ECO211 EXTRA REVISION

Chapter 7 International Trade

ANSWERS TO QUESTION TO PONDER:

CHAPTER 7: INTERNATIONAL TRADE

Structured / Essay Questions

1. The following table shows the total production of two countries that produce
only two goods. Both countries have the same number of population.

Production by 1 unit of factor

Country Butter Milk
Australia
New Zealand 30 bars 40 litres

20 bars 46 litres

a) Calculate the opportunity cost to produce 1 bar of butter and 1 litre of milk
in both countries.

b) Identify the comparative advantage gained by each of the country.
c) Based on the comparative advantage principle, show how the total world

output can increase by calculating the total world output before and after
specialization is practiced.
d) State three (3) assumptions to look for gain in absolute advantage theory.

2. The following data shows the production possibilities of two countries before
trade.

COUNTRY COMMODITY Cloths
Shoes (units)
India (units) 2000
China 400
2400
1200

a) Which country has an absolute advantage in the production of shoes?
b) Calculate the comparative advantage of producing shoes and cloths in

both countries?
c) Specify which country should specialize in the production of cloths. Give

your reason?
d) Illustrate a production table after specialization for both the countries.
e) Suggest a term of trade in which both nations are to gain equally from

international trade.
f) List three (3) advantages of international trade.

3. a) Define comparative advantage.

b) There are two (2) countries, M and N which produce two (2) products by
using all their existing resources. Country M can produce either 360
tonnes of paddy or 120 tonnes of palm oil and country N can produce
either 72 tonnes of paddy or 60 tonnes of palm oil. Constant cost prevails
in each country.

Chapter 7 International Trade

Explain using appropriate schedule to how these two countries will have a
comparative advantage over another and show the gains after
international trade. Then, if the term of trade agreed between these two
countries is 1 palm oil for 2 paddy, build a consumption table after
specialization.

ANSWERS to Q1:

Production by 1 unit of factor

Country Butter Milk
Australia
New Zealand 30 bars 40 litres

Total 20 bars 46 litres

50 bars 86 litres

Before specialisation

1a.

Opportunity cost (units)

COUNTRY 1 Butter 1 Milk

Austr 40/30=1.33 M 30/40= 0.75 B
NZ 46/20=2.3 M 20/46= 0.43 B

1b. Australia has the absolute advantage in butter production.
While New Zealand has the absolute advantage in milk production.

1c. Before specialization:

Total 50 bars 86 litres

After specialization:

Production by 1 unit of factor

Country Butter Milk
Australia
New Zealand 60 bars 0 litres

Total 0 bars 92 litres

60 bars 92 litres

There is AN INCREASE WORLD PRODUCTION AFTER
SPECIALISATION: Butter increases by 10 bars and milk increases by 6
litres.

Chapter 7 International Trade

1d. three assumptions: - has 2 countries in the world
- produces 2 goods only
- fixed resources.
- constant cost.

ANSWERS TO Q2:

COMMODITY

COUNTRY Shoes Cloths
(units)
(units) 2000

India 400 2400
4400
China 1200

Total 1600

Before specialisation

2, a) Which country has an absolute advantage in the production of shoes?
China

b) Calculate the comparative advantage of producing shoes and cloths in
both countries?

Opportunity cost (units)

COUNTRY 1 Shoe 1 Cloth

India 2000/400=5cloth 400/2000= 0.2shoe
China
2400/1200=2C 1200/2400=0.5S

c) Specify which country should specialize in the production of cloths. Give
your reason?
India specialize in cloth because has lower opportunity cost.

d) Illustrate a production table after specialization for both the countries.

COMMODITY

COUNTRY Shoes Cloths
(units)
(units) 4000

India 0 0
4000
China 2400

Total 2400

After specialisation

Chapter 7 International Trade

e) Suggest a term of trade in which both nations are to gain equally from
international trade.
2C < 1 S < 5C

Or

0.2S < 1C < 0.5S

f) List three (3) advantages of international trade.

ANSWERS to Q3:

3a. Define comparative advantage..

3b.

COMMODITY

COUNTRY Paddy Palm Oil

M (tonnes) (tonnes)
N
360 120
Total
72 60

432 180

Before specialisation

Q? to show comparative advantage:

Opportunity cost (units)

COUNTRY 1 Pdy 1 PO

M 120/360=0.33 PO 360/120= 3 Pdy
N 60/72= 0.83 PO 72/60=1.2 Pdy

M will specialize in paddy because has lower opportunity cost.
And N will specialize in Palm oil .

Chapter 7 International Trade

Q? the gain after international trade:

COMMODITY

COUNTRY Paddy Palm Oil

M (tonnes) (tonnes)
N
720 0
Total
0 120

720 120

After specialisation

Gain in comparative advantage whereby the production of paddy has risen to
720 tonnes compared to before specialization is only 432 tonnes.

Q? consumption table after specialization:
Wth TOT 1 palm oil : 2 paddy

COMMODITY

COUNTRY Paddy Palm Oil

M (tonnes) (tonnes)
N
600 60
Total
120 60

720 120

Consumption Table

Here the exchange is 60 palm oil : 120 paddy

ECO211 Chapter 8 Balance of Payment

CHAPTER 8

BALANCE OF PAYMENT

Tutorial Questions To Ponder:

1. The data below is the balance of payment of Country Pinang

Sebatang for the year 2005.

Item RM million

Export of tangible goods 40,690

Import of tangible goods 36,450

Freight and insurance (net) -1,850

Other transportations -20

Tourism 340

Investment income 2990

Government transactions -240

Other services -530

Net transfer 110

Official long-term capital -350

Corporate investment 3,500

Net private capital 580

Error and omission 320

Based on the above information, calculate: the trade account
balance

i) the trade account balance
ii) the balance of services
iii) the current account balance
iv) the capital and financial account balance.
v) the overall balance
vi) net change in reserve
vii) if changes in the Bank Negara Official Reserves for

the year 2004 is RM200,000 million, calculate the
change in Bank Negara Official Reserve for the
year 2005.

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ECO211 Chapter 8 Balance of Payment

Answers:

i) Trade Account Balance = Export – Import
= 40,690 – 36450
= 4240 mil.

ii) Balance of Services = Freight and insurance +
Other transportation +
Tourism +
Government Transaction +
Other services

= – 1850 – 20 + 340 – 240 – 530

= – 2300 mil.

iii) Current Account Balance = Trade Bal. + +
Service Bal. +
Investment income
Net Transfers.

= 4240 – 2300 + 2990 + 110

= 5040 mil.

iv) Capital and Financial Account
= Capital Account + Financial Acc.
= Off LT capital + Net private capital + Corporate
investment

= – 350 + 580 + 3 500

= 230 mil.

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ECO211 Chapter 8 Balance of Payment

v) Overall Balance = 5040 + 230 + 3500 + 320
= 9090 mil. (SURPLUS BOP)

vi) Net change in reserve = – 9090 (an addition to reserve).

vii) The change in Bank Negara Official Reserve
= 200,000 + 9090
= 209,090 mil.

2. The following are extracts from the balance of payments of Country
Berjaya in the year 2005 (in RM million)

Items RM
million
Import of goods
Export of goods 3460
Invisible receipts 6580
Expenditure on travel abroad 5450
Net military expenditure overseas 2590
Net investment 3220
Official borrowing from IMF and other 5400

monetary authorities 3500
Errors and omission 500

Calculate: Trade balance
a) Service balance
b) Current account balance
c) Basic balance
d) Overall balance of payment
e)

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ECO211 Chapter 8 Balance of Payment

f) Differentiate between balance of trade and
balance of payment.

ANSWER:

a) Trade balance
= X– M
= 6580 – 3460
= 3120 mil.

b) Service balance
= Invisible receipts – expenditure on travel abroad
+ Net military expenditure overseas
= 5450 – 2590 + 3220
= 6080 mil.

c) Current account balance
= Trade Bal. +
Service Bal. +
Investment income +
Net Transfers.
= 3120 + 6080
= 9200 mil.

d) Overall balance of payment
= Current Ac + Capital and Financial Ac. + Error
= 9200 + 5400 + 500
= 15100 mil.

e) Differentiate between balance of trade and balance of payment.

BOT = Merchandised Ac = X – M (physical gools)

BOP = Overall balance of a country’s record of account of
monetary inflows and outflows in a period of time.

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ECO211 Chapter 8 Balance of Payment

3. The items below are the international transactions for Country
Melati Putih in the year 2008.

Items RM million
40
Foreign students at local universities receiving scholarship 80
450
Aid to other country 250
Dividend and profit from overseas 25
Receipts from air services 90
Payment of interest on loan 58
Official investment at overseas 410
Private investment at overseas -5
Portfolio investments 540
Errors and omission 330
Imports of visible items
Export of visible items

Calculate: Invisible trade balance
a) Current account balance
b) Capital and financial account
c) Overall balance
d) Net change in central bank international reserves.
e)

ANSWERS:

a) Invisible trade balance
= Service Balance
= Receipts from air services
= 250 mil.

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ECO211 Chapter 8 Balance of Payment

b) Current account balance

= Visible Trade Bal. +
Service Bal. +
Investment income +
Net Transfers.

= (X – M) +
visible balance +
(dividend & profit from overseas –
payment of interest on loan) +
(foreign students – aid to other country)

= (330 – 540) + 250 + (450 – 25) + (40 – 80)
= (– 210) + 250 + (425) – (40)

= 425 mil.

c) Capital and financial account
= Official investment at overseas
+ Private investment at overseas
+ Portfolio investment.
= – ( 90 ) – ( 58 ) + 410.
= 262 mil.

d) Overall balance
= Current Ac + Capital and Financial Ac. + Error
= 425 + 262 + ( – 5 )
= 682 mil. (SURPLUS BOP)

e) Net change in central bank international reserves.
= – 682 mil.

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ECO211 Chapter 8 Balance of Payment

Multiple Choice Questions:

1. The capital account on a nation’s balance of payments includes all
of the following except
A. Capital inflow to the country
B. Capital outflow from the country
C. Net income from investment
D. Short term loans received by the citizens of the
Country.
ANSWER: C

2. The balance of payments are always balanced because:
A. The value of exports and imports will be the same in
the long run.
B. The balance on capital account normally offsets the
balance on current account.
C. Invisible exports and imports compensate any
imbalance on visible trade balance
D. All of the above

ANSWER: B

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ECO211 Chapter 8 Balance of Payment

3. The following figures are taken from a country’s Balance of Payment
account

Items RM million
Visible and invisible imports 30
Visible and invisible exports 32
Transfers received from abroad 10
Transfers paid to abroad 10
Capital outflows 15
Capital inflows 17

Which of the following describes the country’s trade position?

Current Account Balance Overall Balance of Payment

A. Surplus Balanced

B. Surplus Surplus

C. Balanced Surplus

D. Deficit Deficit

Current Account Balance Overall Balance of Payment

+2 +2
–0 +2
+4
+2

ANSWER: B

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ECO211 Chapter 8 Balance of Payment

4. A surplus in the current account of the balance of payment means
A. an excess value of exported goods over imported
goods
B. an excess of total receipts from goods and services
over total payments for goods and services, plus net
transfers and net incomes.
C. an excess value of exported services over imported
services
D. an excess of gold and capital received over gold and
capital paid abroad.

ANSWER: B

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