Practice Problems

This appendix provides practice problems for review. The problems are designed to reinforce the main tools used in the course: comparative advantage, factor endowments, surplus analysis, trade barriers, export policy, WTO rules, regional trade agreements, exchange rates, gravity models, Oman trade profile, and TINA simulations.

Part I. Foundations of international trade

Problem 1. Trade openness

A country has exports of USD 28 billion, imports of USD 36 billion, and GDP of USD 120 billion.

  1. Calculate the trade balance.
  2. Calculate the trade openness ratio.
  3. Interpret the result in one sentence.
  4. Does a high openness ratio automatically mean higher welfare? Explain briefly.

Problem 2. Ricardian model

Two countries, Oman and Kuwait, produce food and cloth. Labor is the only input.

Country Labor required for 1 unit of food Labor required for 1 unit of cloth Labor supply
Oman 1 2 2,000
Kuwait 2 1 2,000
  1. Write the labor constraint for each country.
  2. Derive the PPF equation for each country, with food on the horizontal axis.
  3. Calculate the opportunity cost of food in each country.
  4. Which country has comparative advantage in food?
  5. Which country has comparative advantage in cloth?
  6. If the world relative price is 1 food = 1 cloth, draw the TPF for each country.

Problem 3. Absolute versus comparative advantage

Suppose Country A can produce either 10 units of wheat or 5 units of dates with one worker. Country B can produce either 12 units of wheat or 12 units of dates with one worker.

  1. Which country has absolute advantage in wheat?
  2. Which country has absolute advantage in dates?
  3. Calculate the opportunity cost of wheat in each country.
  4. Which country has comparative advantage in wheat?
  5. Explain why absolute advantage is not enough to determine trade patterns.

Problem 4. Heckscher-Ohlin model

There are two goods: cloth and food. Cloth is labor-intensive and food is capital-intensive. Home is labor abundant and Foreign is capital abundant.

  1. Which good should Home export according to the HO theorem?
  2. Which good should Foreign export?
  3. What happens to the real wage in Home after trade?
  4. What happens to the real return to capital in Home after trade?
  5. Why can trade create winners and losers within the same country?

Problem 5. Factor-price equations

Suppose the pricing equations for cloth and food are:

\[ 2w + 2r = 4 \]

\[ w + 3r = 4 \]

  1. Solve for the wage \(w\) and rent \(r\).
  2. Now suppose the price of cloth rises to 6, so the first equation becomes:

\[ 2w + 2r = 6 \]

while the food equation remains unchanged.

  1. Solve for the new wage and rent.
  2. Calculate the percentage change in \(w\) and \(r\).
  3. Which factor gains from the increase in the price of cloth?

Part II. Trade welfare and policy instruments

Problem 6. Autarky surplus

A country has demand and supply:

\[ Q_d = 80 - P \]

\[ Q_s = P \]

  1. Find the autarky price and quantity.
  2. Calculate consumer surplus.
  3. Calculate producer surplus.
  4. Calculate total surplus.

Problem 7. Free trade with two countries

Country 1 has:

\[ Q_d = 80 - P, \quad Q_s = P \]

Country 2 has:

\[ Q_d = 100 - 0.5P, \quad Q_s = 0.5P \]

  1. Find the autarky price in each country.
  2. Identify the exporter and importer.
  3. Derive Country 1 export supply.
  4. Derive Country 2 import demand.
  5. Find the world price.
  6. Calculate trade volume.
  7. Calculate total surplus in each country after trade.
  8. Compare world total surplus before and after trade.

Problem 8. Supply shock

Using the same two-country setup as Problem 7, suppose Country 1 supply changes to:

\[ Q_s = 0.5P \]

  1. Derive the new export supply curve for Country 1.
  2. Find the new world price.
  3. Calculate the new trade volume.
  4. Explain who loses from the supply shock.
  5. Explain why world welfare changes.

Problem 9. Small-country tariff

A small importing country faces a world price of USD 10. It imposes a tariff of USD 2 per unit.

  1. What is the new domestic price?
  2. What happens to domestic consumption?
  3. What happens to domestic production?
  4. What happens to imports?
  5. Identify the four welfare effects: consumer surplus, producer surplus, government revenue, and deadweight loss.

Problem 10. Effective rate of protection

Producing 1 kg of cheese requires 10 liters of milk and 10 grams of starter culture. World prices are:

Item World price
Cheese USD 20 per kg
Milk USD 1 per liter
Starter culture USD 0.50 per gram

A country imposes a 20 percent tariff on cheese and a 10 percent tariff on both inputs.

  1. Calculate value added at world prices.
  2. Calculate value added at domestic protected prices.
  3. Calculate the effective rate of protection.
  4. Explain why ERP can differ from the nominal tariff on cheese.

Problem 11. Export subsidy

Oman exports fish to a neighboring market. Suppose an export subsidy raises the price received by Omani producers.

  1. What happens to Omani fish production?
  2. What happens to domestic consumption in Oman?
  3. What happens to Omani consumer surplus?
  4. What happens to Omani producer surplus?
  5. Why is an export subsidy usually welfare reducing for the exporting country?

Part III. WTO, agriculture, and RTAs

Problem 12. WTO principles

Briefly explain each principle:

  1. Most-favored nation treatment
  2. National treatment
  3. Binding and predictability
  4. Transparency
  5. Fair competition

Then explain why regional trade agreements are allowed even though they discriminate in favor of members.

Problem 13. Agreement on Agriculture

Classify each policy as Market Access, Domestic Support, or Export Competition.

  1. A country reduces an import quota and replaces it with a tariff.
  2. A government buys wheat at a guaranteed price above the market price.
  3. A country subsidizes the international transport cost of exported dairy products.
  4. A government funds agricultural research and pest control.
  5. A country binds its tariff rate at the WTO.

Problem 14. SPS measures

A country bans imports of fresh fruit from a region because of a pest risk.

  1. Is this an SPS issue? Explain.
  2. What scientific justification is required?
  3. What is meant by equivalence?
  4. How can an SPS measure become disguised protectionism?

Problem 15. Trade creation and trade diversion

The UK imports all compact cars. The import demand curve is:

\[ Q = 70 - 0.01P \]

Quantities are in thousand cars. Japan sells cars at USD 5,000. Germany sells cars at USD 5,500. The UK tariff is USD 1,000 per car on all imports.

Before an FTA, the UK imports from Japan.

After an FTA with Germany, the tariff on German cars becomes zero while Japan still faces the tariff.

  1. Calculate the delivered price from Japan before the FTA.
  2. Calculate the delivered price from Germany before the FTA.
  3. Calculate the delivered price from Germany after the FTA.
  4. Calculate initial and final import quantities.
  5. Calculate the consumer surplus gain.
  6. Calculate lost tariff revenue.
  7. Calculate the net welfare effect.
  8. Does trade creation or trade diversion dominate?

Part IV. Applied trade models

Problem 16. Exchange rates and import prices

Suppose the price of imported wheat is USD 300 per ton. The exchange rate is 0.385 OMR per USD.

  1. Calculate the price in OMR.
  2. Suppose the Omani rial depreciates to 0.400 OMR per USD. Calculate the new price in OMR.
  3. Explain how depreciation affects food import costs.
  4. Who is likely to be affected most by higher food import costs?

Problem 17. Gravity model signs

A simple gravity model is:

\[ \ln Trade_{ij} = \alpha_0 + \alpha_1\ln GDP_i + \alpha_2\ln GDP_j - \alpha_3\ln Distance_{ij} + u_{ij} \]

  1. What sign do you expect for \(\alpha_1\)?
  2. What sign do you expect for \(\alpha_2\)?
  3. Why does distance usually reduce trade?
  4. Give two additional variables that could be added to the gravity model.

Problem 18. Gravity model interpretation

Suppose a gravity model estimates that the coefficient on distance is \(-0.8\).

  1. Interpret the coefficient in words.
  2. What happens to trade if distance increases by 10 percent?
  3. Why might Oman trade heavily with nearby GCC countries even if some larger economies are farther away?

Part V. Oman applications and student projects

Problem 19. Oman trade profile

Oman’s GDP is USD 114,667 million and trade is 48.9 percent of GDP.

  1. Estimate total trade.
  2. Explain what the trade openness ratio tells us.
  3. Explain one limitation of the trade openness ratio.
  4. Why is export concentration in fuels and mining products important for policy?
  5. Why are agricultural imports important for food security?

Problem 20. TINA simulation interpretation

A TINA simulation shows that a proposed FTA creates USD 400 million in trade creation and USD 150 million in trade diversion.

  1. Calculate the total trade effect.
  2. Is trade creation larger than trade diversion?
  3. Does this automatically prove the agreement is welfare improving? Explain.
  4. What additional information would be useful?

Problem 21. Oman-India CEPA project interpretation

A simulation of the Oman-India CEPA shows that trade gains are positive for both sides, but Oman’s export gains are concentrated in energy and chemical products while India’s gains are broader and include several food products.

  1. What does this suggest about Oman’s export diversification?
  2. What does this suggest about India’s role in Oman’s food imports?
  3. Why might tariff liberalization alone be insufficient to create balanced trade gains?
  4. What complementary policies could Oman use to increase benefits from the agreement?

Selected answers

Answer 1

Trade balance:

\[ TB = 28 - 36 = -8 \]

The country has a trade deficit of USD 8 billion.

Trade openness:

\[ \frac{28 + 36}{120} \times 100 = 53.3\% \]

Answer 6

Autarky:

\[ 80 - P = P \]

\[ P = 40, \quad Q = 40 \]

Consumer surplus:

\[ CS = \frac{1}{2}(80 - 40)(40) = 800 \]

Producer surplus:

\[ PS = \frac{1}{2}(40)(40) = 800 \]

Total surplus:

\[ TS = 1600 \]

Answer 10

World value added:

\[ VA_w = 20 - (10 \times 1 + 10 \times 0.5) = 20 - 15 = 5 \]

Domestic output price:

\[ 20 \times 1.20 = 24 \]

Domestic input cost:

\[ 10 \times 1.10 + 5 \times 1.10 = 16.5 \]

Domestic value added:

\[ VA_d = 24 - 16.5 = 7.5 \]

Effective rate of protection:

\[ ERP = \frac{7.5 - 5}{5} \times 100 = 50\% \]