1. Guide 1.1
Book Chapter 01
Globalization and the Multinational Firm
1. Country A can produce 10 yards of textiles or 6 pounds of food per unit of input.
Compute the opportunity cost of producing one additional unit of food instead of
textiles.
A. 1 yard of textiles per 1.67 pounds of food
B. 1 pound of food per 1.67 yards of textiles
C. 1 yard of textiles per .6 pounds of food
D. 1 pound of food per .6 yards of textiles
6/10 = .6 pounds of food
2. (p.24-25) Country A can produce 10 yards of textiles or 6 pounds of food per unit of
input. Country B can produce 8 yards of textiles or 5 pounds of food per unit of input.
A. Country A is relatively more efficient than Country B in the production of textiles
B. Country B is relatively more efficient than Country A in the production of food
C. Country A has an absolute advantage over Country B in the production of food and
textiles
D. All of the above
Country A has an opportunity cost of 1 yard of textiles per .6 (= 6/10) pounds of food;
Country B has an opportunity cost of 1 yard of textiles for .63 (= 5/8) pounds of food.
Country A has an opportunity cost of 1 pound of food per 1.67 (= 10/6) yards of textiles;
Country B has an opportunity cost of 1 pound of food for 1.60 (= 8/5) yards of textiles.
Thus, Country A has an absolute advantage and a relative efficiency over Country B in
the production of textiles. Country B has a relative efficiency over Country A in the
production of food. Country B does not have an absolute advantage over Country A in
the production of food or textiles.
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2. 3. Countries A and B currently consume 400 units of food and 400 units of textiles each
and currently do not trade with one another. The citizens of country A have to give up
one unit of food to gain two units of textiles, while the citizens of country B have to give
up one unit of textiles to gain two units of food. Their production possibilities curves are
shown.
Under the theory of comparative advantage,
A. The citizens of country A should make food and trade with the citizens of country B
for textiles
B. The citizens of country A should make textiles and trade with the citizens of country
B for food
C. There are no gains from trade in this example
D. A is twice as good as B at making food and B is twice as good as A at making
textiles
Consider the shape of the combined production possibilities curve with and without
trade: The citizens of country A should make textiles and trade with the citizens of
country B for food; the citizens will be able to go from the point shown on the combined
no trade line to somewhere better.
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3. 4. Counties A and B currently consume 400 units of food and 400 units of textiles each
and currently do not trade with one another. The citizens of country A have to give up
one unit of food to gain two units of textiles, while the citizens of country B have to give
up one unit of textiles to gain two units of food. Their production possibilities curves are
shown.
Under the theory of comparative advantage, if free trade is allowed, the market clearing
price (or exchange rate if you will) between food and textiles will be
A. One unit of food for one unit of textiles
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4. B. Somewhere between One unit of food for two units of textiles and two units of food
for one unit of textiles
C. One unit of food for two units of textiles
D. Two units of food for one unit of textiles
Consider the shape of the combined production possibilities curve with and without
trade: The citizens of country A should make textiles and trade with the citizens of
country B for food; the citizens will be able to go from the point shown on the combined
no trade line to somewhere better.
However, all that we know of the price is that it must make both parties better off, hence
b)
5. Countries A and B currently consume 400 units of food and 400 units of textiles each
and currently do not trade with one another. The citizens of country A have to give up
one unit of food to gain two units of textiles, while the citizens of country B have to give
up one unit of textiles to gain two units of food. Their production possibilities curves are
shown.
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5. Suppose that trade is allowed and that the international exchange rate between food
and textiles is one-for-one. The increased consumption following trade will be:
A. An increase of 400 units of food and 400 units of textiles
B. An increase of 1,200 units of food and 1,200 units of textiles
C. An increase of 800 units of food and 800 units of textiles
D. There are no gains from trade in this example
Consider the shape of the combined production possibilities curve with and without
trade: The citizens of country A should make textiles and trade with the citizens of
country B for food; the citizens will be able to go from the point shown on the combined
no trade line to the point where the combined with trade curve kinks. At a world price of
1 to 1 producers in both A and B will specialize completely and the out put will be 1,200
units of both food and textiles.
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6. (For questions 6-11) The table below shows the bushels of wheat and the bottles of
beer that North and South Dakota can produce per day of labor under two different
hypothetical situations (Cases I and II).
6 Which state has a comparative advantage in wheat production in Case I?
A. South Dakota
B. North Dakota
C. Neither state
1 bottle of beer gets you 4 bushels of wheat in South Dakota but 1 bottle of beer gets
only ½ bushel of wheat in North Dakota. If you had a bottle of beer and wanted a bushel
of wheat, where would you trade?
7. Which state has a comparative advantage in wheat production in Case II?
A. South Dakota
B. North Dakota
C. Neither state
4 bottles of beer gets you 3 bushels of wheat in South Dakota but 4 bottles of beer gets
only 2 bushels of wheat in North Dakota. If you had a bottle of beer and wanted a
bushel of wheat, where would you trade?
8. What is the relative price of wheat in North Dakota prior to trade in Case II?
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7. A. 2 bushels of wheat = ½ bottle of beer
B. ½ bushel of wheat = 2 bottles of beer
C. 1 bushel of wheat = ½ bottle of beer
D. 1 bushel of wheat = 2 bottles of beer
9. For case II, in what range must the "international" price of wheat fall? i.e. if North and
South Dakota trade only with each other, what is the range of prices possible?
A. Between 1 bushel of wheat = 4/3 bottles of beer and 1 bushel of wheat = 2 bottles of
beer
B. Between 1 bushel of wheat = 3/4 bottles of beer and 1 bushel of wheat = 2 bottles of
beer
C. Between 1 bushel of wheat = 3/4 bottles of beer and 1 bushel of wheat = ½ bottles of
beer
D. None of the above
10. For case II, let the international price be 1 bottle = 1 bushel. Derive South Dakota's
"trading possibilities curve”.
A. Choice a
B. Choice b
C. Choice c
D. Choice d
South Dakota will specialize in making beer and will be able to trade for wheat at the 1-1
price. They will be better off with trade.
11. For case II, let the international price be 1 bottle = 1 bushel. Derive North Dakota's
"trading possibilities curve."
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8. A. Choice a
B. Choice b
C. Choice c
D. Choice d
North Dakota will also specialize in making beer and will be able to trade for wheat at
the 1-1 price. They will be better off with trade.
Note: these last two questions make a good pair, you could be tempted to make one
state produce beer and another produce wheat just for the sake of symmetry.
Book Chapter 02
International Monetary System
1. Suppose that the pound is pegged to gold at £20 per ounce and the dollar is pegged
to gold at $35 per ounce. This implies an exchange rate of $1.75 per pound. If the
current market exchange rate is $1.80 per pound, how would you take advantage of this
situation? Hint: assume that you have $350 available for investment.
A. Start with $350. Buy 10 ounces of gold with dollars at $35 per ounce. Convert the
gold to £200 at £20 per ounce. Exchange the £200 for dollars at the current rate of
$1.80 per pound to get $360.
B. Start with $350. Exchange the dollars for pounds at the current rate of $1.80 per
pound. Buy gold with pounds at £20 per ounce. Convert the gold to dollars at $35 per
ounce.
C. a) and b) both work
D. none of the above
2. (p.26) Prior to the 1870s, both gold and silver were used as international means of
payment and the exchange rates among currencies were determined by either their
gold or silver contents. Suppose that the dollar was pegged to gold at $30 per ounce,
the French franc is pegged to gold at 90 francs per ounce and to silver at 9 francs per
ounce of silver, and the German mark pegged to silver at 1 mark per ounce of silver.
What would the exchange rate between the U.S. dollar and German mark be under this
system?
A. 1 German mark = $2
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9. B. 1 German mark = $0.50
C. 1 German mark = $3
D. 1 German mark = $1
Start with $30, buy one ounce of gold. Sell that ounce of gold for FF90. Sell the FF90 for
10 ounces of silver. Buy 10 German marks. Thus, $30 = DM10.
3. Suppose that country A and country B are both on a bimetallic standard. In country A
the ratio is 15 to one (i.e. an ounce of gold is worth 15 times as much as an ounce of
silver in that currency), while in country B the ratio is ten to one. If the free flow of capital
is allowed between countries A and B is this a sustainable framework?
A. Yes
B. No
C. There is not enough information to make an informed determination.
Suppose that the two countries currencies are $ and € and that
This implies an exchange rate of €1 = $3 in gold exchange and €1 = $2 in silver
exchange.
Clearly the currency traders will want to buy euro for $2 via silver and sell euro for $3
via gold.
4. (p.26) Suppose that both gold and silver are used as international means of payment
and the exchange rates among currencies are determined by either their gold or silver
contents. Suppose that the dollar was pegged to gold at $20 per ounce, the Japanese
yen is pegged to gold at 120,000 yen per ounce and to silver at 8,000 yen per ounce of
silver, and the Australian dollar is pegged to silver at $5 per ounce of silver. What would
the exchange rate between the U.S. dollar and Australian dollar be under this system?
A. $1 U.S. = $1 Australian
B. $1 U.S. = $2 Australian
C. $1 U.S. = $3 Australian
D. None of the above
Start with $20, buy one ounce of gold. Sell that ounce of gold for ×120,000. Sell the yen
for 15 ounces of silver. Buy 3 Australian dollars. Thus, $1 U.S. = $3 Australian.
5. Suppose that Britain pegs the pound to gold at six pounds per ounce, whereas the
exchange rate between pounds and U.S. dollars is $5 = £1. What should an ounce of
gold be worth in U.S. dollars?
A. $29.40
B. $30.00
C. $0.83
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10. D. $1.20
1oz. gold = £6 and £1 = $5 so £6 = $30 = 1oz. gold
6. (p.28) Suppose that the British pound is pegged to gold at £6 per ounce, whereas
one ounce of gold is worth €12. Under the gold standard, any misalignment of the
exchange rate will be automatically corrected by cross border flows of gold. Calculate
the possible gains for buying €1,000, if the British pound becomes undervalued and
trades for €1.80. (Assume zero shipping costs).
(Hint: Gold is first purchased using the devalued British pound from the Bank of
England, then shipped to France and sold for €1,000 to the Bank of France).
A. £55.56
B. £65.56
C. £75.56
D. £85.56
Since an ounce of gold should be worth the same north or south of the English Channel,
it should be €12 = £6. So our exchange rate implied by gold prices is €2 = £1, therefore
buying €1,000 should cost £500:
€1,000×£1/€2 = £500.00
If the pound is undervalued at €1.80, we find that €1,000 costs £555.56:
€1,000×£1/€1.80 = £555.56
Therefore, the savings in buying €1,000 by using gold and not posted exchange rates:
£555.56 - £500.00 = £55.56
7. Suppose that Britain pegs the pound to gold at the market price of £6 per ounce, and
the United States pegs the dollar to gold at the market price of $36 per ounce. If the
official exchange rate between pounds and U.S. dollars is $5 = £1. Which of the
following trades is profitable?
A. Start with £100 and trade for $500 at the official exchange rate. Redeem the $500 for
13.89 ounces of gold. Trade the gold for £83.33.
B. Start with $100 and buy gold. Sell the gold for £16.67. Sell the pounds at the official
exchange rate.
C. Start with £100 and buy gold. Sell the gold for $600.
D. Start with $500 and trade for £100 at the official exchange rate. Redeem the £100 for
16 2/3 ounces of gold. Trade the gold for $600.
1oz. gold = £6 and $36 = 1oz. gold so £1 = $6 in the gold market. So make money by
buying pounds at $5 at the official exchange rate and selling the pounds for $6 by going
through the gold market. Answer c is wrong because it fails to include the last step: sell
the gold for £120.
8. The G-7 is composed of
A. Canada, France, Japan, Germany, Italy, the U.K., and the United States.
B. Switzerland, France, Japan, Germany, Italy, the U.K., and the United States.
C. Switzerland, France, North Korea, Germany, Italy, the U.K., and the United States.
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11. D. Switzerland, France, Japan, Germany, Canada, the U.K., and the United States.
9. (p. 54) Consider the supply-demand framework for the British pound relative to the
U.S. dollar shown in the nearby chart. The exchange rate is currently $1.80 = £1.00.
Which of the following is correct?
A. To "fix" the exchange rate at $1.80 = £1.00, the Federal Reserve could use
contractionary monetary policy to shift the demand curve to the left.
B. To "fix" the exchange rate at $1.80 = £1.00, the U.S. government could use
contractionary fiscal policy to shift the demand curve to the left.
C. The British Government could use fiscal or monetary policy to shift the supply curve
to the right to fix the exchange rate to $1.80 = £1.00.
D. All of the above.
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