International Business Quiz

Chapter 05 - International Trade Theory

Chapter 05International Trade Theory

True / False Questions

1. (p. 154) Countries such as the U.S should not participate in free trade because it leads to a migration of jobs overseas and ultimately leads to lower living standards. FALSE

Difficulty: Medium

2. (p. 154) 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 is known as free trade. TRUE

Difficulty: Easy

3. (p. 155) According to the theories of Smith, Ricardo and Heckscher-Ohlin, if a country can produce a product itself it should not import that product. FALSE

Difficulty: Medium

4. (p. 155) 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. TRUE

Difficulty: Medium

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5. (p. 155) The Heckscher-Ohlin theory emphasizes the interplay between the proportions in which the factors of production are available in different countries and the proportions in which they are need for producing particular goods. TRUE

Difficulty: Medium

6. (p. 155) The Heckscher-Ohlin theory has proven to be a powerful explanation of world trade patterns. FALSE

Difficulty: Medium

7. (p. 156) New trade 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 only support a limited number of firms. TRUE

Difficulty: Medium

8. (p. 156) Ricardo noted the importance of country factors such as domestic demand and domestic rivalry in explaining a nation's dominance in the production and export of particular products. FALSE

Difficulty: Hard

9. (p. 156) The theory of absolute advantage was the first theory of international trade. FALSE

Difficulty: Easy

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10. (p. 156) According to the theory of comparative advantage, it is in a country's best interest to maintain a trade surplus and to export more than it imports. FALSE

Difficulty: Medium

11. (p. 157) When a gain by one country results in a loss by another, there is a zero-sum game. TRUE

Difficulty: Medium

12. (p. 160) Smith's theory of international trade suggests that when one country has an absolute advantage in the production of all goods, the country might not derive any benefit from international trade. TRUE

Difficulty: Medium

13. (p. 160) According to Ricardo, there may be cases when it makes sense for a country to buy goods from another country that it can make more efficiently itself. TRUE

Difficulty: Hard

14. (p. 162) While popular in its time, Ricardo's theory is no longer a major intellectual weapon for those who argue for free trade. FALSE

Difficulty: Medium

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15. (p. 162) Ricardo's theory of comparative advantage provides a strong rationale for encouraging free trade. TRUE

Difficulty: Medium

16. (p. 162) The theory of comparative advantage suggests that trade is a positive-sum game in which all countries that participate realize economic gains. TRUE

Difficulty: Medium

17. (p. 163) Political opposition to the adoption of a free trade regime typically comes from those whose jobs are most at risk. TRUE

Difficulty: Medium

18. (p. 164) Because of diminishing returns, it is not feasible for a country to specialize to the degree suggested by the simple Ricardian model. TRUE

Difficulty: Medium

19. (p. 166) In general, economic studies suggest that countries that adopt a more open stance toward international trade enjoy higher growth rates than those who keep their economies closed to trade. TRUE

Difficulty: Medium

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20. (p. 168) The Heckscher-Ohlin theory argues that free trade is not beneficial to most nations. FALSE

Difficulty: Easy

21. (p. 169) The Heckscher-Ohlin theory gains predictive power once the impact of differences of technology on productivity is controlled for. TRUE

Difficulty: Medium

22. (p. 169) Ray Vernon suggested the wealth and size of the U.S. market gave U.S. firms a strong incentive to develop new consumer products. TRUE

Difficulty: Medium

23. (p. 169) A central point in Vernon's product life cycle was that demand for new products tends to be solely based on price factors. FALSE

Difficulty: Medium

24. (p. 170) Historically, the product life cycle theory seems to be an accurate explanation of international trade patterns. TRUE

Difficulty: Hard

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25. (p. 170-171) Because a growing number of new products are now introduced simultaneously in the U.S, Japan and the advanced European nations, Vernon's product life cycle is limited in explaining world trade patterns. TRUE

Difficulty: Medium

26. (p. 172) Economies of scale are unit cost reductions associated with a large scale of output. TRUE

Difficulty: Easy

27. (p. 173) Trade is mutually beneficial, according to new trade theory, because it allows for the specialization of production, the realization of scale economies and the production of a greater variety of products at lower prices. TRUE

Difficulty: Medium

28. (p. 173) New trade theory suggests that nations may benefit from trade even when they do not differ in resource endowments or technology. TRUE

Difficulty: Medium

29. (p. 174) New trade theory and the Heckscher-Ohlin theory are in complete agreement with regard to world trade patterns. FALSE

Difficulty: Hard

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30. (p. 175) According to Porter, four broad attributes of a nation shape the environment in which local firms compete include. These are supply conditions, factor endowments, regulation and advanced factors. FALSE

Difficulty: Medium

31. (p. 175) Porter argues that favorable demand conditions will result in competitive advantage unless the state of rivalry is sufficient to cause firms to respond to them. FALSE

Difficulty: Hard

32. (p. 176) Factor endowments lie at the center of the Heckscher–Ohlin theory. TRUE

Difficulty: Easy

33. (p. 176) According to Porter, the characteristics of home demand are particularly important in shaping the attributes of domestically made products and in creating pressures for innovation and quality. TRUE

Difficulty: Easy

34. (p. 177) Porter suggests that different nations are characterized by different management ideologies, which either help them or do not help them to build national competitive advantage. TRUE

Difficulty: Medium

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35. (p. 179) Porter's diamond of competitive advantage has proven to be a powerful predictor of world trade patterns. FALSE

Difficulty: Medium

36. (p. 179) 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. TRUE

Difficulty: Easy

37. (p. 180) Assembly of electronic components is a relatively labor-intensive process requiring only low-skilled labor and cost pressures are intense. As a result, final assembly may be carried out in a country such as the United States. FALSE

Difficulty: Easy

38. (p. 180) According to the new trade theory, firms that establish a first-mover advantage with regard to the production of a particular new product may subsequently dominate global trade in that product. TRUE

Difficulty: Easy

39. (p. 180) The theories of international trade claim that promoting free trade is generally in the best interests of an individual firm, although it may not always be in the best interest of a country. FALSE

Difficulty: Medium

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40. (p. 181) 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. TRUE

Difficulty: Easy

Multiple Choice Questions

41. (p. 154) Propagated in the 16th and 17th centuries, _____ advocated that countries should simultaneously encourage exports and discourage imports. A. EthnocentrismB. CapitalismC. CollectivismD. Mercantilism

Difficulty: Easy

42. (p. 154) According to _____, maintaining a laissez-faire stance toward trade is to the best interests of a country. A. The mercantilist philosophyB. Adam SmithC. Milton FriedmanD. John Stuart Mill

Difficulty: Medium

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43. (p. 154) Free trade A. Formed the basis for the mercantilist philosophyB. Is in direct contrast to the notion of the invisible hand as advocated by SmithC. Refers to a situation where a government does not attempt to influence through quotas or duties what its citizens can buy from another countryD. Rejects the laissez-faire stance toward trade and maintains that it is not in the best interests of a country

Difficulty: Medium

44. (p. 154) This theory, proposed in 1776, was the first to explain why unrestricted free trade is beneficial to a country. A. MercantilismB. Heckscher-OhlinC. Comparative advantageD. Absolute advantage

Difficulty: Medium

45. (p. 154) Which of the following scholars argued that the "invisible hand" of the market mechanism, rather than government policy, should determine what a country imports and what it exports? A. Milton FriedmanB. John Stuart MillC. Carl MarxD. Adam Smith

Difficulty: Hard

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46. (p. 154) This theory, advanced by the 19th-century English economist David Ricardo, forms the intellectual basis of the modern argument for unrestricted free trade. A. Heckscher-OhlinB. MercantilismC. Comparative advantageD. Absolute advantage

Difficulty: Medium

47. (p. 155) All of the following theories show why it is beneficial for a country to engage in international trade even for products it is able to produce for itself, except A. Mercantilism.B. Heckscher-OhlinC. Comparative advantageD. Absolute advantage

Difficulty: Hard

48. (p. 155) _____ suggests that international differences in labor productivity are key to understanding patterns of international trade. A. MercantilismB. VernonC. Michael PorterD. David Ricardo

Difficulty: Hard

49. (p. 155) This theory explains the observed patterns of international trade by emphasizing the interplay between the proportions in which the factors of production are available in different countries and the proportions in which they are needed for producing particular goods. A. MercantilismB. Absolute advantageC. Heckscher-OhlinD. Comparative advantage

Difficulty: Medium

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50. (p. 155) Which of the following is an assumption of the Heckscher-Ohlin theory? A. Countries have varying endowments of the various factors of productionB. Gold and silver were the mainstays of national wealth and essential to vigorous commerceC. It is in a country's best interests to maintain a trade surplusD. Trade is a zero-sum game

Difficulty: Medium

51. (p. 155-156) The product life cycle theory was developed by A. Adam SmithB. David RicardoC. Raymond VernonD. Eli Heckscher

Difficulty: Hard

52. (p. 156) Identify the incorrect statement pertaining to Raymond Vernon's product life-cycle theory. A. Early in their life cycle, most new products are produced in and exported from the country in which they were developedB. As a new product becomes widely accepted internationally production starts in other countriesC. A product in the early stage of the product life cycle is imported by the country where it was innovatedD. A product may ultimately be exported back to the country of its original innovation

Difficulty: Hard

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53. (p. 156) Which 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? A. Balanced tradeB. Heckscher-OlinC. New tradeD. Product life cycle

Difficulty: Medium

54. (p. 156) The theory of _____, developed by Michael Porter, focuses on the importance of country factors, in addition to factor endowments, such as domestic demand and domestic rivalry in explaining a nation's dominance in the production and export of particular products. A. New tradeB. Absolute advantageC. Comparative advantageD. National competitive advantage

Difficulty: Medium

55. (p. 156) The theory of _____ makes a crude case for government involvement in promoting exports and limiting imports. A. MercantilismB. Free tradeC. Absolute advantageD. Comparative advantage

Difficulty: Medium

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56. (p. 156) Identify the theory that can be interpreted as justifying some limited government intervention to support the development of certain export-oriented industries. A. Theory of national competitive advantageB. Heckscher-Ohlin theoryC. Theory of comparative advantageD. Theory of absolute advantage

Difficulty: Medium

57. (p. 156) According to the _____, U.S is a major player in the commercial jet aircraft industry because U.S firms were first movers in the world market. A. Product life cycle theoryB. Theory of mercantilismC. New trade theoryD. Theory of absolute advantage

Difficulty: Hard

58. (p. 156) The main tenet of mercantilism was that it was in a country's best interest to maintain a trade A. BalanceB. EmbargoC. SurplusD. Deficit

Difficulty: Medium

59. (p. 156) Under mercantilism, countries strived to maintain A. High exports and low importsB. Low exports and high importsC. An inflow of gold and high importsD. An outflow of gold, high exports

Difficulty: Medium

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60. (p. 157) When a government limits imports via tariffs and quotas and subsidizes exports in order to maximize exports and minimize imports, the country is following A. A mercantilist philosophyB. The theory of absolute advantageC. The theory of comparative advantageD. The Heckscher-Ohlin theory

Difficulty: Hard

61. (p. 157) Mercantilism viewed trade as A. A zero-sum gameB. An economic evilC. A non essential economic activityD. A threat to a government's independence

Difficulty: Easy

62. (p. 157) China, 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 is viewed by critics as following a A. Zero-sum gameB. Neo-mercantilist policyC. Positive-sum gameD. Free trade policy

Difficulty: Medium

63. (p. 157) 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 strictly domestic salesB. Trade these goods for the goods produced by other countriesC. Sell these goods to the highest domestic or international bidderD. Prohibit the import of these goods from other countries

Difficulty: Medium

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64. (p. 157) According to Adam Smith, if a country is more efficient than any other country in producing a particular product, the country has a(n) ______ in the production of the product. A. Absolute advantageB. Comparative advantageC. Relative advantageD. Proportional advantage

Difficulty: Medium

65. (p. 158) The different combinations of two goods that an economy could efficiently produce with limited productive resources can be referred to as a country's A. Economic outputB. Efficiency graphC. Productivity curveD. Production possibility frontier

Difficulty: Medium

66. (p. 160) Trade produces net gains for all involved and hence is a A. Zero-sum gameB. Balance of trade gameC. Positive-sum gameD. Equilibrium-gain game

Difficulty: Easy

67. (p. 160) According to the theory of _____, it makes sense for a country to specialize in producing the goods it produces most efficiently and buy the products it produces less efficiently from other countries, even if it could produce the good more efficiently itself. A. Strategic tradeB. Pertinent advantageC. Comparative advantageD. Absolute advantage

Difficulty: Medium

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68. (p. 162) What is the basic message of the theory of comparative advantage? A. Countries are similar in their ability to produce goods efficientlyB. International trade is rarely beneficial to a countryC. Potential world production is greater with unrestricted free trade than it is with restricted tradeD. Trade is a zero-sum game

Difficulty: Medium

69. (p. 162) A basic tenet of Ricardo's theory is that A. Consumers in those countries with an absolute advantage in the production of all goods might derive no benefits from international tradeB. Consumers in all nations can consume more if there are no restrictions on tradeC. Restrictions on trade help consumers in countries that lack an absolute advantage in the production of a particular goodD. Trade is a zero-sum game

Difficulty: Medium

70. (p. 162) The comparative advantage model of trade assumed that a country's stock of resource and the efficiency with which it utilizes those resources A. Remains the same over timeB. Increases over timeC. Decreases with timeD. Follows a bell-shaped curve

Difficulty: Medium

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71. (p. 163) Economist _____ argued that 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. David RicardoB. Michael PorterC. Adam SmithD. Paul Samuelson

Difficulty: Hard

72. (p. 163) _____ means that the units of resources required to produce a good are assumed to remain unvarying no matter where one is on a country's production possibility frontier. A. Economies of scaleB. Law of diminishing returnsC. Constant returns to specializationD. Zero-sum game

Difficulty: Easy

73. (p. 163) _____ occur(s) when more units of resources are required to produce each additional unit. A. Economies of scaleB. Diminishing returns to specializationC. A positive-sum gameD. Constant returns to specialization

Difficulty: Easy

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74. (p. 164) The simple comparative advantage model assumes constant returns to specialization. However, it is more realistic to assume diminishing returns to specialization because of all of the following reasons except A. All resources are of the same qualityB. Different goods use resources in different proportionsC. As a country tries to increase its output of a certain good, it is more likely to draw on more marginal resources whose productivity is not as great as those initially employedD. If a country specializes to the degree suggested by the simple Ricardian model, the gains from specialization are likely to be exhausted before specialization is complete

Difficulty: Medium

75. (p. 164) Which of these suggest that the gains from specialization are likely to be exhausted before specialization is complete? A. Economies of scaleB. Diminishing returns to specializationC. Economies of scopeD. Constant returns to specialization

Difficulty: Easy

76. (p. 164) Even if we relax the assumptions of the simple Ricardian model that there are constant returns to scale and realistically assume diminishing returns to specialization, it can still be concluded that A. The benefits of unrestricted trade do not holdB. Free trade is beneficial but the gains may not be as great as in a constant returns caseC. Governments should intervene in the market to bring about a zero-sum gameD. The benefits of free trade are comparatively much less than government regulated trade

Difficulty: Medium

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77. (p. 164-165) The simple comparative advantage model assumes that trade does not change a country's stock of resources or their utilization efficiency. If we relax this assumption to make allowances for dynamic changes, all of the following become apparent except A. Opening the economy to trade would be likely to generate dynamic gainsB. Free trade may increase the country's stock of resources.C. Free trade might increase the efficiency with which the country uses its resourcesD. Dynamic gains will cause the country's PPF to shift inward

Difficulty: Hard

78. (p. 165-66) According to the _____ model, when a rich country such as the U.S enters into a free trade agreement with a poor country that rapidly experiences dynamic gains, the rich country is likely to not have net gains. A. Absolute advantageB. MercantilistC. Heckscher-OhlinD. Samuelson

Difficulty: Medium

79. (p. 168) According to Heckscher and Ohlin, _____ meant the extent to which a country is provided with such resources as land, labor and capital. A. Factors of productionB. Economic facilitatorsC. Factor endowmentsD. Manufacturing factors

Difficulty: Easy

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80. (p. 168) Which theory predicts that countries will export those goods that make intensive use of those factors that are locally abundant, while importing goods that make intensive use of factors that are locally scarce? A. Comparative advantageB. Absolute advantageC. Heckscher-OlinD. Samuelson

Difficulty: Easy

81. (p. 168) Contrary to what the Heckscher-Ohlin theory would predict, the United States has been a primary importer rather than an exporter of capital goods. This phenomenon is referred to as the _____ paradox. A. Zero-sumB. LeontiefC. EmpiricalD. Ricardo

Difficulty: Easy

82. (p. 169) This theory, initially proposed by Raymond Vernon, was based on the observation that for most of the 20th 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. A. Competitive advantageB. Product life cycleC. New tradeD. Strategic trade

Difficulty: Medium

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83. (p. 169) Raymond Vernon argued that new products were developed by U.S. firms and first sold in the U.S. market because A. European competitors were not active in product R&DB. American firms were able to take advantage of tax credits for product R&DC. The wealth and size of the U.S market gave the firms an incentive to develop new productsD. The low cost of U.S. labor gave U.S. firms an incentive to develop costly process innovations

Difficulty: Medium

84. (p. 170) During the _____ stage of Vernon's product life cycle, as the market in the United States and other advanced nations matures, the product moves toward standardization and price becomes important. A. InitialB. Early middleC. Late middleD. Late

Difficulty: Medium

85. (p. 170) According to the product life cycle theory, the locus of global production initially switches from the U.S. to other advanced nations and then from those nations to developing countries. The consequence of this trend for the pattern of world trade is that over time the U.S. A. Becomes the sole producer of a productB. Switches from being an exporter of the product to being an importer of the productC. Switches from being an importer of the product to being an exporter of the productD. Becomes the sole consumer of the product

Difficulty: Medium

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86. (p. 171) The product life cycle theory A. Remains a relevant theory of explaining international trade in the modern worldB. Was useful for explaining the pattern of trade during the brief period of American global dominanceC. Proved to be a poor explanation of world trade patterns during the 1960s and 1970sD. Was a strong predictor of trade patterns during the 1800s

Difficulty: Easy

87. (p. 172) _____ suggests that when nations trade, each nation may be able to specialize in producing a narrower range of products than it would in the absence of trade and through trade, each nation can simultaneously increase the variety of goods available to its consumers and lower the costs of those goods. A. The product life cycle theoryB. Porter's diamond of competitive advantageC. New trade theoryD. The theory of comparative advantage

Difficulty: Easy

88. (p. 173) A firm that captures scale economies ahead of later entrants and consequently benefits from a lower cost structure has A. An absolute advantageB. A fixed advantageC. A first mover advantageD. A late mover advantage

Difficulty: Easy

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89. (p. 174) According to the new trade theorists, because early entrants are able to gain _____, the early entrants into an industry may get a lock on the world market that discourages subsequent entry. A. Zero-sum advantageB. Highly skilled employeesC. Process expertiseD. Economies of scale

Difficulty: Medium

90. (p. 174) _____ argues that scale economies and first mover advantages help explain trade patterns. A. New trade theoryB. The theory of absolute advantageC. The competitive advantage of nationsD. Heckscher-Ohlin theory

Difficulty: Easy

91. (p. 175) According to Porter all of the following are broad attributes of a nation that shape the environment in which local firms compete, except A. Factor endowmentsB. Supply fluctuationsC. Relating and supporting industriesD. Firm strategy, structure and rivalry

Difficulty: Medium

92. (p. 180) According to Porter, which of the following is an example of an advanced factor? A. Natural resourcesB. Skilled laborC. LocationD. Demographics

Difficulty: Easy

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93. (p. 176) According to Porter, advanced factors A. Include natural resources, climate, location and demographicsB. Are the least significant for competitive advantageC. Are naturally endowedD. Are a product of investment by individuals, companies and governments

Difficulty: Medium

94. (p. 177) Porter explains the U.S' loss of competitiveness in engineering-based industries where manufacturing processes and product design issues are critical as a consequence of A. Differing management ideologiesB. Differing factor endowmentsC. Differing demand conditionsD. Chance

Difficulty: Hard

95. (p. 181) Identify the theory that suggests that it is in the best interest of business for a firm to invest in upgrading advanced factors of production. A. Theory of competitive advantageB. Product life cycle theoryC. New trade theoryD. National competitive advantage theory

Difficulty: Medium

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Essay Questions

96. (p. 154-155) What are the benefits of free trade?

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. Common sense suggests that some international trade is beneficial. Theories by Smith, Ricardo and Heckscher-Ohlin suggest that a country's economy may gain if its citizens buy certain products from other nations that could be produced at home. The gains arise because international trade allows a country to specialize in the manufacture and export of products that can be produced most efficiently in that country, while importing products that can be produced more efficiently in other countries.

Difficulty: Medium

97. (p. 156-157) Discuss the mercantilist philosophy. What was the theory's main flaw?

Mercantilism was the first theory of international 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. By doing so, a country would accumulate gold and silver and consequently, increase its national wealth, prestige and power. Consistent with this belief, the mercantilist doctrine advocated government intervention to achieve a surplus in the balance of trade. The flaw with mercantilism was that it viewed trade as a zero-sum game in which a gain by one country resulted in a loss by another country.

Difficulty: Medium

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98. (p. 157-160) What was Adams Smith's contribution to the theory of why nations trade? What is the theory of absolute advantage?

Adam Smith attacked the mercantilist philosophy in his 1776 landmark book, the Wealth of Nations. Smith argued that countries differ in their ability to produce good efficiently. Smith suggested that when a country was more efficient at producing a particular good than any other country, the country had an absolute advantage in the production of that good. 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.Smith's basic argument 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.

Difficulty: Medium

99. (p. 160-162) How did David Ricardo extend Adam Smith's work? Explain the theory of comparative advantage.

David Ricardo took Adam's Smith's theory of absolute advantage one step further by exploring what might happen when one country has an absolute advantage in the production of all goods. Smith's theory suggests that such a country might not benefit from trade, however Ricardo suggested that it makes sense for a country to specialize in the production of those goods that it produces most efficiently or has a comparative advantage in and to buy the goods that it produces less efficiently from other countries. According to Ricardo, potential world production is greater with unrestricted free trade than it is with restricted free trade. Ricardo's theory remains a popular weapon for free trade supporters.

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Difficulty: Medium

100. (p. 166-167) Discuss the link between trade and economic growth.

Research shows that in general, countries that adopt a more open stance toward international trade enjoy higher growth rates than those that close their economies to trade. Higher growth should in turn, raise income level and living standards.

Difficulty: Medium

101. (p. 168) Explain the Heckscher-Ohlin theory. What is the relationship between Heckscher-Ohlin's work and the theory of comparative advantage?

Heckscher and Ohlin suggested that comparative advantage arises from differences in national factor endowments. 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 use of factors that are locally scarce. Thus, Heckscher and Ohlin suggest that free trade is beneficial, but argue that the pattern of trade is determined by differences in factor endowments, rather than differences in productivity.

Difficulty: Medium

102. (p. 168) What is the Leontief Paradox?

Wassily Leontief tested the Heckscher-Ohlin theory. Leontief postulated that since the U.S was relatively abundant in capital compared to other nations, the U.S would be an exporter of capital-intensive goods and an importer of labor-intensive goods. However, Leontief found that U.S exports were less capital intensive than U.S imports. Because this result was at variance with the predictions of Heckscher-Ohlin, it has become known as the Leontief paradox.

Difficulty: Medium

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103. (p. 169) Explain the product life cycle theory.

The product life cycle theory, proposed by Raymond Vernon in the mid-1960s, was based on the observation that for most of the 20th 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. It suggests that the wealth and size of the U.S market gave American firms a strong incentive to develop new consumer products. Vernon argued that most new products were initially produced in the U.S. According to Vernon, early in the life cycle of a product most new products are produced and are exported from the country in which they were developed. As a new product becomes widely accepted internationally, production starts in other countries. As a result, the theory suggests, the product may ultimately be exported back to the country of its innovation.

Difficulty: Medium

104. (p. 170-171) Evaluate the product life cycle. How well does the theory hold up? What are the theory's weaknesses?

When viewed historically, the product lie cycle theory appears to be an accurate explanation of international trade patterns. However, from an Asian or a European perspective the theory is ethnocentric. Many new products are now introduced in Japan or Europe or even simultaneously in the U.S, Europe and Japan. In general, while Vernon's theory was useful for explaining trade during the brief period of American dominance, it is not particularly relevant in today's global economy.

Difficulty: Medium

105. (p. 172) What are economies of scale? Why are they important in understanding trade patterns?

Economies of scale are unit cost reductions associated with a large volume of output. Economies of scale are a major source of cost reductions in many industries. Because of the need to achieve economies of scale, some global industries may only be able to support a small number of firms. World trade patterns would reflect this phenomenon.

Difficulty: Easy

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106. (p. 172-173) Explain the new trade theory. What is the role of economies of scale in this theory?

The new trade theory emerged in the 1970s when several economists suggested that economies of scale might play a role in world trade. New trade theory suggests that (1) through its impact on economies of scale, trade can increase the variety of goods available to consumers and decrease average costs of those goods and (2) in those industries when the output required to attain economies of scale represents a significant proportion of total world demand, the global market may only be able to support a small number of enterprises.

Difficulty: Medium

107. (p. 173) Explain the connections between economies of scale, first-mover advantages and trade patterns?

First mover advantages are the economic and strategic advantages that accrue to early entrants into an industry. Because they are able to gain economies of scale, early entrants may get a lock on the world market that discourages subsequent entry. In other words, the ability of first-movers to reap economies of scale creates a barrier to entry. Countries may dominate in the export of certain goods because economies of scale are important to their production and because firms located in those countries were first to capture scale economies, giving them a first mover advantage.

Difficulty: Medium

108. (p. 173-174) Discuss the implications of the new trade theory.

The new trade theory suggests that countries may benefit from trade even when they do not differ in resource endowments or technology. Through trade, a country can specialize in the production of certain products and achieve scale economies and thus, lower production costs and trade for other products. Consumers should benefit from lower prices. New trade theory also suggests that a company may dominate a certain industry simply because it got there first. If the firm can achieve economies of scale, they may act as a barrier to entry to other firms.

Difficulty: Medium

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109. (p. 174) Does new trade theory support the work of Heckscher and Ohlin? Is the theory at variance with the theory of comparative advantage?

New trade theory does not support Heckscher and Ohlin's work. In fact, new trade theorists argue that the U.S is a major exporter of commercial jet aircraft not because the country is better endowed with the factors of production required to make a plane, but because Boeing, an American firm, was one of the first movers in the industry. In contrast, the theory does support the theory of comparative advantage.

Difficulty: Medium

110. (p. 174) Does new trade theory support government intervention and strategic trade policy? Explain.

According to new trade theorists, luck, entrepreneurship and innovation are all important in giving a firm first mover advantages. Therefore, new trade theory supports the notion of government intervention on the basis that a government, through the judicious use of subsidies, could increase the chances of its domestic firms becoming first movers in newly emerging industries.

Difficulty: Medium

111. (p. 175) What are the four attributes identified by Porter as being important in determining why a nation achieves success in a particular industry?

The four attributes identified by Porter include factor endowments; demand conditions or the nature of home demand for the industry's product or service; related and supporting industries or the presence or absence in a nation of supplier industries and related industries that are internationally competitive and firm strategy, structure and rivalry or the conditions in the nation governing how companies are created, organized and managed and the nature of domestic rivalry.

Difficulty: Medium

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112. (p. 176) What is the difference between basic factors and advanced factors in Porter's Diamond?

Porter differentiates between factors of production. According to Porter, there are basic factors such as natural resources, climate and demographics and advanced factors such as infrastructure, skilled labor and research facilities. Advanced factors are a product of investment by individuals.

Porter suggests that advanced factors are most important for competitive advantage.

Difficulty: Medium

113. (p. 176) Porter has stated that a nation's firms gain competitive advantage if their domestic consumers are sophisticated and demanding. Explain this statement.

Firms are typically most sensitive to the needs of their closest customers. Therefore, according to Porter, the characteristics of home country demand will shape the attributes of domestically made products and create pressure for innovation and quality. Porter suggests that if a nation's domestic consumers are sophisticated and demanding, the nation's firms will gain a competitive advantage.

Difficulty: Medium

114. (p. 177-179) What is the role of government in Porter's theory?

According to Porter, government can influence each of the four main attributes of his model. For example, factor endowments can be affected by subsidies or policies toward education, domestic demand can be shaped through local product standards, regulations can influence supporting and related industries and firm rivalry can be affected by tax policies and anti trust regulations.

Difficulty: Medium

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115. (p. 179-181) Discuss the implications of international trade theory for a firm.

The implications of trade theory for a firm are reflected in location implications, firms can capitalize on the differences between countries by dispersing their production activities around the globe to wherever a product can be produced the most efficiently; in first-mover implications, it pays to invest substantial financial resources in trying to build a first mover advantage and in policy implications, it is in the best interests of a firm to invest in upgrading advanced factors of production and to lobby the government to adopt policies that have a favorable impact on Porter's Diamond.

Difficulty: Medium

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International Business Quiz