WGU C211 Global Economics Advanced Prep:
Master International Trade & Macroeconomic
Policy Practice Questions & Detailed
Explanations
Subject: Global Economics (International Trade, Comparative Advantage, and
Macroeconomic Policy)
Question 1: A nation experiencing a persistent current account deficit while maintaining a fixed
exchange rate regime is most likely to face which of the following long-term adjustments under
the monetary approach to the balance of payments?
A) An increase in the domestic money supply due to central bank intervention.
B) A continuous decline in international reserves, eventually forcing a devaluation.
C) An automatic rebalancing through immediate wage-price flexibility without reserve loss.
D) A shift toward capital account surplus that permanently offsets the trade imbalance without
policy intervention.
Correct Answer: B) A continuous decline in international reserves, eventually forcing a
devaluation.
Explanation: The monetary approach views balance of payments deficits as a reflection of an
excess supply of money in the domestic economy. Under a fixed exchange rate, the central bank
must sell foreign reserves to support the domestic currency, leading to a decline in the monetary
base. If the deficit persists, reserve depletion becomes unsustainable, forcing a devaluation to
restore equilibrium.
Question 2: In the context of the Heckscher-Ohlin model, what occurs when a country
experiences an exogenous increase in its capital endowment while labor remains constant?
A) The Production Possibility Frontier (PPF) shifts outward, biased toward the labor-intensive
good.
B) The Rybczynski theorem suggests an increase in the output of the capital-intensive good and
a decrease in the output of the labor-intensive good.
C) The Stolper-Samuelson theorem predicts a decline in the real return to capital.
D) The country loses its comparative advantage in all traded goods.
,Correct Answer: B) The Rybczynski theorem suggests an increase in the output of the
capital-intensive good and a decrease in the output of the labor-intensive good.
Explanation: The Rybczynski theorem states that at constant relative goods prices, an increase in
one factor of production will lead to an expansion in the production of the good that uses that
factor intensively and a contraction in the production of the other good.
Question 3: Under the Mundell-Fleming model with perfect capital mobility, what is the primary
impact of a contractionary monetary policy in a country with a floating exchange rate?
A) The interest rate remains unchanged, and the exchange rate depreciates.
B) The interest rate rises, leading to a capital inflow, currency appreciation, and a decrease in net
exports.
C) The interest rate falls, leading to capital outflow and an increase in aggregate demand.
D) Domestic income increases due to the improvement in the trade balance.
Correct Answer: B) The interest rate rises, leading to a capital inflow, currency
appreciation, and a decrease in net exports.
Explanation: Contractionary monetary policy reduces the money supply, raising domestic
interest rates. With perfect capital mobility, this attracts foreign capital, driving up demand for
the currency and causing appreciation. The resulting stronger currency makes exports more
expensive and imports cheaper, worsening net exports.
Question 4: Which of the following best describes the "Leontief Paradox" as it pertains to
classical trade theory?
A) The empirical finding that the US, despite being capital-abundant, exported labor-intensive
goods.
B) The discovery that international trade does not equalize factor prices.
C) The observation that technology transfer prevents developing nations from industrializing.
D) The theory that tariffs are always welfare-enhancing for large economies.
Correct Answer: A) The empirical finding that the US, despite being capital-abundant,
exported labor-intensive goods.
Explanation: Wassily Leontief discovered that US exports were more labor-intensive than US
imports, which contradicted the standard Heckscher-Ohlin prediction that a capital-abundant
country like the US should export capital-intensive goods.
,Question 5: If a country implements an optimal tariff in a large-country scenario, what is the net
effect on national welfare?
A) It always decreases because tariffs create consumption distortions.
B) It increases, provided the terms-of-trade gain exceeds the deadweight loss from production
and consumption distortions.
C) It remains unchanged because the gain in tariff revenue exactly offsets the deadweight loss.
D) It increases because domestic firms can capture the entire global market share.
Correct Answer: B) It increases, provided the terms-of-trade gain exceeds the deadweight
loss from production and consumption distortions.
Explanation: A large country has enough market power to influence world prices. By imposing a
tariff, it lowers the world price of the import (terms-of-trade improvement). If this gain exceeds
the efficiency losses (deadweight loss) from distorted production and consumption, the net
national welfare increases.
Question 6: According to the Balassa-Samuelson effect, why do countries with higher
productivity growth in the tradable sector tend to have higher real exchange rates?
A) Because they export more capital, driving up the interest rate.
B) Because higher productivity in tradables leads to higher wages, which spill over into the non-
tradable sector, increasing non-tradable prices.
C) Because the central bank artificially pegs the currency to maximize export revenue.
D) Because tradable goods prices must remain identical across borders regardless of
productivity.
Correct Answer: B) Because higher productivity in tradables leads to higher wages, which
spill over into the non-tradable sector, increasing non-tradable prices.
Explanation: The Balassa-Samuelson effect posits that wage growth in the highly productive
tradable sector pulls up wages in the less productive non-tradable sector. Since non-tradables
cannot be traded, their prices must rise to cover the higher labor costs, resulting in a higher
overall price level and an appreciated real exchange rate.
Question 7: Under the Absorbtion Approach to the balance of trade, what must happen for a
currency devaluation to successfully improve the trade balance?
A) The Marshall-Lerner condition must be violated.
, B) The country must reduce its domestic absorption (C + I + G) relative to its total income (Y).
C) The country must increase government spending to stimulate export production.
D) The central bank must lower interest rates to encourage domestic investment.
Correct Answer: B) The country must reduce its domestic absorption (C + I + G) relative to
its total income (Y).
Explanation: The absorption approach focuses on $TB = Y - A$. If a devaluation is to improve
the trade balance, the domestic economy must either increase output ($Y$) or decrease
absorption ($A$). If absorption remains constant while the currency devalues, the trade balance
will not improve effectively.
Question 8: What is the primary difference between a "first-generation" and "second-generation"
currency crisis model?
A) First-gen models focus on sunspots; second-gen models focus on budget deficits.
B) First-gen models emphasize inconsistent fiscal policies/money growth; second-gen models
emphasize the government’s trade-off between defending the peg and the costs of
unemployment.
C) First-gen models require capital controls; second-gen models assume perfect information.
D) Second-gen models always result in hyperinflation.
Correct Answer: B) First-gen models emphasize inconsistent fiscal policies/money growth;
second-gen models emphasize the government’s trade-off between defending the peg and
the costs of unemployment.
Explanation: First-generation models (Krugman) focus on the depletion of reserves due to fiscal
deficits. Second-generation models (Obstfeld) focus on multiple equilibria and self-fulfilling
attacks where the cost of maintaining a peg (high interest rates causing recession) outweighs the
benefit of maintaining the exchange rate.
Question 9: If a country is a price-taker in international commodity markets, what is the welfare
impact of an import quota compared to an equivalent tariff?
A) The quota is always more efficient than a tariff.
B) If the government auctions the quota licenses, the revenue effect is identical, but if licenses
are allocated arbitrarily, the welfare loss is greater due to rent-seeking.
C) The quota eliminates all deadweight loss associated with trade protection.
Master International Trade & Macroeconomic
Policy Practice Questions & Detailed
Explanations
Subject: Global Economics (International Trade, Comparative Advantage, and
Macroeconomic Policy)
Question 1: A nation experiencing a persistent current account deficit while maintaining a fixed
exchange rate regime is most likely to face which of the following long-term adjustments under
the monetary approach to the balance of payments?
A) An increase in the domestic money supply due to central bank intervention.
B) A continuous decline in international reserves, eventually forcing a devaluation.
C) An automatic rebalancing through immediate wage-price flexibility without reserve loss.
D) A shift toward capital account surplus that permanently offsets the trade imbalance without
policy intervention.
Correct Answer: B) A continuous decline in international reserves, eventually forcing a
devaluation.
Explanation: The monetary approach views balance of payments deficits as a reflection of an
excess supply of money in the domestic economy. Under a fixed exchange rate, the central bank
must sell foreign reserves to support the domestic currency, leading to a decline in the monetary
base. If the deficit persists, reserve depletion becomes unsustainable, forcing a devaluation to
restore equilibrium.
Question 2: In the context of the Heckscher-Ohlin model, what occurs when a country
experiences an exogenous increase in its capital endowment while labor remains constant?
A) The Production Possibility Frontier (PPF) shifts outward, biased toward the labor-intensive
good.
B) The Rybczynski theorem suggests an increase in the output of the capital-intensive good and
a decrease in the output of the labor-intensive good.
C) The Stolper-Samuelson theorem predicts a decline in the real return to capital.
D) The country loses its comparative advantage in all traded goods.
,Correct Answer: B) The Rybczynski theorem suggests an increase in the output of the
capital-intensive good and a decrease in the output of the labor-intensive good.
Explanation: The Rybczynski theorem states that at constant relative goods prices, an increase in
one factor of production will lead to an expansion in the production of the good that uses that
factor intensively and a contraction in the production of the other good.
Question 3: Under the Mundell-Fleming model with perfect capital mobility, what is the primary
impact of a contractionary monetary policy in a country with a floating exchange rate?
A) The interest rate remains unchanged, and the exchange rate depreciates.
B) The interest rate rises, leading to a capital inflow, currency appreciation, and a decrease in net
exports.
C) The interest rate falls, leading to capital outflow and an increase in aggregate demand.
D) Domestic income increases due to the improvement in the trade balance.
Correct Answer: B) The interest rate rises, leading to a capital inflow, currency
appreciation, and a decrease in net exports.
Explanation: Contractionary monetary policy reduces the money supply, raising domestic
interest rates. With perfect capital mobility, this attracts foreign capital, driving up demand for
the currency and causing appreciation. The resulting stronger currency makes exports more
expensive and imports cheaper, worsening net exports.
Question 4: Which of the following best describes the "Leontief Paradox" as it pertains to
classical trade theory?
A) The empirical finding that the US, despite being capital-abundant, exported labor-intensive
goods.
B) The discovery that international trade does not equalize factor prices.
C) The observation that technology transfer prevents developing nations from industrializing.
D) The theory that tariffs are always welfare-enhancing for large economies.
Correct Answer: A) The empirical finding that the US, despite being capital-abundant,
exported labor-intensive goods.
Explanation: Wassily Leontief discovered that US exports were more labor-intensive than US
imports, which contradicted the standard Heckscher-Ohlin prediction that a capital-abundant
country like the US should export capital-intensive goods.
,Question 5: If a country implements an optimal tariff in a large-country scenario, what is the net
effect on national welfare?
A) It always decreases because tariffs create consumption distortions.
B) It increases, provided the terms-of-trade gain exceeds the deadweight loss from production
and consumption distortions.
C) It remains unchanged because the gain in tariff revenue exactly offsets the deadweight loss.
D) It increases because domestic firms can capture the entire global market share.
Correct Answer: B) It increases, provided the terms-of-trade gain exceeds the deadweight
loss from production and consumption distortions.
Explanation: A large country has enough market power to influence world prices. By imposing a
tariff, it lowers the world price of the import (terms-of-trade improvement). If this gain exceeds
the efficiency losses (deadweight loss) from distorted production and consumption, the net
national welfare increases.
Question 6: According to the Balassa-Samuelson effect, why do countries with higher
productivity growth in the tradable sector tend to have higher real exchange rates?
A) Because they export more capital, driving up the interest rate.
B) Because higher productivity in tradables leads to higher wages, which spill over into the non-
tradable sector, increasing non-tradable prices.
C) Because the central bank artificially pegs the currency to maximize export revenue.
D) Because tradable goods prices must remain identical across borders regardless of
productivity.
Correct Answer: B) Because higher productivity in tradables leads to higher wages, which
spill over into the non-tradable sector, increasing non-tradable prices.
Explanation: The Balassa-Samuelson effect posits that wage growth in the highly productive
tradable sector pulls up wages in the less productive non-tradable sector. Since non-tradables
cannot be traded, their prices must rise to cover the higher labor costs, resulting in a higher
overall price level and an appreciated real exchange rate.
Question 7: Under the Absorbtion Approach to the balance of trade, what must happen for a
currency devaluation to successfully improve the trade balance?
A) The Marshall-Lerner condition must be violated.
, B) The country must reduce its domestic absorption (C + I + G) relative to its total income (Y).
C) The country must increase government spending to stimulate export production.
D) The central bank must lower interest rates to encourage domestic investment.
Correct Answer: B) The country must reduce its domestic absorption (C + I + G) relative to
its total income (Y).
Explanation: The absorption approach focuses on $TB = Y - A$. If a devaluation is to improve
the trade balance, the domestic economy must either increase output ($Y$) or decrease
absorption ($A$). If absorption remains constant while the currency devalues, the trade balance
will not improve effectively.
Question 8: What is the primary difference between a "first-generation" and "second-generation"
currency crisis model?
A) First-gen models focus on sunspots; second-gen models focus on budget deficits.
B) First-gen models emphasize inconsistent fiscal policies/money growth; second-gen models
emphasize the government’s trade-off between defending the peg and the costs of
unemployment.
C) First-gen models require capital controls; second-gen models assume perfect information.
D) Second-gen models always result in hyperinflation.
Correct Answer: B) First-gen models emphasize inconsistent fiscal policies/money growth;
second-gen models emphasize the government’s trade-off between defending the peg and
the costs of unemployment.
Explanation: First-generation models (Krugman) focus on the depletion of reserves due to fiscal
deficits. Second-generation models (Obstfeld) focus on multiple equilibria and self-fulfilling
attacks where the cost of maintaining a peg (high interest rates causing recession) outweighs the
benefit of maintaining the exchange rate.
Question 9: If a country is a price-taker in international commodity markets, what is the welfare
impact of an import quota compared to an equivalent tariff?
A) The quota is always more efficient than a tariff.
B) If the government auctions the quota licenses, the revenue effect is identical, but if licenses
are allocated arbitrarily, the welfare loss is greater due to rent-seeking.
C) The quota eliminates all deadweight loss associated with trade protection.
