Question 1

The percentage change in the nominal exchange rate equals the percentage change in the real exchange rate plus the:

Accepted Answer

The percentage change in the nominal exchange rate is affected by both the percentage change in the real exchange rate and the inflation rate differential between the two countries. Specifically, the nominal exchange rate changes due to changes in relative purchasing power between the two currencies, which is captured by the real exchange rate. Inflation rate differential affects the relative price level between the two countries, which in turn affects the exchange rate. Therefore, option A, foreign inflation rate minus the domestic inflation rate, is the correct choice.

Question 2

In a small open economy, if the government adopts a policy that lowers imports, then that policy:

Accepted Answer

In a small open economy, a policy that lowers imports directly affects the trade balance by reducing the amount of goods and services bought from abroad. However, this action can lead to an appreciation of the real exchange rate because it can reduce the demand for foreign currency (needed to buy those imports), making the domestic currency more valuable in comparison. An appreciated (or raised) real exchange rate makes domestic goods more expensive relative to foreign goods, which could reduce exports and increase imports over time, counteracting the initial policy effect. However, the immediate effect of the policy per the question's framing does not change net exports directly because it specifically targets imports. The change in net exports would depend on subsequent adjustments in the economy, which are not specified in the question.

Question 3

Which of the following would decrease the real exchange rate in a small open economy in the long run?

Accepted Answer

A reduction in government spending decreases the demand for domestic currency to purchase government bonds, which can lead to a decrease in the real exchange rate as the currency's value falls relative to foreign currencies.

Question 4

In a large but open economy, when a fiscal expansion takes place, the interest rate goes up and some investment is crowded out, and the expansion also causes a trade:

Accepted Answer

In a large but open economy, when there is a fiscal expansion, the increase in demand for loanable funds leads to an increase in the interest rate. This increase in the interest rate reduces investment and causes some crowding out. Additionally, as a result of the fiscal expansion, there is an increase in income and an increase in demand. This leads to an increase in imports which increases the trade deficit. The increase in demand for domestic currency to purchase foreign currency to pay for the imports raises the value of the domestic currency, causing a rise in the real exchange rate. Therefore, the correct choice is B) deficit and a rise in the real exchange rate.

Question 5

One consequence of high inflation is a(n):

Accepted Answer

The answer of One consequence of high inflation is a(n):
...

Question 6

If the real exchange rate between the United States and Japan remains unchanged, and the inflation rate in the United States is 6 percent and the inflation rate in Japan is 3 percent, the:

Accepted Answer

If the real exchange rate remains unchanged, then the nominal exchange rate must adjust to reflect the difference in inflation rates. In this case, since the inflation rate is higher in the United States than in Japan, the U.S. dollar should depreciate relative to the yen. Therefore, the yen will appreciate by 3 percent against the dollar.

Question 7

Protectionist policies in a small open economy do not alter the trade balance because the:

Accepted Answer

In a small open economy, protectionist policies, such as tariffs and quotas, increase the price of imports, making them less attractive to consumers. As a result, the demand for imports decreases and the demand for domestically produced goods increases, leading to an increase in net exports. This increase in net exports puts upward pressure on the exchange rate, causing it to appreciate. The appreciation of the exchange rate offsets the impact of the protectionist policies on the trade balance, as the increase in net exports is exactly offset by the decrease in the price competitiveness of domestic goods due to the appreciation of the exchange rate. Therefore, protectionist policies in a small open economy do not alter the trade balance because the exchange rate adjusts to offset the increase in net exports.

Question 8

The currencies of countries with high inflation rates relative to the United States have tended to , and the currencies of countries with low inflation rates relative to the United States have tended to .

Accepted Answer

Countries with high inflation rates typically have a decrease in purchasing power, making their currency less valuable compared to the US dollar. This leads to a depreciation of their currency relative to the US dollar. Conversely, countries with low inflation rates tend to have an increase in purchasing power, making their currency more valuable compared to the US dollar. This leads to an appreciation of their currency relative to the US dollar.

Question 9

If a country has a high rate of inflation relative to the United States, the dollar will buy:

Accepted Answer

When a country experiences a high rate of inflation relative to the United States, the value of its currency tends to decrease in comparison to the US dollar. This means that over time, the US dollar will be able to buy more of the foreign currency.

Question 10

If the nominal exchange rate falls 10 percent, the domestic price level rises 4 percent, and the foreign price level rises 6 percent, the real exchange rate will fall:

Accepted Answer

The real exchange rate is calculated as the nominal exchange rate multiplied by the ratio of domestic prices to foreign prices:

Real exchange rate = Nominal exchange rate x (Domestic price level / Foreign price level)

Substituting the given values, we get:

Real exchange rate = (0.9) x (1.04/1.06) = 0.8679

This represents a fall of 8.21 percent from the initial value of 0.945 (which would be the real exchange rate if there were no changes in prices or nominal exchange rates). Rounding this to the nearest percent gives us a fall of 8 percent.

Question 11

Net capital outflow in a large country:

Accepted Answer

The answer of Net capital outflow in a large country:
...

Question 12

Protectionist policies implemented in a small open economy with a trade deficit have the effect of the trade deficit and the quantity of imports and exports.

Accepted Answer

Protectionist policies, such as tariffs or quotas, are designed to reduce imports, which can decrease the trade deficit by reducing the quantity of imports. However, they can also lead to a decrease in exports if other countries retaliate or if domestic costs rise, making exports less competitive.

Question 13

According to purchasing power parity, if the dollar price of oil is higher in New York than in London, arbitrageurs will oil in New York and oil in London to drive the price of oil in New York.

Accepted Answer

According to purchasing-power parity, if the dollar price of oil is higher in New York than in London, arbitrageurs will sell oil in New York (where the price is higher) and buy oil in London (where the price is lower) to drive down the price of oil in New York. This process helps in equalizing the price differences due to arbitrage.

Question 14

The idea that the amount of any currency that can buy a particular good in one country should be able to buy (after being exchanged for the local currency) the same quantity of the same good anywhere in the world is called:

Accepted Answer

The idea described in the question is known as purchasing power parity (PPP), which suggests that exchange rates between currencies should adjust to equalize the price of a basket of goods and services across countries. This means that the same amount of one currency should be able to buy the same quantity of a good in any country, as long as the goods are priced in the same currency. Option A, the theory of the real exchange rate, is related to PPP but focuses more on the long-term determinants of exchange rates, such as productivity and inflation. Option B, equal currency conversion, is not an established concept in economics. Option C, international monetary exchange, does not accurately describe the idea in question.

Question 15

For a closed economy, when net capital outflow is measured along the horizontal axis and the real interest rate is measured along the vertical axis, net capital outflow is drawn as a:

Accepted Answer

In a closed economy, there is no international trade in goods and services or financial assets, meaning there are no capital flows into or out of the economy. Therefore, net capital outflow is always zero, regardless of the real interest rate, which is represented as a vertical line at 0 on a graph where net capital outflow is on the horizontal axis and the real interest rate is on the vertical axis.

Question 16

If purchasing power parity holds, then changes in domestic saving will the real exchange rate.

Accepted Answer

If purchasing power parity holds, the real exchange rate will adjust to keep prices equal across countries. Changes in domestic saving will not directly impact prices or inflation, so the real exchange rate will not change.

Question 17

If the purchasing-power parity theory is true, then:

Accepted Answer

The purchasing-power parity theory suggests that changes in the nominal exchange rate between two currencies are determined by changes in the price levels between the two countries. This theory implies that the exchange rate adjusts to equalize the purchasing power of different currencies.

Question 18

The law of one price is enforced by:

Accepted Answer

The law of one price is enforced by arbitrageurs, who seek to make profits by exploiting price differences between different markets. They do this by buying a good in a cheaper market and simultaneously selling it in a more expensive market until the prices equalize, which removes the opportunity for profit. Governments, producers and consumers are not typically responsible for enforcing the law of one price.

Question 19

In a small open economy, if the government adopts a policy that lowers imports, then the quantity of exports:

Accepted Answer

In a small open economy, if imports decrease, it typically leads to an appreciation of the domestic currency due to a reduced supply of the domestic currency in the foreign exchange market. This appreciation makes exports more expensive for foreign buyers, reducing the quantity of exports. According to the balance of payments theory, under a floating exchange rate system, the decrease in imports will be matched by an equal decrease in exports to keep the balance of payments balanced.

Question 20

An effective policy to reduce a trade deficit in a small open economy would be to:

Accepted Answer

The answer of An effective policy to reduce a trade...

Quiz 5: The Open Economy