Chapter 03 Political Economy and Economic Development Answer Key

True / False Questions

1. GNI per capita can be adjusted by purchasing power to account for differences in the cost of
living.

TRUE
To account for differences in the cost of living, one can adjust GNI per capita by purchasing power.
Referred to as a purchasing power parity (PPP) adjustment, it allows for a more direct comparison
of living standards in different countries.

2. The base for the purchasing power parity adjustment of the GNI is the cost of living in the United
States.

TRUE
Referred to as a purchasing power parity (PPP) adjustment, it allows for a more direct comparison
of living standards in different countries. The base for the adjustment is the cost of living in the
United States.

3. GNI and PPP data are useful because they provide a dynamic analysis of economic development.

FALSE
The GNI and PPP data give a static picture of development. They tell us, for example, that China is
much poorer than the United States, but they do not tell us if China is closing the gap.
4. In Sen's view, development is an economic process that should be assessed by material output
measures such as GNI per capita.

FALSE
The Nobel Prize-winning economist Amartya Sen has argued that development should be
assessed less by material output measures such as GNI per capita and more by the capabilities and
opportunities that people enjoy. In Sen's view, development is not just an economic process, but it
is a political one too.

5. Life expectancy at birth is one of the measures used by the Human Development Index (HDI) to
measure the quality of human life in different nations.

TRUE
The HDI is based on three measures: life expectancy at birth (a function of health care), educational
attainment (measured by a combination of the adult literacy rate and enrollment in primary,
secondary, and tertiary education), and whether average incomes, based on PPP estimates, are
sufficient to meet the basic needs of life in a country (adequate food, shelter, and health care).

6. Political freedoms is one of the measures used by the Human Development Index (HDI) to
measure the quality of human life in different nations.

FALSE
The HDI is based on three measures: life expectancy at birth (a function of health care), educational
attainment (measured by a combination of the adult literacy rate and enrollment in primary,
secondary, and tertiary education), and whether average incomes, based on PPP estimates, are
sufficient to meet the basic needs of life in a country (adequate food, shelter, and health care).
7. If a country's economy is to sustain long-run economic growth, the business environment must be
conducive to innovations and entrepreneurial activity.

TRUE
Innovations in production and business processes lead to an increase in the productivity of labor
and capital, which further boosts economic growth rates. Entrepreneurs first commercialize
innovative new products and processes, and entrepreneurial activity provides much of the
dynamism in an economy.

8. In a planned economy, the means of production are owned by private individuals.

FALSE
In a planned economy, the state owns all means of production. Consequently, entrepreneurial
individuals have few economic incentives to develop valuable new innovations, because it is the
state, rather than the individual, that captures most of the gains.

9. The economic freedom associated with a market economy creates greater incentives for
innovation and entrepreneurship than either a planned or a mixed economy.

TRUE
It has been argued that the economic freedom associated with a market economy creates greater
incentives for innovation and entrepreneurship than either a planned or a mixed economy.

10. Privatization refers to the process of hiring private management consultancy firms to manage
state-owned enterprises.

FALSE
Privatization refers to the process of selling state-owned enterprises to private investors.
11. The state can expropriate the profits from innovation through legal means.

TRUE
The state can expropriate the profits from innovation through legal means, such as excessive
taxation, or through illegal means, such as demands from state bureaucrats for kickbacks in return
for granting an individual or firm a license to do business in a certain area (i.e., corruption).

12. Peruvian development economist Hernando de Soto has argued that the chronic inability of
property owners to establish legal title to the property they own is a key problem for innovation,
and entrepreneurial activity in developing nations.

TRUE
The influential Peruvian development economist Hernando de Soto has argued that much of the
developing world will fail to reap the benefits of capitalism until property rights are better defined
and protected. His arguments are interesting because he says the key problem is not the risk of
expropriation but the chronic inability of property owners to establish legal title to the property
they own.

13. Some totalitarian regimes have fostered a market economy and strong property rights protection
and have experienced rapid economic growth.

TRUE
Some totalitarian regimes have fostered a market economy and strong property rights protection
and have experienced rapid economic growth.

14. Totalitarian states promote human freedom and human development, which facilitates economic
progress.

FALSE
Totalitarian states, by limiting human freedom, also suppress human development and therefore
are detrimental to progress.
15. Democracy is one of the consequences of economic growth and progress.

TRUE
Several of the fastest-growing Asian economies adopted more democratic governments during
the past three decades, including South Korea and Taiwan. Thus, although democracy may not
always be the cause of initial economic progress, it seems to be one consequence of that progress.

16. Anecdotal comparisons suggest that the assertion that nations that invest more in education will
have higher growth rates is true.

TRUE
Education emerges as another important determinant of economic development. The general
assertion is that nations that invest more in education will have higher growth rates because an
educated population is a more productive population.

17. Since the late 1980s, there has been a strong move away from a more free market economic
model and toward a more centrally planned and mixed economies.

FALSE
The political economy of many of the world's nation-states has changed radically since the late
1980s. There has been a strong move away from centrally planned and mixed economies and
toward a more free market economic model.

18. Many totalitarian regimes were able to deliver economic progress to the vast bulk of their
populations, which curbed the spread of democracy during the late 1980s.

FALSE
One of the causes for the spread of democracy is that many totalitarian regimes failed to deliver
economic progress to the vast bulk of their populations.
19. New information and communication technologies have enabled the spread of democratic ideals.

TRUE
New information and communication technologies have created new conduits for the spread of
democratic ideals and information from free societies. Today, the Internet is allowing democratic
ideals to penetrate closed societies as never before.

20. One of the reasons for the spread of democracy is the emergence of increasingly prosperous
middle and working classes who have pushed for democratic reforms.

TRUE
In many countries the economic advances of the past quarter century have led to the emergence
of increasingly prosperous middle and working classes who have pushed for democratic reforms.

21. Political scientist Samuel Huntington predicts that there will be a more harmonious world
dominated by a universal civilization characterized by democratic regimes and free market
capitalism.

FALSE
Huntington sees a world that is split into different civilizations, each of which has its own value
systems and ideology.

22. According to political scientist Samuel Huntington's thesis, global terrorism is a product of the
tension between civilizations and the clash of value systems and ideology.

TRUE
In Huntington's thesis, global terrorism is a product of the tension between civilizations and the
clash of value systems and ideology.
23. Transformation from centrally planned command economies to market-based economies can be
attributed to the fact that command and mixed economies failed to deliver the sustained
economic performance achieved by countries adopting market-based systems.

TRUE
Command and mixed economies failed to deliver the kind of sustained economic performance
that was achieved by countries adopting market-based systems, such as the United States,
Switzerland, Hong Kong, and Taiwan. As a consequence, even more states have gravitated toward
the market-based model.

24. Economic freedom necessarily equates with political freedom.

FALSE
Economic freedom does not necessarily equate with political freedom.

25. In a command economy, the prices are determined by the free interplay of demand and supply.

FALSE
Before the collapse of communism, the governments in most command economies exercised tight
control over prices and output, setting both through detailed state planning.

26. Deregulation involves prohibiting private enterprises from operating in most sectors of the
economy.

FALSE
Deregulation involves removing legal restrictions to the free play of markets, the establishment of
private enterprises, and the manner in which private enterprises operate.
27. In mixed economies, in certain sectors the state set prices, owned businesses, limited private
enterprise, restricted investment by foreigners, and restricted international trade.

TRUE
In mixed economies, the role of the state was more limited; but here too, in certain sectors the
state set prices, owned businesses, limited private enterprise, restricted investment by foreigners,
and restricted international trade.

28. Privatization reduces the incentive of business owners to increase productivity, enter new markets,
and to exit losing ones.

FALSE
Privatization is seen as a way to stimulate gains in economic efficiency by giving new private
owners a powerful incentive—the reward of greater profits—to search for increases in productivity,
to enter new markets, and to exit losing ones.

29. Studies of privatization in central Europe have shown that the process often fails to deliver
predicted benefits if the newly privatized firms continue to receive subsidies from the state and if
they are protected from foreign competition.

TRUE
Studies of privatization in central Europe have shown that the process often fails to deliver
predicted benefits if the newly privatized firms continue to receive subsidies from the state and if
they are protected from foreign competition by barriers to international trade and foreign direct
investment.

30. For privatization to work, it must also be accompanied by a more general deregulation and
opening of the economy.

TRUE
For privatization to work, it must also be accompanied by a more general deregulation and
opening of the economy.
31. The government of a country takes over the airport security industries following a major terrorist
attack, to improve airport security. This is an example of privatization.

FALSE
Privatization transfers the ownership of state property into the hands of private individuals,
frequently by the sale of state assets through an auction.

32. A well-functioning market economy requires laws protecting private property rights and providing
mechanisms for contract enforcement.

TRUE
Without a legal system that protects property rights, and without the machinery to enforce that
system, the incentive to engage in economic activity can be reduced substantially by private and
public entities, including organized crime, that expropriate the profits generated by the efforts of
private-sector entrepreneurs.

33. When communism collapsed, many of the communist countries lacked the legal structure required
to protect property rights because all the property was earlier held by the state.

TRUE
When communism collapsed, many of these countries lacked the legal structure required to
protect property rights, all property having been held by the state. Although many nations have
made big strides toward instituting the required system, it will be many more years before the
legal system is functioning as smoothly as it does in the West.

34. A market with a large number of consumers, with low living standards will have a relatively large
market when measured in economic terms.

FALSE
While some markets are very large when measured by number of consumers (e.g., China and
India), low living standards may imply limited purchasing power and therefore a relatively small
market when measured in economic terms.
35. The long-run monetary benefits of doing business in a country are a function of the size of the
market, the present wealth of consumers in that market, and the likely future wealth of consumers.

TRUE
The long-run monetary benefits of doing business in a country are a function of the size of the
market, the present wealth (purchasing power) of consumers in that market, and the likely future
wealth of consumers.

36. By identifying and investing early in a potential future economic star, international firms can build
brand loyalty and gain experience in that country's business practices.

TRUE
By identifying and investing early in a potential future economic star, international firms may build
brand loyalty and gain experience in that country's business practices.

37. First-mover advantages are the advantages that accrue to early entrants into a market.

TRUE
First-mover advantages are the advantages that accrue to early entrants into a market.

38. A country's economic system and property rights regime are reasonably good predictors of
economic prospects.

TRUE
A country's economic system and property rights regime are reasonably good predictors of
economic prospects. Countries with free market economies in which property rights are protected
tend to achieve greater economic growth rates than command economies or economies where
property rights are poorly protected.
39. Countries with free market economies in which property rights are protected tend to achieve lower
economic growth rates than command economies where property rights are poorly protected.

FALSE
A country's economic system and property rights regime are reasonably good predictors of
economic prospects. Countries with free market economies in which property rights are protected
tend to achieve greater economic growth rates than command economies or economies where
property rights are poorly protected.

40. It may be more costly to do business in relatively primitive or undeveloped economies because of
the lack of infrastructure and supporting businesses.

TRUE
It may be more costly to do business in relatively primitive or undeveloped economies because of
the lack of infrastructure and supporting businesses. At the extreme, an international firm may
have to provide its own infrastructure and supporting business, which obviously raises costs.

41. Economic risks are independent of political risk.

FALSE
Economic risks are not independent of political risk. Economic mismanagement may give rise to
significant social unrest and hence political risk.

42. One visible indicator of political risks tends to be a country's inflation rate.

FALSE
One visible indicator of economic mismanagement tends to be a country's inflation rate. Another
is the level of business and government debt in the country.
43. The overall attractiveness of a country as a potential market or investment site for an international
business depends on balancing the benefits, costs, and risks associated with doing business in that
country.

TRUE
The overall attractiveness of a country as a potential market or investment site for an international
business depends on balancing the benefits, costs, and risks associated with doing business in that
country.

Multiple Choice Questions

44. GNI per person figures can be misleading because _____.

A. they also include barter agreements

B. they provide a dynamic picture of development
C. they don't consider differences in the cost of living
D. they don't consider exchange rate
One common measure of economic development is a country's gross national income (GNI) per
head of population. GNI per person figures can be misleading because they don't consider
differences in the cost of living.

45. Which of the following helps in adjusting GNI such that it accounts for the differences in the cost of
living?

A. Purchasing power parity (PPP) adjustment

B. Human Development Index
C. Debt to GNI ratio
D. Consumer Price Index
To account for differences in the cost of living, one can adjust GNI per capita by purchasing power.
Referred to as a purchasing power parity (PPP) adjustment, it allows for a more direct comparison
of living standards in different countries.
46. In some countries, the official GNI per capita measured at PPP data does not reflect the actual the
total annual income because:

A. it doesn't consider differences in the cost of living.

B. it gives a static picture of development.
C. it fails to include income earned from other countries in the form of dividends.
D. large amounts of economic activity may be in the form of barter agreements.
In some countries the "official" figures do not tell the entire story because large amounts of
economic activity may be in the form of unrecorded cash transactions, or barter agreements.
Estimates suggest that in India it may be around 50 percent of GDP, which implies that the Indian
economy is half as big again as the officially reported figures.

47. Which of the following is a measure that is developed by the United Nations to measure the
quality of life in different nations?

A. Gross national income

B. Human Development Index
C. Purchasing power parity
D. Gross domestic product
Sen's influential thesis has been picked up by the United Nations, which has developed the Human
Development Index (HDI) to measure the quality of human life in different nations.

48. The HDI is based on all of the following measures EXCEPT:

A. life expectancy at birth.

B. political freedom.
C. educational attainment.
D. whether average incomes are sufficient to meet the basic needs of life.
The HDI comes much closer to Amartya Sen's conception of how development should be
measured than narrow economic measures such as GNI per capita—although Sen's thesis
suggests that political freedoms should also be included in the index, and they are not.
49. _____, a Nobel Prize-winning economist, has argued that development is not just an economic
process, but it is a political one as well.

A. Hernando de Soto
B. Karl Marx
C. Samuel Huntington
D. Amartya Sen
The Nobel Prize-winning economist Amartya Sen has argued that development is not just an
economic process, but it is a political one too, and to succeed requires the "democratization" of
political communities to give citizens a voice in the important decisions made for the community.

50. According to Amartya Sen, development should be:

A. seen as a process of expanding the real freedoms that people experience.

B. seen as a non-political concept that focuses on the net income of a country.
C. should be viewed as a purely economic process.
D. assessed by material output measures such as GNI per capita.
The Nobel Prize-winning economist Amartya Sen has argued that development should be
assessed less by material output measures such as GNI per capita and more by the capabilities and
opportunities that people enjoy. According to Sen, development should be seen as a process of
expanding the real freedoms that people experience.
51. Which of the following statement pertaining to innovation and entrepreneurship is NOT true?

A. They are the engines of growth.

B. They require strong property rights.
C. They require state ownership of means of production.
D. They require a market economy.
The lack of economic freedom and incentives for innovation occurred in many mixed economies in
those sectors where the state had a monopoly. This stagnation provided the impetus for the
widespread privatization of state-owned enterprises that was witnessed in many mixed economies
during the mid-1980s and is still going on today.

52. A market economy encourages innovation because _____.

A. state ownership of enterprises reduces risks of innovation

B. economic freedom leads to greater incentives for innovation
C. government-owned and funded research centers become hubs of innovation
D. the prices of goods and services, including new products, are fixed by government
The economic freedom associated with a market economy creates greater incentives for
innovation and entrepreneurship than either a planned or a mixed economy. In a market economy,
any individual who has an innovative idea is free to try to make money out of that idea by starting
a business (by engaging in entrepreneurial activity).
53. Stagnation can occur in planned economies because:

A. entrepreneurial individuals have few economic incentives for innovation.

B. private ownership of means of production leads to exploitation of workers.
C. prices of goods and services are fixed by market forces of demand and supply.
D. lack of barriers to trade results in increased competition for domestic producers.
The lack of economic freedom and incentives for innovation was probably a main factor in the
economic stagnation of many former communist states and led ultimately to their collapse at the
end of the 1980s. Similar stagnation occurred in many mixed economies in those sectors where the
state had a monopoly (such as coal mining and telecommunications in Great Britain).

54. _____ is required for a business environment to be conducive to innovation and entrepreneurial
activity.

A. State ownership of means of production

B. Strong legal protection of property rights
C. Barriers to foreign trade and investment
D. Government regulation of the market
Strong legal protection of property rights is another requirement for a business environment to be
conducive to innovation, entrepreneurial activity, and hence economic growth.

55. The state can expropriate the profits from innovation through legal means, such as _____.

A. bureaucratic kickbacks
B. excessive taxation
C. black market transactions
D. privatization
The state can expropriate the profits from innovation through legal means, such as excessive
taxation, or through illegal means, such as demands from state bureaucrats for kickbacks in return
for granting an individual or firm a license to do business in a certain area (i.e., corruption).
56. The influential Peruvian development economist Hernando de Soto has argued that much of the
developing world will fail to reap the benefits of capitalism until _____.

A. they have political stability

B. they invest in infrastructural development
C. they have better defined and secure property rights
D. they have adequate market regulation
The influential Peruvian development economist Hernando de Soto has argued that much of the
developing world will fail to reap the benefits of capitalism until property rights are better defined
and protected.

57. According to Hernando de Soto, which of the following factors is essential for the developing
world to be able to reap the benefits of innovation and entrepreneurship?

A. Detailed state planning

B. Restricting direct investment by foreign enterprises
C. Strong property rights
D. Market regulation
The influential Peruvian development economist Hernando de Soto has argued that much of the
developing world will fail to reap the benefits of capitalism until property rights are better defined
and protected.
58. A free market economy in which property rights are protected leads to subsequent economic
growth, which often leads to the establishment of:

A. a democratic regime.
B. a planned economy.
C. government owned enterprises.
D. a socialist economy.
While it is possible to argue that democracy is not a necessary precondition for a free market
economy in which property rights are protected, subsequent economic growth often leads to
establishment of a democratic regime.

59. The political economy of many of the world's nation-states has changed radically since the late
1980s. All of the following are trends that have been evident EXCEPT:

A. a wave of democratic revolutions has swept the world.

B. totalitarian governments collapsed and have been replaced by democratically elected
governments.
C. there has been a strong move away from centrally planned economies toward free market
economic models.
D. mixed economies are fast replacing market economies.
There has been a strong move away from centrally planned and mixed economies and toward a
more free market economic model.
60. Since the late 1980s, there has been a spread of democracy. This is because _____.

A. a state's ability to control access to uncensored information has increased

B. the socialist model failed to deliver economic progress to the vast bulk of their populations
C. in many countries the middle and working classes have become less powerful
D. in many countries state-ownership of firms has encouraged innovation and entrepreneurship
Many totalitarian regimes failed to deliver economic progress to the vast bulk of their populations.
In looking for alternatives to the socialist model, the populations of these countries could not have
failed to notice that most of the world's strongest economies were governed by representative
democracies.

61. In many countries entrepreneurs and other business leaders, eager to protect their property rights
and ensure the dispassionate enforcement of contracts, had pushed for _____. This contributed to a
wave of democratic revolutions during the late 1980s and early 1990s.

A. state ownership of productive resources

B. regulated markets
C. democratic reforms
D. planned economies
In many countries the economic advances of the past quarter century have led to the emergence
of increasingly prosperous middle and working classes who have pushed for democratic reforms.
Entrepreneurs and other business leaders, eager to protect their property rights and ensure the
dispassionate enforcement of contracts, are another force pressing for more accountable and
open government.
62. Political scientist Samuel Huntington argues that modernization in non-Western societies can result
in a retreat toward the traditional. This is exemplified by _____.

A. the Islamic resurgence

B. the popularization of modern gadgets
C. the adoption of Western culture
D. the higher levels of literacy and education
Huntington maintains that while many societies may be modernizing—they are adopting the
material paraphernalia of the modern world, from automobiles to Coca-Cola and MTV—they are
not becoming more Western. On the contrary, Huntington theorizes that modernization in non-
Western societies can result in a retreat toward the traditional, such as the resurgence of Islam in
many traditionally Muslim societies.

63. According to political scientist Samuel Huntington, the rise of Islamic fundamentalism is a response
to _____.

A. the corruption prevalent in planned economies

B. the restricted access to formal education
C. the alienation produced by modernization
D. the restrictions associated with totalitarian regimes
Huntington theorizes that modernization in non-Western societies can result in a retreat toward
the traditional, such as the resurgence of Islam in many traditionally Muslim societies. The rise of
Islamic fundamentalism is portrayed as a response to the alienation produced by modernization.
64. Which of the following statements is true about Samuel Huntington?

A. Samuel Huntington argues that there is a universal civilization based on widespread acceptance
of Western democratic ideals.
B. Samuel Huntington argues that the rise of Islamic fundamentalism is a response to the
alienation produced by modernization.
C. Samuel Huntington argues that global terrorism is a product of the static nature of traditional
values and religious systems.
D. Samuel Huntington argues that many societies, by adopting the material paraphernalia of the
modern world, are becoming more Western.
Huntington theorizes that modernization in non-Western societies can result in a retreat toward
the traditional, such as the resurgence of Islam in many traditionally Muslim societies.

65. Paralleling the spread of democracy, since the 1980s there has been the transformation from:

A. free-market economies to socialist economies.

B. mixed economies to collectivist economies.
C. open economies to closed economies.
D. command economies to market-based economies.
Paralleling the spread of democracy since the 1980s has been the transformation from centrally
planned command economies to market-based economies. More than 30 countries that were in
the former Soviet Union or the Eastern European Communist bloc have changed their economic
systems.
66. Many states in Asia, Latin America, and Western Europe have shifted away from a mixed economy
to a market-based economy. Which of the following measures is most likely to be promoted by
such states?

A. State-ownership of enterprises
B. Fixing of prices by the government
C. Deregulation of the economy
D. Lowering competition
Many states in Asia, Latin America, and Western Europe have sold state-owned businesses to
private investors (privatization) and deregulated their economies to promote greater competition.

67. Which of the following is a step in the shift toward a market-based economic system?

A. Increasing trade barriers

B. Increasing price controls
C. Nationalization
D. Creation of a legal system to safeguard property rights
The shift toward a market-based economic system often entails a number of steps: deregulation,
privatization, and creation of a legal system to safeguard property rights.

68. _____ involves removing legal restrictions to the free play of markets, the establishment of private
enterprises, and the manner in which private enterprises operate.

A. Deregulation
B. Trade certification
C. A product law
D. A liability law
Deregulation involves removing legal restrictions to the free play of markets, the establishment of
private enterprises, and the manner in which private enterprises operate.
69. Which of the following is an example of deregulation?

A. A country that implements a simplified income tax filing system

B. A country that takes over a leading private bank to prevent it from filing for bankruptcy
C. A country that provides agricultural subsidies to farmers
D. A country that encourages foreign direct investment
Deregulation involves removing legal restrictions to the free play of markets, the establishment of
private enterprises, and the manner in which private enterprises operate.

70. Which of the following is a characteristic of a command economy?

A. Promotion of foreign direct investment

B. Allowing prices to be set by the interplay between demand and supply
C. Limited international trade
D. Restricted state-ownership of means of production
The governments in most command economies exercised tight control over prices and output.
They also prohibited private enterprises from operating in most sectors of the economy, severely
restricted direct investment by foreign enterprises, and limited international trade.

71. The finance minister of a country considers several large, state-owned iron manufacturing units to
be inefficient and a source of corruption. To generate resources for public expenditure and
promote economic growth, the government decides to auction an entire iron manufacturing plant
to sell it to a strategic investor. This process exemplifies _____.

A. nationalization
B. industrialization
C. liberalization
D. privatization
Privatization transfers the ownership of state property into the hands of private individuals,
frequently by the sale of state assets through an auction.
72. Studies of privatization in central Europe have shown that the process often fails to deliver
predicted benefits if the newly privatized firms:

A. stop receiving subsidies from the government.

B. are completely owned by private individuals.
C. are sheltered from foreign competition.
D. are allowed to restructure their operations.
For privatization to work, it must also be accompanied by a more general deregulation and
opening of the economy.

73. The sale of state assets through an auction is most likely to lead to _____.

A. trade certification
B. privatization
C. nationalization
D. market regulation
Privatization transfers the ownership of state property into the hands of private individuals,
frequently by the sale of state assets through an auction.

74. For privatization to work, it must also be accompanied by:

A. an increase in trade barriers and tariffs.

B. an increase in government subsidies.
C. stronger barriers to foreign competition.
D. a general deregulation of the economy.
For privatization to work, it must also be accompanied by a more general deregulation and
opening of the economy.
75. Which of the following factors is NOT likely to make a country a more attractive location for
international business?

A. Democratic regimes
B. Planned economies
C. Strong protection of property rights
D. Market-based economic policies
Countries with democratic regimes, market-based economic policies, and strong protection of
property rights are more likely to attain high and sustained economic growth rates, and are thus a
more attractive location for international business.

76. The benefits of doing business in a country are a function of all of the following EXCEPT:

A. the size of the market.

B. its present wealth.
C. its past growth.
D. its future growth prospects.
In the most general sense, the long-run monetary benefits of doing business in a country are a
function of the size of the market, the present wealth of consumers in that market, and the likely
future wealth of consumers.

77. Sony was a pioneer in the portable music market segment. Sony's Walkman was an innovative
product which created a new category altogether and made Sony a technological leader. This gave
the company an edge over other consumer electronics brands that introduced portable music
players for a very long time. In this example, Sony had the:

A. vertical integration advantage.

B. purchasing power parity advantage.
C. free-rider advantage.
D. first-mover advantage.
First-mover advantages are the advantages that accrue to early entrants into a market.
78. Google launched Google Plus to gain a foothold in the social media market. However, given that
there are numerous social networking platforms and Facebook is already a leader in social media,
Google Plus found it challenging to generate brand loyalty and establish itself in the market. This
was because of _____.

A. incumbent disadvantage.
B. disintermediation disadvantage.
C. late-mover disadvantage.
D. horizontal integration disadvantage.
Late-mover disadvantages are the handicaps that late entrants might suffer.

79. In all of the following scenarios, the costs of doing business in a country tend to be greater,
EXCEPT where:

A. political payoffs are required to gain market access.

B. supporting infrastructure is lacking.
C. local laws set strict standards with regard to environmental pollution.
D. there is limits or caps on damage awards.
The costs of doing business in a country tend to be greater where political payoffs are required to
gain market access, where supporting infrastructure is lacking or underdeveloped, and where
adhering to local laws and regulations is costly. It can also be more costly to do business in a
country like the United States, where the absence of a cap on damage awards has meant spiraling
liability insurance rates.
80. The likelihood that a trading partner will opportunistically break a contract or expropriate property
rights is called a(n) _____.

A. economic risk
B. legal risk
C. cultural risk
D. political risk
A legal risk can be defined as the likelihood that a trading partner will opportunistically break a
contract or expropriate property rights.

Essay Questions

81. What is gross national income? Is it related to purchasing power parity?

A common measure of economic development is a country's gross national income (GNI) per head
of population. GNI is regarded as a yardstick for the economic activity of a country; it measures the
total annual income received by residents of a nation. GNI per person figures can be misleading
because they don't consider differences in the cost of living. To account for differences in the cost
of living, one can adjust GNI per capita by purchasing power. Referred to as a purchasing power
parity (PPP) adjustment, it allows for a more direct comparison of living standards in different
countries.

82. What is the philosophy of Amartya Sen?

Amartya Sen is a Nobel Prize-winning economist who has argued that economic development
should be assessed less by material output measures such as GNI per capita and more by the
capabilities and opportunities that people enjoy. According to Sen, development should be seen
as a process of expanding the real freedoms that people experience.
83. What are the conditions required to encourage innovation and entrepreneurship?

It has been argued that the economic freedom associated with a market economy creates greater
incentives for innovation and entrepreneurship than either a planned or a mixed economy.
In a market economy, any individual who has an innovative idea is free to try to make money out
of that idea by starting a business (by engaging in entrepreneurial activity). Similarly, existing
businesses are free to improve their operations through innovation. To the extent that they are
successful, both individual entrepreneurs and established businesses can reap rewards in the form
of high profits. Thus, market economies contain enormous incentives to develop innovations.

84. Why are democratic regimes more conducive to economic growth than dictatorships?

Some totalitarian regimes have fostered a market economy and strong property rights protection
and have experienced rapid economic growth. However, there is no guarantee that a dictatorship
will continue to pursue such progressive policies. Dictators are rarely benevolent. Many are
tempted to use the apparatus of the state to further their own private ends, violating property
rights and stalling economic growth. Totalitarian states, by limiting human freedom, also suppress
human development and therefore are detrimental to progress. Given this, it seems likely that
democratic regimes are far more conducive to long-term economic growth than are dictatorships,
even benevolent ones.

85. Explain how geography of a nation influences its economic development.

The influential Harvard University economist Jeffrey Sachs argues that by virtue of favorable
geography, certain societies are more likely to engage in trade than others and are thus more
likely to be open to and develop market-based economic systems, which in turn promotes faster
economic growth. He also argues that, irrespective of the economic and political institutions a
country adopts, adverse geographical conditions, such as the high rate of disease, poor soils, and
hostile climate that afflict many tropical countries, can have a negative impact on development.
86. Why does education lead to economic development?

Nations that invest more in education will have higher growth rates because an educated
population is a more productive population. A survey of 14 statistical studies that looked at the
relationship between a country's investment in education and its subsequent growth rates
concluded investment in education did have a positive and statistically significant impact on a
country's rate of economic growth.

87. Discuss the three main reasons for the spread of democracy.

There are three main reasons for the spread of democracy. First, many totalitarian regimes failed to
deliver economic progress to the vast bulk of their populations. Second, new information and
communication technologies have broken down the ability of the state to control access to
uncensored information. Third, in many countries the economic advances of the past quarter-
century have led to the emergence of increasingly prosperous middle and working classes who
have pushed for democratic reforms.

88. Discuss Samuel Huntington's views on Islamic fundamentalism.

According to Samuel Huntington's thesis, global terrorism is a product of the tension between
civilizations and the clash of value systems and ideology. He maintains that while many societies
may be modernizing, they are not becoming more Western. Huntington theorizes that
modernization in non-Western societies can result in a retreat toward the traditional, such as the
resurgence of Islam in many traditionally Muslim societies. According to him, the rise of Islamic
fundamentalism is a response to the alienation produced by modernization.
89. Since the 1980s, there has been a transformation from centrally planned command economies to
market-based economies. What is the rationale for this transformation?

The rationale for economic transformation has been the same the world over. In general,
command and mixed economies failed to deliver the kind of sustained economic performance that
was achieved by countries adopting market-based systems, such as the United States, Switzerland,
Hong Kong, and Taiwan. As a consequence, even more states have gravitated toward the market-
based model.

90. What is deregulation? What are the steps involved in the deregulation of a command economy?

Deregulation involves removing legal restrictions to the free play of markets, the establishment of
private enterprises, and the manner in which private enterprises operate. Deregulation in
command economies involved removing price controls, thereby allowing prices to be set by the
interplay between demand and supply; abolishing laws regulating the establishment and operation
of private enterprises; and relaxing or removing restrictions on direct investment by foreign
enterprises and international trade.

91. Is privatization by itself enough to guarantee economic growth? Why? Explain using an example.

As privatization has proceeded around the world, it has become clear that simply selling state-
owned assets to private investors is not enough to guarantee economic growth. If the newly
privatized firms continue to receive subsidies from the state and if they are protected from foreign
competition by barriers to international trade and foreign direct investment, they will have little
incentive to restructure their operations to become more efficient. For privatization to work, it must
also be accompanied by a more general deregulation and opening of the economy. For example,
when Brazil decided to privatize the state-owned telephone monopoly, Telebras Brazil, the
government also split the company into four independent units that were to compete with each
other and removed barriers to foreign direct investment in telecommunications services. This
action ensured that the newly privatized entities would face significant competition and thus would
have to improve their operating efficiency to survive.
92. How does the ownership structure of newly privatized firms affect its functioning?

Many former command economies lack the legal regulations regarding corporate governance that
are found in advanced Western economies. In such cases, managers with a small ownership stake
can often gain control over the newly privatized entity and run it for their own benefit, while
ignoring the interests of other shareholders.

93. Explain why a well-functioning market economy requires strong legal systems?

A well-functioning market economy requires laws protecting private property rights and providing
mechanisms for contract enforcement. Without a legal system that protects property rights, and
without the machinery to enforce that system, the incentive to engage in economic activity can be
reduced substantially. Private and public entities, including organized crime, can expropriate the
profits generated by the efforts of private-sector entrepreneurs.

94. What are the factors that determine the long-run monetary benefits of doing business in a
country?

The long-run monetary benefits of doing business in a country are a function of the size of the
market, the present wealth (purchasing power) of consumers in that market, and the likely future
wealth of consumers. While some markets are very large when measured by number of consumers
(e.g., China and India), low living standards may imply limited purchasing power and therefore a
relatively small market when measured in economic terms.
95. What are first-mover advantages? Explain with an example.

First-mover advantages are the advantages that accrue to early entrants into a market. By
identifying and investing early in a country with high potential for future growth, international firms
may build brand loyalty and gain experience in that country's business practices. These will pay
back substantial dividends if that country achieves sustained high economic growth rates. For
example, eBay was the first company to take the auction process online. Coca-Cola was the first
cola producer, and began selling its product to the public in 1886; this has given it considerable
advantage over competitors.

96. What are late-mover disadvantages?

Late-mover disadvantages are the handicaps that late entrants might suffer. Late entrants may find
that they lack the brand loyalty and experience necessary to achieve a significant presence in the
market.

97. What are the factors that determine the costs of doing business in a country?

A number of political, economic, and legal factors determine the costs of doing business in a
country. With regard to political factors, a company may have to pay off politically powerful
entities in a country before the government allows it to do business there. With regard to
economic factors, one of the most important variables is the sophistication of a country's
economy. As for legal factors, it can be more costly to do business in a country where local laws
and regulations set strict standards with regard to product safety, safety in the workplace,
environmental pollution, and the like (since adhering to such regulations is costly).
98. Why does doing business in a country with a relatively unsophisticated economy result in
increased costs?

One of the most important economic variables is the sophistication of a country's economy. It may
be more costly to do business in relatively primitive or undeveloped economies because of the
lack of infrastructure and supporting businesses. At the extreme, an international firm may have to
provide its own infrastructure and supporting business, which obviously raises costs. When
McDonald's decided to open its first restaurant in Moscow, it found that to serve food and drink
indistinguishable from that served in McDonald's restaurants elsewhere, it had to vertically
integrate backward to supply its own needs.

99. Describe how overinvestment led to the 1997-98 financial crises in Southeast Asia.

In Asian states such as Indonesia, Thailand, and South Korea, businesses increased their debt
rapidly during the 1990s, often at the behest of the government. The result was overinvestment.
Many of these investments turned out to be uneconomic. The borrowers failed to generate the
profits necessary to service their debt payment obligations. In turn, the banks that had lent money
to these businesses suddenly found that they had rapid increases in nonperforming loans on their
books. Foreign investors, believing that many local companies and banks might go bankrupt,
pulled their money out of these countries, selling local stock, bonds, and currency. This action
precipitated the 1997-98 financial crises in Southeast Asia.

100. What are the factors that contribute to the risks of doing business in a country?

The risks of doing business in a country are determined by a number of political, economic, and
legal factors. Political risk has been defined as the likelihood that political forces will cause drastic
changes in a country's business environment that adversely affect the profit and other goals of a
business enterprise. An economic risk can be defined as the likelihood that economic
mismanagement will cause drastic changes in a country's business environment that hurt the profit
and other goals of a particular business enterprise. A legal risk can be defined as the likelihood
that a trading partner will opportunistically break a contract or expropriate property rights.