International Trade, Globalisation and Exchange Rates: practice questions

Question 1

The government of Bellduna wants to protect its domestic solar-panel manufacturers from cheaper imported solar panels. Rather than adding any tax to the price of imported panels, it sets a maximum limit on the total number of solar panels that may legally enter Bellduna from abroad each year.

Which method of trade protection is the government of Bellduna using?

Accepted Answer

B

Question 2

Verantia has fertile highland soil and a climate ideally suited to growing coffee at a low cost. Kastoria has advanced textile factories and a long-trained workforce that lets it produce cotton cloth at a low cost. Neither country currently trades with the other, and each curren…

Accepted Answer

((a)) Specialisation by country is when a country concentrates its resources on producing the good(s) or service(s) it can produce most efficiently or at the lowest cost, rather than trying to produce everything it needs itself, and then trades with other countries for the goods and s…  ((b)) Verantia's fertile highland soil and suitable climate let it grow coffee at a low cost, while Kastoria's advanced factories and trained workforce let it produce cloth at a low cost. Free trade allows each country to concentrate its resources on the good it can produce most cheap…  ((c)) One advantage to Verantia is that, by specialising in coffee and importing cloth rather than producing it domestically, its resources are used where they are most productive, so Verantia can produce more coffee overall and access cloth more cheaply than if it tried to make it do…

Question 3

Northmere currently imports steel piping from Sarnovia at a price of $40 per unit. Northmere's own domestic steel-pipe producers charge $44 per unit for an equivalent product. The government of Northmere then imposes a specific tariff of $6 per unit on all steel piping imported…

Accepted Answer

((a)) $46 per unit (40 + 6 = 46).  ((b)) Before the tariff, the imported steel piping ($40) was cheaper than Northmere's domestic product ($44), so buyers likely favoured the import. After the $6 tariff, the imported price rises to $46, which is now more expensive than the $44 domestic price, so buyers are likely to sw…  ((c)) Two acceptable reasons: to protect a strategic industry (steel piping) that the government considers important, for example for national infrastructure or security; and to raise tax revenue for the government from the tariff charged on every imported unit.  ((d)) The tariff raises the price of steel piping in Northmere from $40 to $46. This increases costs for Northmere firms (for example, construction firms) that use steel piping as an input, and reduces the purchasing power of anyone who buys it directly, effects which are likely to be…

Question 4

Verantia's currency is the veran and Kastoria's currency is the kastor. Both currencies float freely in the foreign exchange market, where the exchange rate between them is determined by demand and supply. The equilibrium exchange rate is initially 1 veran = 4 kastors. (a) Defin…

Accepted Answer

((a)) An appreciation is a rise in the value of a currency against another currency (or currencies) in a floating exchange rate system, caused purely by market forces of demand and supply for that currency, without any direct government intervention. After an appreciation, one unit of…  ((b)) Foreign buyers of Verantian machinery must first buy verans (using their own kastors) in the foreign exchange market in order to pay Verantian exporters, so a rise in global demand for Verantian machinery increases demand for verans. With the supply of verans unchanged, this inc…  ((c)(i)) Before: 2000×4=8 000 kastors. After: 2000×5=10 000 kastors. The machinery now costs more in kastors even though Verantia has not changed its veran price, making it less price-competitive for Kastorian buyers, so Kastorian demand for this export is likely to fall.  ((c)(ii)) Before: 2500÷4=625 verans. After: 2500÷5=500 verans. The cloth now costs fewer verans even though the kastor price is unchanged, making it cheaper for Verantian buyers, so Verantian demand for this import is likely to rise.

Question 5

The table below shows the value of each component of Doverly's current account of the balance of payments for last year, in $ million. A positive number means Doverly earned more from that component than it paid out; a negative number means Doverly paid out more than it earned.…

Accepted Answer

((a)) The current account of the balance of payments is a record of a country's transactions with the rest of the world in trade in goods, trade in services, primary income (e.g. profit, interest and dividends) and secondary income (e.g. transfers such as remittances and aid) over a p…  ((b)) Balance = -450+130+40-20=-300. Doverly has a current account deficit of $300 million.  ((c)) One possible cause: if inflation in Doverly has been running higher than in its trading partners, Doverly's goods and services become less price-competitive abroad (reducing export revenue) while imports become comparatively more attractive to Doverly's own consumers (increasing…  ((d)) First, a persistent deficit means spending is leaking out of Doverly's economy to pay for net imports and other outflows rather than supporting domestic firms, which can reduce aggregate demand, slow economic growth and raise unemployment in industries that produce exports or co…

Question 6

Rasenda and Tolmira used to produce almost all their own goods domestically, with very little trade between them. The two countries then remove all barriers to trade with each other, and each begins to specialise in the goods it can produce most efficiently.

Which of the following is most likely to be a genuine benefit that consumers in Rasenda gain as a direct result of this move towards specialisation and free trade?

Accepted Answer

C

Question 7

Sendara produces cotton fabric domestically and can also import unlimited quantities of fabric from Palvia at a fixed world price of $3 per metre. The table below shows Sendara's domestic demand and domestic supply schedules for cotton fabric at different prices. Price ($ per me…

Accepted Answer

((a)) 50 million metres, since quantity demanded at $3 (80 million metres) minus domestic quantity supplied at $3 (30 million metres) equals the quantity that must be imported to satisfy the remaining demand.  ((b)) New equilibrium price = $4 per metre, the price at which quantity demanded (65 million metres) equals domestic supply plus the quota (45 million metres plus the 20 million metre quota, also 65 million metres). Domestic producers supply 45 million metres at this price.  ((c)) The total quantity bought by consumers falls from 80 million metres (at the $3 world price, before the quota) to 65 million metres (at the $4 price, after the quota), a decrease of 15 million metres.  ((d)) Domestic producers sell a larger quantity, 45 million metres instead of 30 million metres, at a higher price, $4 per metre instead of $3 per metre, so their total revenue rises substantially as a result of the quota.

Question 8

A small company in Kelmoor has just started manufacturing electric bicycles. Because the company is new, it has not yet built up the scale of production or the experience of established foreign manufacturers, so it currently makes electric bicycles at a much higher cost than fir…

Accepted Answer

B

Question 9

Solenna's currency is the pama and Bryndor's currency is the ring. Both currencies float freely in the foreign exchange market. The equilibrium exchange rate is initially 1 pama = 8 rings. (a) Define what is meant by a depreciation of a currency in a floating exchange rate syste…

Accepted Answer

((a)) A depreciation is a fall in the value of a currency against another currency (or currencies) in a floating exchange rate system, caused purely by market forces of demand and supply for that currency, without any direct government intervention. After a depreciation, one unit of t…  ((b)) Solennan importers who want to buy Bryndorian electronics must first obtain rings, which they do by selling pamas (their own currency) in the foreign exchange market in order to buy rings from Bryndorian suppliers. A rise in Solennan demand for these imports therefore increases…  ((c)(i)) At the original rate, 900×8=7200 rings. At the new rate, 900×6=5400 rings. The furniture now costs Bryndorian buyers fewer rings than before, even though the Solennan firm has not changed its pama price, so it becomes more price-competitive in Bryndor and Bryndorian demand for t…  ((c)(ii)) At the original rate, 3600÷8=450 pamas. At the new rate, 3600÷6=600 pamas. The electronics now cost Solennan buyers more pamas than before, even though the Bryndorian firm has not changed its ring price, so this import becomes more expensive for Solenna and Solennan demand for i…

Question 10

The table below shows three of the four components of Fenmoor's current account of the balance of payments for last year, in $ million. Fenmoor's overall current account balance for the year was a surplus of $250 million. Component $ million Trade in goods +180 Trade in services…

Accepted Answer

((a)) A current account surplus occurs when the sum of a country's trade in goods, trade in services, primary income and secondary income with the rest of the world is positive, meaning the country earns more from these transactions with abroad over the period than it pays out.  ((b)) Secondary income = $10 million, since 180+90-30+x=250 gives 240+x=250, so x=10.  ((c)) A persistent surplus means more foreign currency is flowing into Fenmoor than is flowing out, so the demand for Fenmoor's currency in the foreign exchange market tends to exceed its supply. This tends to cause an appreciation of Fenmoor's currency, which over time makes Fenmoor'…  ((d)) A large surplus means Fenmoor is producing more than it is consuming or investing at home, so resources devoted to earning income from abroad could instead have been used to raise domestic consumption, investment or living standards. A persistent surplus can also encourage tradi…

International Trade, Globalisation and Exchange Rates: Economics 0455 (Cambridge O Level / IGCSE)

Syllabus coverage

Question 1

Question 2

Question 3

Question 4

Question 5

Question 6

Question 7

Question 8

Question 9

Question 10

Component	$ million
Trade in goods	-450
Trade in services	+130
Primary income	+40
Secondary income	-20

Component	$ million
Trade in goods	+180
Trade in services	+90
Primary income	-30
Secondary income	?