Question 1

When the government increases the government budget deficit, national saving decreases.

Accepted Answer

When the government increases the budget deficit, it means that it is spending more than it is collecting in revenue. This results in a decrease in national saving because the government is borrowing from the public or from foreign entities to finance its spending, which reduces the amount of savings available for private investment.

Question 2

In the open-economy macroeconomic model, other things the same, when a Canadian resident imports a foreign good, our model treats this as a decrease in the demand for dollars in the foreign-currency exchange market.

Accepted Answer

When a Canadian resident imports a foreign good, they need to exchange Canadian dollars for the foreign currency to pay for the import. This increases the supply of Canadian dollars in the foreign exchange market, and therefore decreases the demand for Canadian dollars, as fewer people will want to hold Canadian dollars to exchange for the foreign currency.

Question 3

Why do higher real interest rates lead to lower net capital outflow?

Accepted Answer

The answer of Why do higher real interest rates lead...

Question 4

When a country imposes a trade restriction, the real exchange rate of that country's currency appreciates.

Accepted Answer

When a country imposes trade restrictions, it reduces the supply of foreign goods in the domestic market, leading to an increase in demand for domestic goods. This increased demand for domestic goods causes the real exchange rate to appreciate, making domestic goods more expensive relative to foreign goods.

Question 5

An import quota imposed by Egypt would reduce Egyptian imports, but have no impact on Egyptian exports.

Accepted Answer

An import quota imposed by Egypt would reduce Egyptian imports, but it could also affect Egyptian exports indirectly through changes in exchange rates, retaliatory trade measures by other countries, or shifts in domestic production that affect export competitiveness.

Question 6

Although trade policies do not affect a country's overall trade balance, they do affect specific firms and industries.

Accepted Answer

Trade policies may not necessarily affect a country's aggregate trade balance, but they can have a significant impact on individual firms and industries within that country. For example, trade barriers such as tariffs or quotas can make it more difficult or expensive for certain firms to export their goods to other countries, while import restrictions may protect domestic industries but limit consumers' access to certain foreign products.

Question 7

According to the open-economy macroeconomic model, if Canada moved from a government budget deficit to a government budget surplus, Canadian real interest rates would increase and the real exchange rate of the Canadian dollar would appreciate.

Accepted Answer

Moving from a government budget deficit to a surplus typically reduces interest rates because the government demands fewer loanable funds, which can lead to a depreciation of the real exchange rate due to lower inflows of foreign capital seeking higher returns.

Question 8

If the real exchange rate of the Canadian dollar were above its equilibrium level, the real exchange rate of the Canadian dollar would appreciate.

Accepted Answer

If the real exchange rate of the Canadian dollar is above its equilibrium level, it suggests that the Canadian dollar is overvalued, leading to a likely depreciation rather than an appreciation to return to equilibrium.

Question 9

Suppose that Canadian investors decide that investment opportunities in African countries have improved. What happens to Canadian net capital outflow? What happens to the Canadian real interest rate?

Accepted Answer

The answer of Suppose that Canadian investors decide that investment...

Question 10

According to the open-economy macroeconomic model, if the Canadian government decreased the government budget deficit, both Canadian domestic investment and Canadian net capital outflow would fall.

Accepted Answer

According to the open-economy macroeconomic model, a decrease in government budget deficit would lead to a decrease in domestic investment due to a decrease in government purchases, and a decrease in net capital outflow due to a decrease in interest rates that would reduce the incentive for capital outflow. Thus, both Canadian domestic investment and Canadian net capital outflow would fall.

Question 11

In the open-economy macroeconomic model, net capital outflow links the markets for loanable funds and foreign-currency exchange.

Accepted Answer

Net capital outflow represents the difference between domestic saving and domestic investment and reflects the flow of funds between a country's financial markets and foreign financial markets. This connection between the domestic loanable funds market and the foreign-currency exchange market is a key feature of the open-economy macroeconomic model.

Question 12

Suppose that Canadian citizens start saving more. What does this imply about the supply of loanable funds and the equilibrium real interest rate? What happens to the real exchange rate?

Accepted Answer

The answer of Suppose that Canadian citizens start saving more....

Question 13

Explain why saving need not equal domestic investment in an open economy.

Accepted Answer

The answer of Explain why saving need not equal domestic...

Question 14

State what, if anything, each of the following does to the supply or demand of loanable funds.
a. Net capital outflow increases at each interest rate.
b. Domestic investment decreases at each interest rate.
c. The government surplus increases.
d. Private saving increases.

Accepted Answer

The answer of State what, if anything, each of the...

Question 15

If policymakers impose import restrictions on automobiles, the Canadian trade deficit would shrink.

Accepted Answer

Imposing import restrictions on automobiles would decrease imports but it could also lead to retaliation from other countries which would decrease exports and potentially create additional economic problems. Therefore, it may not necessarily lead to a decrease in the trade deficit.

Question 16

The key determinant of net capital outflow is the real exchange rate.

Accepted Answer

The key determinant of net capital outflow is the difference between domestic and foreign real interest rates, not the real exchange rate. Net capital outflow is primarily driven by investors seeking the highest returns on their investments, which are influenced by interest rates rather than exchange rates.

Question 17

According to the open-economy macroeconomic model, an increase in the Canadian government budget surplus increases Canadian net capital outflow, causes the real exchange rate of the dollar to depreciate, and increases Canadian net exports.

Accepted Answer

An increase in the government budget surplus can lead to lower interest rates, which encourages capital outflow. This increases the supply of the Canadian dollar in the foreign exchange market, causing the real exchange rate to depreciate and making Canadian goods cheaper for foreigners, thus increasing net exports.

Question 18

If Great Britain suffers from capital flight, British domestic investment will fall and British net exports will increase.

Accepted Answer

Capital flight refers to the movement of funds out of a country in search of better returns or safer investment options. As a result, domestic investment in the country decreases, which can lead to a decrease in economic growth. However, with a weakened currency due to capital flight, exports become more competitive and can increase, leading to higher net exports.

Question 19

Because depreciation of the real exchange rate of the dollar increases Canadian net exports, the demand curve for dollars in the foreign-currency exchange market is upward sloping.

Accepted Answer

The demand curve for dollars in the foreign-currency exchange market is downward sloping because as the value of the dollar depreciates (or the real exchange rate decreases), foreign currencies become more expensive in terms of dollars, making US goods cheaper for foreigners and increasing the demand for dollars to purchase these cheaper goods.

Question 20

Other things the same, when a Canadian company imports cotton from Egypt, the open-economy macroeconomic model treats this transaction as a decrease in the quantity of dollars demanded in the Canadian foreign-currency exchange market.

Accepted Answer

When a Canadian company imports cotton from Egypt, it needs to exchange Canadian dollars for Egyptian pounds to pay for the cotton. This increases the supply of Canadian dollars in the foreign-currency exchange market and decreases the demand for Egyptian pounds, leading to a decrease in the quantity of dollars demanded.

Quiz 13: A Macroeconomic Theory of the Small Open Economy