Deck 17: Output and the Exchange Rate in the Short Run

Question 1

A country's domestic currency's real exchange rate, q, is defined as

A) E.
B) E times P.
C) E times P .
D) (E times P )/P.
E) P/(E times P ).

Answer 1

(E times P )/P.

Question 2

Current account is given by the equation:

A) CA = IM - EX (measured in terms of domestic output).
B) CA = IM - EX (measured in terms of foreign output).
C) CA = EX - IM (measured in terms of domestic output).
D) CA = EX - IM (measured in terms of foreign output).
E) CA = EX + IM (measured in terms of domestic output).

Answer 2

CA = EX - IM (measured in terms of domestic output).

Question 3

Which of the following would cause the current account to decrease?

A) an increase in the nominal exchange rate, E
B) an appreciation of the home currency
C) an increase in disposable income
D) an increase in foreign prices, P
E) a decrease in domestic prices, P

Answer 3

an increase in disposable income

Question 4

Which one of the following statements is the MOST accurate?

A) An increase in the real exchange rate and an increase in disposable income improve the current account.
B) A decrease in the real exchange rate and a decrease in disposable income improve the current account.
C) A decrease in the real exchange rate and an increase in disposable income improve the current account.
D) An increase in the real exchange rate and a decrease in disposable income improve the current account.
E) An increase in the real exchange rate and a decrease in disposable income lowers the current account.

Question 5

The real exchange rate, q, is defined as

A) the price of the foreign basket in terms of the domestic one.
B) the price of the domestic basket in terms of the foreign one.
C) the price of the foreign basket.
D) the price of the domestic basket.
E) the nominal exchange rate in terms of the domestic basket.

Question 6

Which of the following compete to determine whether the current account improves or worsens following a rise in the real exchange rate?

A) appreciation and depreciation
B) crowding out effect and producers effect
C) volume effect and value effect
D) volume effect and inflation
E) producers effect and value effect

Question 7

The domestic currency price of a representative domestic expenditure basket is

A) P, the domestic price level.
B) E, the nominal exchange rate.
C) P times E, the domestic price level times the domestic price level.
D) P , the foreign price level.
E) P times E, the foreign price level times the nominal exchange rate.

Question 8

Which one of the following statements is MOST accurate?

A) In general, consumption demand rises by less than disposable income.
B) In general, consumption demand rises by more than disposable income.
C) In general, consumption demand rises by more than income.
D) In general, consumption demand rises by the same amount as disposable income rises.
E) In general, consumption demand rises are unrelated to disposable income rises.

Question 9

If the representative basket of European goods and services costs 40 euros, the representative U.S. basket costs $50, and the dollar/euro exchange rate is $0.90 per euro, then the price of the European basket in terms of U.S. basket is

A) [(0.9 $/euro) (40 euro per a European basket)]/[(50 $/U.S. basket)].
B) [(0.9 $/euro) (50 $/U.S. basket)]/[(40 euro per a European basket)].
C) [(40 euro per a European basket)]/[(50 $/U.S. basket) (0.9 $/euro)].
D) [(50 $/U.S. basket)].
E) [(0.9 $/euro) (40 euro per a European basket) (50 $ U.S. basket)].

Question 10

An increase in the real exchange rate

A) makes imports more expensive.
B) makes imports less expensive.
C) does not affect import values.
D) always makes the number of imports rise.
E) makes domestic consumers spend more on only foreign imports.

Question 11

Which one of the following statements is the MOST accurate?

A) An increase in disposable income improves the current account.
B) An increase in disposable income does not affect the current account.
C) An increase in disposable income worsens the current account.
D) An increase in income worsens the current account.
E) An increase in income improves the current account.

Question 12

The current account balance is

A) the supply of a country's exports less the country's own demand for imports.
B) the demand for a country's exports plus the country's own demand for imports.
C) the country's own demand for imports less the demand for a country's exports.
D) the demand for a country's exports less the country's own demand for imports.
E) the country's federal reserves minus the national debt.

Question 13

The domestic currency price of a representative foreign expenditure basket is

A) P, the domestic price level.
B) E, the nominal exchange rate.
C) P times E, the domestic price level times the domestic price level.
D) P , the foreign price level.
E) P times E, the foreign price level times the nominal exchange rate.

Question 14

When the real exchange rate rises

A) imports measured in terms of domestic output will rise.
B) imports measured in terms of domestic output will fall.
C) imports measured in terms of domestic output will never be affected.
D) imports measured in terms of domestic output may rise or fall.
E) imports measured in terms of foreign output will rise.

Question 15

Assuming that the value effect dominates, the current account will increase if

A) the real exchange rate decreases.
B) the real exchange rate increases.
C) disposable income increases.
D) exports fall.
E) domestic prices fall.

Question 16

When EP /P rises

A) IM will rise.
B) IM will fall.
C) IM may rise or fall.
D) IM is not affected.
E) IM and P* will both rise.

Question 17

How does an increase in the real exchange rate affect exports and imports?

A) exports increase; imports decrease
B) exports decrease; imports increase
C) exports increase; imports change ambiguously
D) exports change ambiguously; imports decrease
E) exports increase; imports are constant

Question 18

The real exchange rate is:

A) how much of a foreign currency you can buy with the domestic currency.
B) foreign CPI divided by the domestic CPI.
C) the price of foreign goods in terms of domestic goods.
D) the price of foreign goods in dollars.
E) the domestic currency divided by the price level.

Question 19

What is the best way to describe aggregate demand?

A) quantity required to satisfy equilibrium
B) exports decrease; imports increase
C) amount of a country's goods and services demanded by households and firms throughout the world
D) individual's demand
E) domestic demand of foreign imports.

Question 20

Disposable income is defined as

A) Y - C.
B) Y - T.
C) C - T.
D) I - C.
E) Y - I.

Question 21

Explain how does an increase in the real exchange rate affect exports and imports?

Question 22

Find the real exchange rate for the following case: Assume that the representative basket of European goods and services costs 40 euros and the representative U.S. basket costs $50, and the dollar/euro exchange rate is $0.90 per euro, then the price of the European basket in terms of U.S. basket is ________.

Question 23

What is an accurate implication resulting from an increase in income?

A) an increase in exchange rate
B) a decrease in exchange rate
C) a decrease in consumption
D) a decrease in output
E) an increase in consumption

Question 24

Find the real exchange rate for the following case: Assume that the representative basket of European goods costs 150 euros and the representative U.S. basket costs $90, and the dollar/euro exchange rate is $0.80 per euro, then the price of the European basket in terms of U.S. basket is:

Question 25

A country's domestic currency's real exchange rate, q, is best described by

A) the price of similar goods in the same market.
B) the price of the domestic basket in terms of the foreign one.
C) the price of a domestic basket.
D) the price of the foreign basket in terms of the domestic basket.
E) the price of different goods baskets in the same market.

Question 26

Why is the economy at full employment in the long run?

A) Only wages have the ability to adjust.
B) Only price can adjust.
C) Prices don't adjust.
D) Wages and the price level eventually adjust to full employment equilibrium levels.
E) Government policies eventually converge on the full employment strategy.

Question 27

What have we assumed when we conclude that a real depreciation of the currency improves the current account?

A) The volume effect outweighs the value effect.
B) The value effect outweighs the volume effect.
C) All else equal and the volume effect outweighs the value effect.
D) All else equal and the value effect outweighs the volume effect.
E) All else equal and the volume effect equals the value effect.

Question 28

Find the real exchange rate for the following case: Assume that the representative basket of European goods costs 100 euros and the representative U.S. basket costs $125, and the dollar/euro exchange rate is $0.75 per euro, then the price of the European basket in terms of U.S. basket is:

Question 29

Which one of the following statements is MOST accurate?

A) In the long run, foreign output depends only on the available domestic supplies of factors of production.
B) In the short run, domestic output depends only on the available domestic supplies of factors of production.
C) In the long run, domestic output depends only on the available domestic supplies of factors of production.
D) In the long run and in the short run, domestic output depends only on the available domestic supplies of factors of production.
E) In the long run, domestic output depends only on the real exchange rate.

Question 30

The aggregate demand for home input can be written as a function of: I. Real exchange rate.
II) Government spending.
III) Disposable income.

A) I only
B) III only
C) I and III
D) II and III
E) I, II, and III

Question 31

Please discuss the volume effect and the value effect in regards to how the current account will move given a change in the real exchange rate.

Question 32

Fill in the following table.

Question 33

Fill in the following table.

Question 34

Which one of the following statements is the MOST accurate?

A) A rise in domestic real income raises aggregate demand for home output.
B) A rise in domestic real income decreases aggregate demand for home output because of the increase demand for import.
C) A rise in domestic real income keeps aggregate demand for home output at the same level.
D) It is difficult to tell whether a rise in domestic real income affects positively or negatively aggregate demand for home output.
E) A rise in domestic real income decreases aggregate demand for home output because the CA is raised.

Question 35

How does a rise in real income affect aggregate demand?

A) Y ↑ implies Yd ↑ implies Im ↑ implies CA ↓ implies AD ↓, but Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ by more.
B) Y ↑ implies Yd ↑ implies Im ↓ implies CA ↓ implies AD ↓, but Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ by more.
C) Y ↑ implies Yd ↑ implies Im ↑ implies CA ↑ implies AD ↑, and Y ↑ implies Yd ↑ implies C ↑ implies AD ↑.
D) Y ↑ implies Yd ↑ implies Im ↑ implies CA ↓ implies AD ↓, but Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ by less.
E) Y ↑ implies Yd ↑ implies Im ↓ implies CA ↓ implies AD ↓, but Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ by less.

Question 36

Which one of the following statements is MOST accurate?

A) Factors of production can only be over-employed in the short run.
B) Factors of production can only be under-employed in the short run.
C) Factors of production can be over- or under-employed in the long run.
D) Factors of production can be over- or under-employed in the short run.
E) Factors of production are fully employed in the short run.

Question 37

What is the real exchange rate? What is its relationship to the current account?

Question 38

Explain how does a rise in real income affect aggregate demand?

Question 39

Monetary expansion causes the current account balance to increase in the short run. Discuss. Is the same the case for fiscal expansion?

Question 40

Find the real exchange rate for the following case: Assume that the representative basket of European goods costs 150 euros and the representative U.S. basket costs $200, and the dollar/euro exchange rate is $1.20 per euro, then the price of the European basket in terms of U.S. basket is:

Question 41

Explain how the AA schedule is derived.

Question 42

How is the AA schedule derived?

A) It is derived by the schedule of interest rate and output combinations that are consistent with equilibrium in the domestic money market and the foreign exchange market.
B) It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the foreign money market and the domestic exchange market.
C) It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the domestic money market and the foreign exchange market.
D) It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the domestic bond market and the foreign asset market.
E) It is derived by the schedule of exchange rate and output combinations that are greater than equilibrium in the foreign money market and the domestic exchange market.

Question 43

In the short run, we assume that the money prices of goods and services are

A) temporarily fixed.
B) permanently fixed.
C) allowed to fluctuate.
D) equal to long-run prices.
E) fully employed.

Question 44

How would you define a DD schedule?

A) the combinations of output and the exchange rate that must hold when the home money market and the foreign exchange market are in equilibrium
B) the combinations of output and the exchange rate that must hold when the output market is in short-run equilibrium
C) factors of production in the long run
D) the aggregate demand in relation to the foreign market value
E) the currency depreciation in relation to the exchange rate

Question 45

Which of the following is the MOST accurate?

A) Any disturbance that lowers aggregate demand for domestic output shifts the DD schedule to the right.
B) Any disturbance that lowers aggregate demand for foreign output shifts the DD schedule to the left.
C) Any disturbance that raises aggregate demand for domestic output shifts the DD schedule to the right.
D) Any disturbance that raises aggregate demand for domestic output shifts the DD schedule to the left.
E) Any disturbance that lowers aggregate demand for domestic output shifts the DD schedule downward.

Question 46

Which of the following does NOT affect the position of the DD curve?

A) monetary policy
B) government spending
C) taxes
D) export demand
E) price levels

Question 47

Temporary tax cuts would cause

A) the AA-curve to shift left.
B) the AA-curve to shift right.
C) the DD-curve to shift left.
D) the DD-curve to shift right.
E) a shift in the AA-curve, although the direction is ambiguous.

Question 48

Explain the difference between the following two expressions:
Y = C(Y^d) + I + G + CA(EP /P, Y^d) and
Y = C + I +G + CA

Question 49

In the short run, any fall in EP /P, regardless of its causes, will cause

A) an upward shift in the aggregate demand function and an expansion of output.
B) an upward shift in the aggregate demand function and a reduction in output.
C) a downward shift in the aggregate demand function and an expansion of output.
D) an downward shift in the aggregate demand function and a reduction in output.
E) an upward shift in the aggregate demand function but leaves output intact.

Question 50

Which of the following equations does NOT state a condition required for equilibrium output:?

A) Y = C(Y^d) + I + G + CA(EP*/P,Y^d)
B) Y = C(Y - T) + I + G + CA(EP*/P,Y - T)
C) Y = D(EP*/P,Y - T,I,G)
D) R = R* + (EP/E)
E) Y = D(EP*/P,Y^d,I,G)

Question 51

The unique equilibrium output level in the short run is found at the intersection of the following curves.

A) aggregate demand and aggregate supply
B) aggregate demand and 45 degree line
C) aggregate supply and 45 degree line
D) aggregate demand and short-run aggregate supply
E) aggregate supply and long-run demand

Question 52

Give 4 examples of situations that would cause the DD-curve to shift to the left.

Question 53

In the short run, any rise in the real exchange rate, EP /P, will cause

A) an upward shift in the aggregate demand function and a reduction in output.
B) an upward shift in the aggregate demand function and an expansion of output.
C) a downward shift in the aggregate demand function and an expansion of output.
D) an downward shift in the aggregate demand function and a reduction in output.
E) an upward shift in the aggregate demand function but leaves output intact.

Question 54

The DD schedule shows all combinations of which 2 variables so that the output market is in equilibrium?

A) imports and exports
B) exports and the exchange rate
C) foreign prices and the exchange rate
D) output and the exchange rate
E) output and exports

Question 55

The interest parity condition requires that:

A) all countries have the same interest rate.
B) there is a unique exchange rate for every output level.
C) purchasing power parity hold.
D) interest rates are fixed in the short run.
E) the money supply is held constant.

Question 56

Discuss the main factors affecting the position of the AA schedule.

Question 57

How is the AA schedule derived?

A) The AA schedule has a positive slope because an increase in output leads to a depreciation of the currency.
B) The AA schedule has a negative slope because an increase in output leads to a decrease in the domestic interest rate.
C) The AA schedule has a negative slope because an increase in output leads to an increase in the domestic interest rate and a domestic currency appreciation.
D) The AA schedule has a positive slope because an increase in the money supply leads to an increase in the domestic interest rate.
E) The AA schedule has a positive slope because a decrease in output leads to a depreciation of the currency.

Question 58

Discuss the main factors affecting the position of the DD schedule.

Question 59

Explain what are the factors that shift the DD Schedule.

Question 60

What would be the best description of what we assume about money prices in the short run?

A) Money prices of goods and services vary.
B) Money prices of goods and services are not related to each other.
C) Money prices of goods are fixed.
D) Money prices of services are fixed.
E) Money prices of goods and services are only temporarily fixed.

Question 61

In the short run, a tax increase

A) shifts the DD curve to the right, increases output and appreciates the currency.
B) shifts the AA curve to the left, increases output and depreciates the currency.
C) shifts the AA curve to the left, decreases output and depreciates the currency.
D) shifts the AA curve to the left, increases output and appreciates the currency.
E) shifts the DD curve to the left, decreases output and depreciates the currency.

Question 62

Explain what are the factors that shift the AA Schedule?

Question 63

Assume the asset market is always in equilibrium. Therefore a fall in Y would result in

A) higher inflation abroad.
B) a decreased demand for domestic products.
C) a contraction of the money supply.
D) a depreciation of the home currency.
E) an appreciation of the home currency.

Question 64

Imagine that the economy is at a point that is above both AA and DD, where both the output and asset markets are out of equilibrium. Which first action is TRUE?

A) The economy will stay at this level in the short run.
B) The exchange rate will first drop to a point on the AA schedule.
C) The exchange rate will first move to a point on the DD schedule.
D) The AA-DD equilibrium will shift to the position of the economy.
E) The exchange rate will first move left to a position on the AA schedule.

Question 65

Using a figure show that under full employment, a temporary fiscal expansion would increase output (over-employment) but cannot increase output in the long run.

Question 66

In the short run, a temporary increase in money supply

A) shifts the DD curve to the right, increases output and appreciates the currency.
B) shifts the AA curve to the left, increases output and depreciates the currency.
C) shifts the AA curve to the left, decreases output and depreciates the currency.
D) shifts the AA curve to the left, increases output and appreciates the currency.
E) shifts the AA curve to the right, increases output and depreciates the currency.

Question 67

Use a figure to study the following question: Imagine that the economy is at a point on the DD-AA schedule that is above both AA and DD, where both the output and asset markets are out of equilibrium. Explain what will happen next.

Question 68

Which of the following have to be in equilibrium for the economy to be in equilibrium?

A) the money market only
B) the goods market only
C) the output and asset markets
D) the savings and investment markets
E) the goods and output markets

Question 69

Imagine that the economy is at a point that is below both AA and DD, where both the output and asset markets are out of equilibrium. Which first action is TRUE?

A) The economy will stay at this level in the short run.
B) The exchange rate will first rise to a point on the AA schedule.
C) The exchange rate will first rise to a point on the DD schedule.
D) The AA-DD equilibrium will shift to the position of the economy.
E) The output level will first increase to a position on the DD schedule.

Question 70

Explain how an increase in government spending would affect the DD-AA schedule in the short run.

Question 71

Assume the output market adjusts more rapidly than the asset market. A point of disequilibrium that is below both AA and DD will therefore initially result in

A) an increase in output.
B) a decrease in output.
C) a contraction of the money supply.
D) a depreciation of the home currency.
E) an appreciation of the home currency.

Question 72

A naïve implication of the DD-AA framework is that either fiscal or monetary policy can lead to full employment. Discuss why this view is naïve.

Question 73

Why does an exchange rate-output combination lying above both DD and AA jump first to AA in equilibrium?

A) Asset prices can adjust immediately.
B) Production plans can adjust immediately.
C) to preserve full employment
D) Prices are nominal and demand is real.
E) Aggregate demand adjusts faster than output.

Question 74

Imagine that the economy is at a point on the DD-AA schedule that is above both AA and DD and where both the output and asset markets are out of equilibrium. Explain what will happen next?

Question 75

What is the AA-curve? Why does it have a negative slope? What factors cause it to shift?

Question 76

In the short run, an increase in government purchases will cause

A) a shift of the DD curve to the left and an increase in output.
B) a shift of the DD curve to the right and a decrease in output.
C) a shift of the DD curve to the left and a decrease in output.
D) a shift of the DD curve to the right and an increase in output.
E) a shift of the DD curve the left and an appreciation of the currency.

Question 77

In the short run, with prices fixed, how would an increase in government spending affect the DD-AA equilibrium?

A) It will increase output and appreciate the currency.
B) It will increase output and depreciate the currency.
C) It will decrease output and appreciate the currency.
D) It will decrease output and depreciate the currency.
E) It will increase output and have no effect on the currency.

Question 78

What is inflation bias? What measures have governments taken to avoid it?

Question 79

What are two ways the government can maintain full employment in an open economy? Also give an example for each.

Question 80

Which one of the following statements is the MOST accurate?

A) For asset markets to remain in equilibrium, a rise in domestic output must be accompanied by a depreciation of domestic currency, all else equal.
B) For asset markets to remain in equilibrium, a fall in domestic output must be accompanied by a depreciation of foreign currency, all else equal.
C) For asset markets to remain in equilibrium, a rise in domestic output must be accompanied by an appreciation of domestic currency, all else equal.
D) For asset markets to remain in equilibrium, a fall in domestic output must be accompanied by an appreciation of domestic currency, all else equal.
E) For asset markets to remain in equilibrium, a fall in domestic output must be accompanied by an appreciation of foreign currency, all else equal.