International Economics, 7e (Gerber)

Chapter 5 Beyond Comparative Advantage

5.1 Introduction: More Reasons to Trade

1) Comparative advantage has mixed results when it comes to predicting a country's trade
patterns. Which of the following is FALSE?
A) There are many products an economy might export and import use the same comparative advantage.
B) A large share of international trade is not based on comparative advantage.
C) Comparative advantage proven completely incapable of predicting trade. ‫غير قادرة تماًم ا على التنبؤ‬
‫بالتجارة‬.
D) Comparative advantage is a dynamic concept, which means that the spread of technology,
improvement in skills, and learning-by-doing may alter a country's comparative advantage over time.
Answer: C
2) Comparative advantage cannot account for a significant portion of world trade.
Answer: TRUE

5.2 Intraindustry Trade

1) Intraindustry trade refers to

A) international trade in products made within the same industry.
B) international trade in products made across different industries.
C) trade that occurs as a result of comparative advantage.
D) the exchange of dissimilar items.
Answer: A
2) Interindustry trade refers to
A) international trade in products made within the same industry.
B) domestic trade in products made within the same industry.
C) international trade in products made across different industries.
D) the exchange of similar items that are differentiated.
Answer: C
3) Intraindustry trade is characterized by what two features of the industry and market?
A) Diseconomies of scale and homogeneous products
B) Non-tariff barriers and large-scale foreign investment
C) Quota auctions and low effective rates of protection
D) Economies of scale and differentiated products
Answer: D
4) Intraindustry trade relies on
A) economies of scale.
B) the product cycle.
C) differences in factor endowments.
D) monopoly pricing.
Answer: A
5) One reason that a large share of the trade between high-income industrial economies is
intraindustry trade is because
A) it is more advantageous than interindustry trade.
B) high-income industrial economies produce in the first stage of the product cycle.
C) high-income industrial economies have dissimilar resource endowments in absolute terms.
D) it allows firms to take advantage of internal economies of scale.
Answer: D
6) An internal economies of scale is defined as
A) an industry with costs that fall for all firms.
B) a firm with falling costs over a specific level of output.
C) a firm with falling costs over a relatively large range of output.
D) a firm with falling costs over a relatively large range of output, but definite declining profits.
Answer: C
7) Which of the following is true about monopolistic competition?
A) One firm serves as the entire industry.
B) A small number of firms serve the entire market.
C) It is competition among many firms producing similar but differentiated products.
D) Firms do not have economies of scale.
Answer: C
8) Which of the following is FALSE about intraindustry trade?
A) Intraindustry trade creates gains from trade.
B) Intraindustry trade is due to comparative advantage.
C) Intraindustry trade may involve heightened competition and lower prices for consumers.
D) Intraindustry trade increases consumer choice.
Answer: B
9) Internal economies of scale means that
A) firms are experiencing lower average production costs due to a geographical concentration of
firms in their industry that make it cheaper and easier to hire highly specialized workers and
inputs.
B) firms will have lower profits after international trade begins, because costs will be higher than
when they just focused on the domestic market.
C) consumers will have less choices once trade begins, because firms will be squeezed out of the
market.
D) expanding the size of the market the firm serves reduces overall per unit costs, since the firm
can spread costs over more output.
Answer: D
10) Which of the following is NOT an example of intraindustry trade?
A) Trading Jeeps for Toyotas
B) Trading Boeing airplanes for Airbus airplanes
C) Trading Bush beer for Heineken beer
D) Trading oil for trucks
Answer: D
11) Which of the following is an example of intraindustry trade?
A) Trading peanut oil for tractors
B) Trading crude oil for automobiles
C) Trading Nokia smartphones for Apple iPhones
D) Trading jeans for cotton
Answer: C
12) Which of the following is NOT a likely result of intraindustry trade based on internal
economies of scale?
A) Job creation at domestic firms entering international trade
B) Lower prices for the domestic consumers of the product now being traded
C) Increased sales and lower per unit costs for the firm doing the exporting
D) Higher prices for the exported product
Answer: D
13) If trade in a particular good interindustry, the expansion of an industry in one country
is likely to lead to the ________ of that industry in the other country. If trade in that good
is intraindustry, expansion of the industry in one country is likely to lead to the ________ in
the other country.
A) decline, decline
B) decline, expansion
C) expansion, decline
D) expansion, expansion
Answer: B
14) An internal economy means that ________, while an external economy means that
________.
A) firm costs fall as firm output increases, firm costs fall as industry output increases
B) firm costs fall as industry output increases, firm costs fall as firm output increases
C) firm costs fall as firm output increases, firm costs rise as industry output increases
D) firm costs fall as industry output increases, firm costs rise as firm output increases
Answer: A
Topic: Intraindustry Trade
15) Interindustry trade is not based on comparative advantage since it consists of the
export and import of similar goods.
Answer: FALSE
16) Economies of scale are an important determinant of comparative advantage-based
trade.
Answer: FALSE
17) If countries have similar factors of production and similar productivities, most of their
trade is likely to be intraindustry.
Answer: TRUE
18) Intraindustry trade can lead to lower prices and job creation in both the exporting and
the importing nation.
Answer: TRUE
19) Intraindustry trade tends to be more controversial than interindustry trade.
Answer: FALSE

20) A substantial amount of trade between industrialized countries is intraindustry or intrafirm

trade rather than interindustry trade.
Answer: TRUE

21) If countries have similar factor endowments and productivities, their trade is likely to be
interindustry.
Answer: FALSE

22) Trading French wine for California wine is an example of intraindustry trade.
Answer: TRUE

23) Intraindustry trade is characterized by what two features?

Answer: Economies of scale and differentiated products
24) If countries have similar factor endowments and productivities, what type of trade are they
most likely to have?
Answer: Intraindustry

25) If the United States and Canada trade hydro-powered electricity for Hollywood films, what
type of trade does this represent?
Answer: Interindustry

26) If the United States and Mexico trade Budweiser for Modelo beer, what type of trade does
this represent?
Answer: Intraindustry

27) Which industry was first covered by a free trade agreement between Canada and the United
States?
Answer: Automobiles
28) Carefully explain why there are gains from intraindustry trade.
Answer: The increased size of markets leads to lower costs through the effect of scale
economies. At the same time, competition among firms forces them to pass on their lower costs
to consumers in the form of lower prices. The expansion of the market that occurs with trade
leads eventually to an increase in the number of firms (although the distribution of firms between
countries is unclear). Consumers benefit both from lower prices and from an increase in the
variety of goods available to them.
Topic: Intraindustry Trade

29) Describe the two sources of economies of scale and how these economies of scale lead to
intraindustry trade.
Answer: Internal economies of scale come from decreasing average costs as production
increases. The source of the decrease in average costs could be the spread of fixed costs over a
greater number of units of output, which might come from plant size, significant research and
development costs, marketing or market research costs, engineering, etc. Increasing the size of
the firm's market decreases average production costs. Consumers benefit from more choices and
lower prices. Product differentiation is enhanced through the introduction of a foreign firm's
products in the domestic market. External economies of scale come from a concentration of an
industry in a specific geographic location. There is no cost advantage to the firm being larger, but
because the industry is focused in a specific location, labor and other input markets are deep and
highly specialized. Firms benefit from knowledge spillover in both formal and informal ways.
Topic: Intraindustry Trade
Difficulty: Difficult
Objective: LO 5.2 Compare and contrast internal and external economies of scale.
AACSB: Application of knowledge

5.3 Trade and Geography

1) Which of the following is FALSE?

A) Economies of scale may be internal, external, or both.
B) With internal economies of scale, the gains from trade include a wider selection of consumer
choices and lower prices.
C) With external economies of scale, the gains from trade are less certain since, in theory, they
can lock in production in a less efficient country and prevent the development of production in a
more efficient country.
D) Internal economies of scale lead firms to regionally concentrate their industry.
Answer: D
2) Which of the following is NOT a situation providing a potential advantage for Mexico
that makes it competitive compared to China in trade with the United States?
A) The product line requires quick turn-around time from or to delivery.
B) The need to manage a just-in-time inventory system
C) Wages are low and the production process is labor intensive.
D) The product is heavy and bulky relative to its final value.
Answer: C
3) Which of the following is FALSE?
A) Most of the maquiladora industry is located in the states of Mexico that border the United
States.
B) The maquiladora industry has not created much employment in Mexico because most of the
production is capital intensive.
C) The maquiladora industry accounts for more than half of Mexico's exports today.
D) Growth in Mexico's northern border cities , such as Tijuana and Ciudad Juarez, took off
almost a decade before NAFTA because of the maquiladora industry.
Answer: B
4) Which of the following is a reason why trade and geography are linked?
A) There are high costs of locating in large urban areas.
B) Many industries have no economies of scale.
C) Competition means that all firms want to locate near each other.
D) Some locations give access to pools of skilled labor or special resources.
Answer: D
5) In an industry where transportation costs are high and there are limited scale economies,
A) firms will locate close to the market.
B) firms will locate close to their input sources.
C) firms might locate in either area.
D) firms will locate where policy makers decide.
Answer: A
6) Most foreign investment is today is directed towards high-income countries because
A) there are tax breaks and subsidies available.
B) markets are larger, so transportation costs are minimized by producing near the market.
C) high-income countries are politically stable.
D) there are no economies of scale in low-income countries.
Answer: B
7) When there are external economies of scale in an industry
A) firm costs decrease as individual firms expand output.
B) firm costs decrease as the industry expands in size.
C) firms will generally increase their size.
D) firms must be located in different regions.
Answer: B
8) Concentration of industries can lead to external economies for all of the following
reasons EXCEPT
A) concentrated industries will not be competitive.
B) concentrated industries will attract a network of input suppliers.
C) concentrated industries will attract a deep pool of skilled labor.
D) concentrated industries will experience knowledge spillovers.
Answer: A
1) Under some circumstances, trade could stifle the development of new industries and
reduce global efficiency. All of the following describe conditions that could lead to that
situation EXCEPT
A) a location has a better-developed linkage between suppliers and producers, giving it a cost
advantage and lower price.
D) a historical accident, such as the shifting of airplane production to the United States to avoid
World War II bombings, causes firms in one location to have a competitive advantage.
C) diseconomies of scale make it impossible for new firms to enter the market.
D) none of the above
Answer: B
10) Most trade between Mexico and the United States is intrafirm.
Answer: TRUE

11) Paul Krugman has stated that international trade is really about geography.
Answer: TRUE

12) The geographical distribution of resources such as skilled labor has little effect on firm
location decisions.
Answer: FALSE

13) To minimize costs, firms should have plants close to every market.
Answer: FALSE

14) Concentration of firms in a particular region is likely to attract skilled labor to that area.
Answer: FALSE
15) Trade can stifle the development of industries than might be more efficient than existing
ones.
Answer: TRUE
16) Explain how concentration of industries in a particular region can lead to external
economies.
Answer: If the firms in a region produce similar products, there are likely to be knowledge
spillovers that help keep all firms abreast of the latest technology and newest developments.
Close physical proximity enhances knowledge spillovers because it creates more opportunities
for information exchange through formal and informal networks of people. The presence of a
large number of producers in one area helps to create a deep labor market for specialized skills.
A third potential advantage to a large geographical concentration is that it can lead to a dense
network of input suppliers. Manufacturers of intermediate inputs prefer to locate near the market
for their products since it holds down transportation costs and may keep them better informed.
Topic: Trade and Geography
Difficulty: Difficult
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

17) Is it possible that trade could prevent the development of new and more efficient industries?
Answer: Yes, under certain circumstances. Using the textbook example, suppose that Europeans
are potentially more efficient at making commercial aircraft than Americans. Their potential can
only be realized, however, after a period of experimentation and development. The initial
problem they face is that the efficiency advantage goes to the United States because of its better
developed linkages between suppliers and producers. The availability of existing planes at a cost
that is lower than initial costs will be in the European industry may deter the development of the
industry.
Topic: Trade and Geography
Difficulty: Difficult
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge
18) Describe how Mexico's manufacturing has changed location and type over time.
Answer: Most of the trade between the United States and Mexico is intrafirm and this occurs
within the context of Mexico's special export processing sector (the maquiladora industry),
which was originally limited to its border with the United States but has expanded to the whole
country, The original purpose of the industry was to generate employment along Mexico's
northern border. American firms could set up in Mexico and pay no tariffs on the inputs they
brought into the country as long as they exported the output. The export processing industry
grew steadily, but most manufacturing in Mexico was still focused on the domestic market. In
the 1980s, Mexico's development strategy was inward looking, and most firms found that it was
less profitable to export than to produce for the home market since goods sold domestically were
protected from competition and goods sold abroad were not. Focus on production for the
domestic market caused most firms to locate near Mexico City or one or two other urban areas,
so that they were close to their final markets. When policy makers shifted their focus to a more
neutral policy with respect to production for domestic or foreign markets, following the 1982
financial crisis, they removed many trade protections, creating a more level playing field for
exporters. This made it relatively more profitable to produce goods for sale in foreign markets
since it took away the advantages of producing for the domestic market. Partly as a consequence
of these policy changes, the export processing industry along Mexico's northern border took off.
By the middle of 2000, the maquiladora was responsible for more than half of Mexico's total
exports. The new incentives caused both Mexican and non-Mexican firms to locate near the
border with the United States, rather than in Mexico City. Under the new rules, the largest
profitable market is the United States rather than Mexico City, and thus it was cost effective to
locate closer to that market.
Topic: Trade and Geography
Difficulty: Difficult
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge
19) How can regional concentration of firms in an industry lead to external economies of scale?
Give examples of these types of industrial clusters in the United States. Are they always
beneficial?
Answer: When an industry is highly concentrated in a specific location, this leads to a decrease
in costs for firms that are located there regardless of their individual size. Close physical
proximity enhances knowledge spillovers that keep all firms abreast of the latest technology and
newest developments. Information can be exchanged through both formal and informal
networks, and this is particularly important in frontier industries undergoing rapid technological
change. Labor markets deepen for highly specialized skills, which reduces search costs and gives
firms a choice of workers with the best skills. Dense networks of highly specialized input
suppliers can also develop. All of these function to enhance production and to reduce costs.
Hollywood, Silicon Valley, Nashville, and many other examples of industrial concentration exist
in the United States. A potential problem for world trade is that an industrial cluster may develop
and prevent potentially more efficient foreign producers from entering a market. These regional
concentrations become self-reinforcing. Small initial differences in costs lead to feedback
mechanisms that create large differences in costs based on production location. Hypothetically, a
region could get an early advantage, form an agglomeration, and the cost advantages may
prevent the development of the industry in another location that could have been more efficient.
Production is thus concentrated with the less efficient producer because the more efficient
producer never has the chance to get off the ground.
Topic: Trade and Geography
Difficulty: Easy
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

5.4 Industrial Policy

1) Which of the following is NOT a problem in the implementation of industrial policies?

A) Choosing the industry to target
B) Knowing the optimum amount of resources to provide the targeted industry
C) The encouragement of rent seeking by firms in other industries
D) The benefits are captured only by domestic firms.
Answer: D
2) Market failures are less likely to occur whenever
A) private returns are greater than social returns.
B) social returns are greater than private returns.
C) the free market produces less than what is socially optimal.
D) new firms can easily attract start-up capital.
Answer: D
3) Which of the following is NOT a reason social returns might be greater than private
returns?
A) Excess competition between firms
B) Knowledge spillovers
C) Spillovers from research and development
D) Capital market imperfections
Answer: A

4) If social returns to the production of a good are greater than private returns, then we
can conclude that relative to the social optimum, the good will be
A) overproduced and underpriced.
B) underproduced and overpriced.
C) overproduced and overpriced.
D) underproduced and underpriced.
Answer: B
5) If social returns to the production of a good are less than private returns, then we can
conclude that relative to the social optimum, the good will be
A) overproduced and underpriced.
B) underproduced and overpriced.
C) overproduced and overpriced.
D) underproduced and underpriced.
Answer: A

6) Suppose that the United States decided to subsidize a major research and development
effort by U.S. firms in the semiconductor industry. Under the current rules of the WTO
and GATT, the U.S. effort is
A) allowed as long as the subsidies are a small percent of the total cost.
B) allowed as long as the subsidies do not involve a direct payment to the industry.
C) not allowed.
D) allowed as long as the subsidies are for developing a "precompetitive" technology.
Answer: D
7) Suppose that the United States decided to subsidize a major competitive effort by the
semiconductor industry to bring to market the next generation computer chip. Under the
current rules of the WTO and GATT, the U.S. effort is
A) allowed as long as the subsidies are a small percent of the total cost.
B) allowed as long as the subsidies do not involve a direct payment to the industry.
C) not allowed.
D) allowed as long as the subsidies do not succeed in creating a new product.
Answer: C
8) WTO rules allow subsides
A) when there are external economies.
B) of "precompetitive" activities such as research.
C) when there are internal economies.
D) when there are positive externalities in production.
Answer: B

9) Which of the following is NOT a true statement about industrial policies?

A) Industrial policies can lead to the development of successful industries.
B) Not all industrial policies are successful.
C) Not all industrial policies are the best use of a nation's resources.
D) Most industrial policies are legal under WTO rules.
Answer: D
Topic: Industrial Policy
Difficulty: Moderate
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

10) Free market economies underproduce goods with positive externalities because
A) there are no benefits to the production of these goods.
B) the additional social benefits are not taken into account by the marketplace.
C) the additional social benefits cannot be measured.
D) the additional social benefits are too small to matter.
Answer: B
Topic: Industrial Policy
Difficulty: Moderate
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

11) One problem with industrial policies is that

A) R&D only benefits the firm that conducts it.
B) governments usually target the wrong industries.
C) it is difficult to measure the extent of market failure.
D) it is not politically popular to support industries.
Answer: C
Topic: Industrial Policy
Difficulty: Easy
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

12) The United States does not use subsidies as part of its policies.
Answer: FALSE
Topic: Industrial Policy
Difficulty: Easy
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

13) Industrial policies have not been effective in encouraging investment in clean energy.
Answer: FALSE
Topic: Industrial Policy
Difficulty: Easy
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

14) Benefits of R&D spending to foreigners may be as much as 1/4 of the total value of the
spending.
Answer: TRUE
Topic: Industrial Policy
Difficulty: Easy
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

15) Sound macroeconomic policies are less important than industrial policies in promoting
growth.
Answer: FALSE
Topic: Industrial Policy
Difficulty: Moderate
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

16) Explain what rent seeking is and how it may reduce the benefits of industrial policies.
Answer: Rent seeking is any activity by firms, individuals, or special interests that is designed to
alter the distribution of income in their favor without adding to the amount of total income in the
economy. If firms know that governments are willing to use industrial policies, they will spend
resources to obtain some of the subsidies. This may require the hiring of lobbyists, economists,
or engineers who will work to persuade the legislature or some other rule makers. The downside
is that it uses resources but does not add to total output.
Topic: Industrial Policy
Difficulty: Moderate
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

17) Japan and Korea use or have used many industrial policies, and they are both considered to
be countries that have developed successfully. Does that mean that the industrial policies caused
their successful development?
Answer: Opponents of industrial policies continue to argue that sound macroeconomic policies,
high rates of saving and investment, and high levels of schooling were the keys to success in
those two countries, and that industrial policies were a distraction at best. It is difficult to
determine cause and effect in economic development.
Topic: Industrial Policy
Difficulty: Easy
Objective: LO 5.5 Explain how transportation costs and internal economies of scale help
determine firm location decisions.
AACSB: Application of knowledge

18) Explain why industrial policies are controversial.

Answer: In some cases, they end up wasting large sums of money. It is difficult to know what
the best industries to promote are, and so government resources may not be used effectively.
Better outcomes may be achieved by simply providing the basic components of a well-
functioning economy, including education, stable institutions, and sound macroeconomic
policies. Additionally, there are a number of problems such as the difficulty of measure the size
of market failures and rent seeking.
Topic: Industrial Policy
Difficulty: Moderate
Objective: LO 5.6 Present the pros and cons of industrial policies.
AACSB: Analytical thinking