Monetary Policy — MCQs

An investment firm is evaluating the economic outlook for Norland, Sudoria, and Bellaria. Norland and Sudoria can produce wheat and textiles using labor with constant opportunity costs. The productivity data in Exhibit 1 show that Norland can produce more of either good per worker-day. The countries are considering a trade agreement under which each would specialize partly according to comparative advantage rather than absolute productivity. Sudoria currently imports steel at a world price of USD 500 per tonne. Its government is considering either a tariff or an import quota designed to produce the same domestic steel price and import quantity. Under the tariff, the government would collect the tariff payments. Under the quota, import licenses would be auctioned competitively to the highest bidders, with the auction proceeds retained by the government. The analyst notes that either policy would raise domestic steel prices, increase domestic production, reduce domestic consumption, and create efficiency losses relative to free trade. Bellaria is a small open economy that has historically received substantial foreign direct investment. A territorial dispute has recently escalated, and negotiations between the affected states have been suspended. Investors now assign a higher probability to capital controls, trade interruptions, and damage to transport infrastructure. Bellaria's sovereign and corporate risk premiums have increased, several multinational firms have delayed new factories, and domestic businesses have reduced capital-expenditure plans. No physical capital has yet been destroyed, but the lower investment rate is expected to persist for several years. The firm also evaluates Bellaria's sources of economic growth using a standard growth-accounting framework. The framework treats output growth as the sum of labor growth weighted by labor's income share, capital growth weighted by capital's income share, and growth in total factor productivity. Exhibit 1 provides all required growth rates and factor shares. The factor shares sum to 100%, and no additional adjustment for human capital is required. One analyst argues that Norland should export both wheat and textiles because it has absolute advantage in both goods. A second analyst argues that the geopolitical dispute affects only short-term market volatility and cannot influence potential growth unless existing factories are destroyed. The portfolio team must assess both claims using opportunity-cost analysis and the effects of persistent uncertainty on capital accumulation.