CIMA BA1 · Chapter 3
International trade, globalisation and exchange rates MCQs with Answers
10 multiple-choice questions on International trade, globalisation and exchange rates for CIMA BA1 Fundamentals of Business Economics. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
One worker in Country X can produce either 20 units of cloth or 10 units of wheat per day. One worker in Country Y can produce either 12 units of cloth or 8 units of wheat per day. According to the theory of comparative advantage:
- A) Country X should produce both goods because it has an absolute advantage in both
- B) Country X should specialise in cloth and Country Y in wheat
- C) Country X should specialise in wheat and Country Y in cloth
- D) There are no gains from trade because Country X is more efficient at both goods
Show answer & explanation
Answer: B) Country X should specialise in cloth and Country Y in wheat
Opportunity cost of 1 wheat: X = 20 / 10 = 2 cloth; Y = 12 / 8 = 1.5 cloth. Y has the lower opportunity cost of wheat. Opportunity cost of 1 cloth: X = 10 / 20 = 0.5 wheat; Y = 8 / 12 = 0.67 wheat, so X has the comparative advantage in cloth. Gains from trade exist even though X has an absolute advantage in both goods.
Question 2
Which of the following is NOT a protectionist measure?
- A) Removing customs duties on trade between members of a free trade area
- B) Imposing a tariff on imported steel
- C) Setting a quota limiting the number of imported cars
- D) Paying subsidies to domestic producers that compete with imports
Show answer & explanation
Answer: A) Removing customs duties on trade between members of a free trade area
Tariffs, quotas and subsidies to domestic producers all protect home industries from foreign competition. Removing customs duties between members is trade liberalisation, the opposite of protectionism.
Question 3
What distinguishes a customs union from a free trade area?
- A) Members of a customs union allow free movement of labour and capital
- B) Members of a free trade area use a single currency
- C) Members of a free trade area set a common external tariff but keep internal tariffs
- D) Members of a customs union adopt a common external tariff on imports from non-members
Show answer & explanation
Answer: D) Members of a customs union adopt a common external tariff on imports from non-members
In a free trade area, members remove barriers between themselves but each sets its own tariffs on non-members. A customs union adds a common external tariff. Free movement of factors of production is a feature of a common market, and a single currency is a feature of monetary union.
Question 4
Which of the following transactions is recorded in the current account of a country's balance of payments?
- A) The purchase of a factory overseas by a domestic company
- B) A long-term loan received from an overseas bank
- C) Dividends received by domestic companies from their overseas subsidiaries
- D) An increase in the central bank's foreign currency reserves
Show answer & explanation
Answer: C) Dividends received by domestic companies from their overseas subsidiaries
The current account records trade in goods and services, primary income (such as dividends, interest and wages) and secondary income (transfers). Purchasing overseas assets and borrowing from abroad are recorded in the financial account, as are changes in official reserves.
Question 5
The exchange rate between the Ruritanian krona (RK) and the US dollar moves from RK1 = $0.80 to RK1 = $0.72. Which of the following statements is correct?
- A) The krona has appreciated, making Ruritania's exports cheaper in dollar terms
- B) The krona has depreciated, making Ruritania's exports cheaper in dollar terms
- C) The krona has depreciated, making Ruritania's imports cheaper in krona terms
- D) The krona has appreciated, making Ruritania's imports more expensive in krona terms
Show answer & explanation
Answer: B) The krona has depreciated, making Ruritania's exports cheaper in dollar terms
One krona now buys fewer dollars ($0.72 rather than $0.80), so the krona has depreciated. Goods priced in krona cost foreign buyers fewer dollars, while imports priced in dollars cost more krona.
Question 6
A Ruritanian exporter sells a machine priced at RK50,000. The exchange rate moves from RK1 = $0.80 to RK1 = $0.72. What is the dollar price of the machine to an American buyer after the change?
- A) $36,000
- B) $40,000
- C) $69,444
- D) $62,500
Show answer & explanation
Answer: A) $36,000
Dollar price = krona price x dollars per krona = RK50,000 x 0.72 = $36,000. Before the change it was RK50,000 x 0.80 = $40,000, so the depreciation has made the export cheaper to the buyer.
Question 7
Which of the following is usually regarded as an advantage of a fixed exchange rate system compared with a freely floating system?
- A) It automatically corrects balance of payments deficits without government action
- B) It allows the central bank to set interest rates purely for domestic objectives
- C) It removes the need for the central bank to hold foreign currency reserves
- D) It gives importers and exporters greater certainty about future exchange rates
Show answer & explanation
Answer: D) It gives importers and exporters greater certainty about future exchange rates
A fixed rate reduces exchange rate uncertainty for traders and investors. However, the authorities must hold reserves to defend the rate and must often direct interest rates at maintaining the peg; automatic correction of imbalances is a claimed advantage of floating rates.
Question 8
The spot exchange rate is H1 = $2.00, where H is the home currency (one unit of H buys $2.00). Annual inflation is expected to be 6% in the home country and 2% in the USA. Using the exact purchasing power parity formula (not the approximation based on the inflation differential), what is the expected exchange rate in one year's time (to four decimal places)?
- A) H1 = $2.0784
- B) H1 = $1.9200
- C) H1 = $1.9245
- D) H1 = $2.0800
Show answer & explanation
Answer: C) H1 = $1.9245
Under PPP the currency with higher inflation depreciates. Exact formula: expected rate = spot x (1 + US inflation) / (1 + home inflation) = 2.00 x 1.02 / 1.06 = $1.9245 per H1 (rounded to four decimal places). $1.9200 uses the approximate 4% inflation differential, which the question excludes, and $2.0784 and $2.0800 apply the inflation rates the wrong way round (exactly and approximately respectively).
Question 9
Which of the following has been a major driver of globalisation?
- A) The introduction of higher import tariffs
- B) Falling transport and communication costs
- C) Stricter controls on international capital movements
- D) Increasing restrictions on foreign direct investment
Show answer & explanation
Answer: B) Falling transport and communication costs
Cheaper transport and rapid, low-cost communications have made it easier for firms to trade, source and operate internationally. Higher tariffs, capital controls and restrictions on foreign investment would all slow globalisation.
Question 10
Which of the following best describes the main role of the World Trade Organization?
- A) Promoting freer trade by negotiating reductions in trade barriers and settling trade disputes between members
- B) Lending to countries facing short-term balance of payments difficulties
- C) Financing long-term development projects in low-income countries
- D) Setting a common interest rate for member countries
Show answer & explanation
Answer: A) Promoting freer trade by negotiating reductions in trade barriers and settling trade disputes between members
The WTO provides a framework for negotiating trade liberalisation and a dispute settlement mechanism. Short-term balance of payments support is associated with the IMF and development lending with the World Bank.