Question 1

Purchasing power parity theory holds that exchange rates are set so that the price of similar goods in different countries reflects the relative interest rates in those countries.

Accepted Answer

Purchasing power parity theory holds that exchange rates are set so that the price of similar goods in different countries reflects the relative purchasing power of those currencies, not the relative interest rates.

Question 2

The effect of a sustained increase in government spending or investment on aggregate output is larger in an open economy than in a closed economy.

Accepted Answer

In an open economy, a portion of the increased spending leaks out through imports, reducing the multiplier effect on aggregate output compared to a closed economy where all spending circulates within the economy, amplifying its impact.

Question 3

Fiscal policy is more effective when the exchange rate is flexible and the economy is open.

Accepted Answer

Fiscal policy tends to be more effective in a closed economy or when the exchange rate is fixed because the impact of government spending or taxation is less likely to be diluted through changes in net exports or exchange rates. In an open economy with a flexible exchange rate, fiscal expansion can lead to currency appreciation, which can reduce net exports and offset the fiscal stimulus.

Question 4

The ________ the economy and ________ exchange rates increase the effectiveness of both expansionary and contractionary monetary policies.

Accepted Answer

An open economy is one that has significant trade relations with other countries, meaning that changes in exchange rates can have a direct impact on the economy. Additionally, flexible exchange rates allow for market forces to adjust the value of a currency, which can help to stabilize an economy in response to monetary policy changes. Therefore, a more open economy with flexible exchange rates increases the effectiveness of both expansionary and contractionary monetary policies.

Question 5

The theory of international exchange that holds that exchange rates are set so that the prices of ________ goods in different countries is ________ is the purchasing power parity theory.

Accepted Answer

The purchasing power parity theory suggests that exchange rates will adjust so that the price of similar goods in different countries will be the same. Therefore, the correct choice is A, where goods in different countries are considered similar and their prices are expected to be the same.

Question 6

Suppose that the price of a Blu-ray disc player is $240 in the United States and 11,000 rupees in India. If the current exchange rate is 40 rupees to the dollar, then purchasing power parity theory would predict that in the long run

Accepted Answer

The answer of Suppose that the price of a Blu-ray...

Question 7

Monetary policy is more effective when the exchange rate is flexible and the economy is open.

Accepted Answer

When the exchange rate is flexible, it allows the central bank to use monetary policy to influence the exchange rate, which in turn affects the economy through its impact on exports, imports, and inflation. In an open economy, changes in monetary policy have a greater impact on output and inflation as the economy is more exposed to international trade and capital flows. In a closed economy with a fixed exchange rate, monetary policy may be less effective due to the rigidity of the exchange rate.

Question 8

________ suggests that the depreciation of a nation's currency may have an ambiguous effect on its balance of trade.

Accepted Answer

The J-curve effect suggests that in the short term, a depreciation of a nation's currency may worsen its balance of trade as the cost of imports increases and the competitiveness of exports takes time to adjust. However, in the long term, the balance of trade should improve as the effects of the cheaper currency attract foreign investment and boost exports.

Question 9

Why does the appreciation of a country's currency tend to decrease its price level?

Accepted Answer

When a country's currency appreciates, imported goods and inputs become cheaper, reducing production costs and potentially leading to lower overall price levels in the economy.

Question 10

In the foreign exchange market between the Mexican peso and the U.S. dollar, an excess supply of Mexican pesos will result in a depreciation of the Mexican peso relative to the U.S. dollar.

Accepted Answer

If there is an excess supply of Mexican pesos in the market, it means there are more pesos than people want to buy. This will increase the supply of pesos, causing their value to decrease relative to the U.S. dollar. As a result, the Mexican peso will depreciate in value relative to the U.S. dollar.

Question 11

If a nation's interest rates are relatively low compared to those of other countries, then the exchange value of its currency will tend to

Accepted Answer

If a nation's interest rates are relatively low compared to those of other countries, then investors will tend to move their funds to countries with higher interest rates. This will increase the supply of the nation's currency in the foreign exchange market, decreasing its value (depreciation) under a system of floating exchange rates. Under a system of fixed exchange rates, the central bank must intervene to maintain the set exchange rate, which may require selling off foreign reserves and ultimately reducing the money supply, leading to a recession.

Question 12

Contractionary monetary policy

Accepted Answer

Contractionary monetary policy, which typically involves raising interest rates, tends to attract foreign capital due to the higher returns on investments. This increased demand for the nation's currency to invest in these higher-yielding assets leads to an appreciation of the currency.

Question 13

If the Fed increases the money supply to fight recession, a floating exchange rate will aid the Fed in fighting recession because

Accepted Answer

As the Fed increases the money supply to fight recession, it leads to a decrease in interest rates. This, in turn, causes a depreciation of the currency, which makes exports cheaper and imports more expensive. As a result, the demand for U.S. goods and services will increase, thereby boosting economic growth and easing the effects of the recession. Therefore, a floating exchange rate will aid the Fed in fighting the recession by allowing for an adjustment of the currency's value to support economic growth.

Question 14

Monetary policies are

Accepted Answer

Monetary policies tend to be more effective in an open economy with a flexible exchange rate because the central bank can use its tools to influence the economy without worrying about maintaining a fixed exchange rate. This flexibility allows for more direct control over domestic economic conditions.

Question 15

Which of the following policies tends to cause the dollar to depreciate?

Accepted Answer

The answer of Which of the following policies tends to...

Question 16

A Big Mac costs $3 in the United States and 50 pesos in Mexico. The purchasing power parity theory would predict that the exchange rate in the long run is

Accepted Answer

The purchasing power parity theory states that in the long run, exchange rates should adjust to equalize the prices of identical basket of goods and services in different countries. Therefore, if a Big Mac costs $3 in the US and 50 pesos in Mexico, the exchange rate should be such that $3 = 50 pesos. 
$3 = 50 pesos 
$1 = 16.67 pesos

Question 17

Expansionary monetary policy causes the exchange rate to depreciate.

Accepted Answer

Expansionary monetary policy, such as increasing the money supply, leads to a decrease in interest rates which makes domestic investments less attractive and foreign investments more attractive, causing an increase in demand for foreign currency and ultimately a depreciation in the exchange rate.

Question 18

The law of one price states that if the costs of transportation are small, then the price of the same good in different countries should be roughly the same.

Accepted Answer

The law of one price states that if there are no barriers to trade such as transportation costs, tariffs, or taxes, the price of the same good in different countries should be roughly the same after adjusting for exchange rates.

Question 19

If the exchange rate between the British pound and the U.S. dollar was $1 = £0.67 last month, and the exchange rate is $1 = £0.72 this month, the U.S. dollar has appreciated relative to the British pound.

Accepted Answer

The answer of If the exchange rate between the British...

Question 20

The observation that the trade balance usually gets worse before it improves after a currency depreciation is referring to the

Accepted Answer

The observation that the trade balance usually worsens before it improves after a currency depreciation is known as the J-curve effect. It describes the phenomenon where the trade balance initially deteriorates because the prices of imports become more expensive while the prices of exports do not initially change, leading to decreased demand for exports. However, over time, the country's exports become more competitive due to the currency depreciation, leading to an improvement in the trade balance.

Quiz 34: Open-Economy Macroeconomics: the Balance of Payments and Exchange Rates