discuss the phenomenon of neo-mercantilism.

Mercantilism viewed trade as a zero-sum game, where a gain by one country results in a loss by another. Adam Smith and David Ricardo demonstrated the shortsightedness of this approach and argued that trade is a positive-sum game, or a situation in which all countries can benefit. However, the mercantilist doctrine is by no means dead. Neo-mercantilists equate political power with economic power and economic power with a balance-of-trade surplus. Critics argue that many nations have adopted a neo-mercantilist strategy that is designed to simultaneously boost exports and limit imports. For example, critics charge that China is pursuing a neo-mercantilist policy, deliberately keeping its currency value low against the U.S. dollar in order to sell more goods to the United States, and thus amass a trade surplus and foreign exchange reserves.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: Mercantilism

139. (p. 167)Describe Adam Smith’s concept of absolute advantage.

According to Smith, countries should specialize in the production of goods for which they have an absolute advantage and then trade those goods for the goods produced by other countries. For instance, during Smith’s time, England had an absolute advantage in the production of textiles, and France had an absolute advantage in the production of wine. According to the concept of absolute advantage, it then only makes sense for England to produce textiles (and export them to France), and France to produce wine (and export it to England). Smith’s basic argument, therefore, was that a country should never produce goods at home that it can buy at a lower cost from other countries. Moreover, Smith argued that by specializing in the production of goods in which each has an absolute advantage, both countries benefit by engaging in trade.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Absolute Advantage

 

140. (p. 172)How does the theory of comparative advantage suggest that trade is a positive-sum game to an even greater degree than does the theory of absolute advantage does?

The basic message of the theory of comparative advantage is that potential world production is greater with unrestricted free trade than it is with restricted trade. Ricardo’s theory suggests that consumers in all nations can consume more if there are no restrictions on trade. This occurs even in countries that lack an absolute advantage in the production of any good. In other words, to an even greater degree than the theory of absolute advantage, the theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains. As such, this theory provides a strong rationale for encouraging free trade. So powerful is Ricardo’s theory that it remains a major intellectual weapon for those who argue for free trade.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

 

141. (p. 175, 176)Discuss Paul Samuelson’s critique of free trade, where he argued that in some circumstances, dynamic gains can lead to an outcome that is not so beneficial.

Paul Samuelson’s critique looks at what happens when a rich country—the United States—enters into a free trade agreement with a poor country—China—that rapidly improves its productivity after the introduction of a free trade regime (i.e., there is a dynamic gain in the efficiency with which resources are used in the poor country). Samuelson’s model suggests that in such cases, the lower prices that U.S. consumers pay for goods imported from China following the introduction of a free trade regime may not be enough to produce a net gain for the U.S. economy if the dynamic effect of free trade is to lower real wage rates in the United States. Samuelson goes on to note that he is particularly concerned about the ability to offshore service jobs that traditionally were not internationally mobile, such as software debugging, call center jobs, accounting jobs, and even medical diagnosis of MRI scans. Recent advances in communications technology have made this possible, effectively expanding the labor market for these jobs to include educated people in places such as India, the Philippines, and China. When coupled with rapid advances in the productivity of foreign labor due to better education, the effect on middle-class wages in the United States, according to Samuelson, may be similar to mass inward migration into the United States—it will lower the market clearing wage rate, perhaps by enough to outweigh the positive benefits of international trade. Having said this, it should be noted that Samuelson concedes that free trade has historically benefited rich counties and he notes that introducing protectionist measures may produce a situation that is worse than the disease the measures are trying to prevent.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: Comparative Advantage

 

142. (p. 178)Describe the Leontief paradox.

Beginning with a famous study published in 1953 by Wassily Leontief, many empirical tests have raised questions about the validity of the Heckscher-Ohlin theory. Using the Heckscher-Ohlin theory, Leontief postulated that since the United States was relatively abundant in capital compared to other nations, the United States would be an exporter of capital-intensive goods and an importer of labor-intensive goods. However, he found that U.S. exports were less capital intensive than U.S. imports. Since this result was at variance with the predictions of the Heckscher-Ohlin theory, it has become known as the Leontief paradox.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: Heckscher-Ohlin Theory

143. (p. 179)In his product life-cycle theory, Raymond Vernon argued that for most of the twentieth century a very large proportion of the world’s new products had been developed by U.S. firms, produced in the U.S., and sold first in the U.S. market. What reasons does he cite for U.S. firms basing initial production at home and not at some low-cost foreign location?

In his product life-cycle theory, Vernon argued that most new products were initially produced in America. Apparently, the pioneering firms believed it was better to keep production facilities close to the market and to the firm’s center of decision making, given the uncertainty and risks inherent in introducing new products. Also, the demand for most new products tends to be based on non-price factors. Consequently, firms can charge relatively high prices for new products, which obviates the need to look for low-cost production sites in other countries.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

 

144. (p. 180)Describe briefly the shortcomings of the product life-cycle theory.

Viewed from an Asian or European perspective, the assertion of the product life-cycle theory that most new products are developed and introduced in the United States seems ethnocentric and increasingly dated. Although it may be true that during U.S. dominance of the global economy (from 1945 to 1975), most new products were introduced in the United States, there have always been important exceptions. These exceptions appear to have become more common in recent years. Many new products are now first introduced in Japan (e.g., videogame consoles) or Europe (new wireless phones). Moreover, with the increased globalization and integration of the world economy, a growing number of new products (e.g., laptop computers, compact disks, and digital cameras) are now introduced simultaneously in the United States, Japan, and the advanced European nations. This may be accompanied by globally dispersed production, with particular components of a new product being produced in those locations around the globe where the mix of factor costs and skills is most favorable (as predicted by the theory of comparative advantage). In sum, although Vernon’s theory may be useful for explaining the pattern of international trade during the brief period of American global dominance, its relevance in the modern world seems more limited.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: The Product Life-Cycle Theory

145. (p. 182)Briefly describe the new trade theory.

The new trade theory began to emerge in the 1970s when a number of economists pointed out that the ability of firms to attain economies of scale might have important implications for international trade. Economies of scale are unit cost reductions associated with a large scale of output. New trade theory makes two important points: First, through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease the average costs of those goods. Second, in those industries where the output required to attain economies of scale represents a significant proportion of total world demand, the global market may be able to support only a small number of enterprises. Thus, world trade in certain products may be dominated by countries whose firms were first movers in their production.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-02
Topic: New Trade Theory

 

146. (p. 183)What are first-mover advantages? Outline the relationship between economies of scale, first-mover advantages and the pattern of trade as indicated by new trade theory.

One of the themes in new trade theory is that the pattern of trade we observe in the world economy may be the result of economies of scale and first-mover advantages. First-mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. The ability to capture scale economies ahead of later entrants, and thus benefit from a lower cost structure, is an important first-mover advantage. New trade theory argues that for those products where economies of scale are significant and represent a substantial proportion of world demand, the first movers in an industry can gain a scale-based cost advantage that later entrants find almost impossible to match. Thus, the pattern of trade that we observe for such products may reflect first-mover advantages. Countries may dominate in the export of certain goods because economies of scale are important in their production and because firms located in those countries were the first to capture scale economies, giving them a first-mover advantage.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-03
Topic: New Trade Theory

 

147. (p. 186)Identify and briefly describe the four broad attributes of a nation identified by Michael Porter as shaping the environment in which local firms compete, and promote or impede the creation of competitive advantage. Also, outline Porter’s conclusions from his analysis.

Porter theorizes that four broad attributes of a nation shape the environment in which local firms compete, and these attributes promote or impede the creation of competitive advantage. These attributes are:
1) Factor Endowments: A nation’s position in factors of production such as skilled labor or the infrastructure necessary to compete in a given industry.
2) Demand Conditions: The nature of home demand for the industry’s product or service.
3) Relating and Supporting Industries: The presence or absence in a nation of supplier industries and related industries that are internationally competitive.
4) Firm Strategy, Structure, and Rivalry: The conditions in the nation governing how companies are created, organized, and managed and the nature of domestic rivalry.
Porter speaks of these four attributes as constituting the diamond. He argues that firms are most likely to succeed in industries or industry segments where the diamond is most favorable. He also argues that the diamond is a mutually reinforcing system. The effect of one attribute is contingent on the state of others.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

 

148. (p. 187)Porter’s theory counts demand conditions as one of the four broad attributes of a nation, shaping the environment in which local firms compete. Briefly explain how it is so and mention at least two examples to support the explanation.

Porter emphasizes the role home demand plays in upgrading competitive advantage. Firms are typically most sensitive to the needs of their closest customers. Thus, the characteristics of home demand are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality. Porter argues that a nation’s firms gain competitive advantage if their domestic consumers are sophisticated and demanding. Such consumers pressure local firms to meet high standards of product quality and to produce innovative products.
Porter notes that Japan’s sophisticated and knowledgeable buyers of cameras helped stimulate the Japanese camera industry to improve product quality and to introduce innovative models. A similar example can be found in the wireless telephone equipment industry, where sophisticated and demanding local customers in Scandinavia helped push Nokia of Finland and Ericsson of Sweden to invest in cellular phone technology long before demand for cellular phones took off in other developed nations.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-02
Topic: National Competitive Advantage: Porter’s Diamond

149. (p. 190)How does Porter’s theory predict patterns in international trade? Do his predictions hold up in a real-world scenario?

According to Porter’s model of international trade, countries should be exporting products from those industries where all four components of the diamond are favorable, while importing in those areas where the components are not favorable. However, we do not know if he is correct. Porter’s theory has not been subjected to detailed empirical testing. Much about the theory rings true, but the same can be said for the new trade theory, the theory of comparative advantage, and the Heckscher-Ohlin theory.

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Easy
Learning Objective: 05-04
Topic: National Competitive Advantage: Porter’s Diamond

 

150. (p. 190)From a profit perspective based on the various international theories, how would a business go about choosing locations for its various productive activities?

From a profit perspective, it makes sense for a firm to disperse its productive activities to those countries where, according to the theory of international trade, they can be performed most efficiently. The result is a global web of productive activities, with different activities being performed in different locations around the globe depending on considerations of comparative advantage, factor endowments, and the like. If the firm does not do this, it may find itself at a competitive disadvantage relative to firms that do.

 

AACSB: Reflective Thinking
Bloom’s: Understand
Difficulty: Medium
Learning Objective: 05-05
Topic: Focus on Managerial Implications

151. (p. 192)Discuss the policy implications of Porter’s theory of national competitive advantage.

Porter’s theory of national competitive advantage suggests that it is in the best interest of business for a firm to invest in upgrading advanced factors of production; for example, to invest in better training for its employees and to increase its commitment to research and development. It is also in the best interests of business to lobby the government to adopt policies that have a favorable impact on each component of the national diamond. Thus, according to Porter, businesses should urge government to increase investment in education, infrastructure, and basic research (since all these enhance advanced factors) and to adopt policies that promote strong competition within domestic markets (since this makes firms stronger international competitors, according to Porter’s findings).

 

AACSB: Analytic
Bloom’s: Remember
Difficulty: Medium
Learning Objective: 05-05
Topic: Focus on Managerial Implications