Question 1

Absolute purchasing power parity means that the real exchange rate is 1:1.

Accepted Answer

Absolute purchasing power parity states that the real exchange rate between two countries should be 1:1, meaning that goods in each country should have the same nominal price after converting currencies. However, this does not always hold true in practice due to differences in production costs, trade barriers, and other factors.

Question 2

Under the international gold standard, the inflows and outflows of gold were intended to maintain economic balance between countries.

Accepted Answer

Under the international gold standard, countries would settle their trade imbalances by inward and outward flows of gold, which would maintain economic balance between countries.

Question 3

Absolute purchasing power parity means

Accepted Answer

Absolute purchasing power parity holds that the nominal exchange rates between currencies are equal to the ratio of the countries' levels of prices. This means that a unit of currency in one country should buy the same quantity of goods in another country when converted at the nominal exchange rate.

Question 4

Foreign aid transfers are part of the _____ account.

Accepted Answer

Foreign aid transfers are considered transactions in the current account because they are transfers of money from one country to another for the purpose of providing assistance or aid. The current account includes transactions in goods, services, income, and current transfers. The capital account includes transactions in assets and liabilities, such as foreign direct investment, portfolio investment, and borrowing. The trade account specifically refers to transactions in goods only.

Question 5

When a country uses a flexible exchange rate, a(n) _____ will cause its currency to depreciate in the foreign exchange market.

Accepted Answer

A flexible exchange rate means that the value of a country's currency is determined by supply and demand in the foreign exchange market. Therefore, any factor that shifts the supply or demand curves for its currency can affect its exchange rate. An increase in interest rates abroad can make the foreign currency more attractive, decreasing the demand for the domestic currency and causing it to depreciate. Similarly, a decrease in domestic interest rates can make the domestic currency less attractive, increasing the supply of the currency and causing it to depreciate. A decrease in foreign income can also decrease the demand for the domestic currency and cause it to depreciate. Therefore, all of these factors can cause a flexible exchange rate currency to depreciate.

Question 6

A Chilean engineer comes to the United States to work on a one-year project and earns $75,000. In the balance of payments, this transaction is a(n) _____ of $75,000.

Accepted Answer

The engineer's earning of $75,000 is an income outflow, meaning money earned by a domestic resident that is paid to a foreign resident.

Question 7

Under a fixed exchange rate system and a neutral monetary policy, an expansionary fiscal policy will be reinforced by an open economy because of the resultant capital _____ U.S. capital markets, which _____ interest rates.

Accepted Answer

An expansionary fiscal policy typically leads to higher interest rates, attracting foreign capital. This inflow of capital to the U.S. capital markets reduces interest rates less than they would increase without such inflows, hence reinforcing the fiscal expansion.

Question 8

Fiscal policies are hampered by flexible exchange rate systems.

Accepted Answer

Flexible exchange rate systems can make it difficult for governments to use fiscal policies effectively as changes in the domestic economy may be offset by changes in the exchange rate. For example, expansionary fiscal policy that leads to higher demand for imports may cause the domestic currency to depreciate, which could offset the intended effects of the policy.

Question 9

Today, the United States operates on a fixed exchange rate system.

Accepted Answer

The United States operates on a flexible exchange rate system, where the value of the currency is determined by market forces of supply and demand.

Question 10

Suppose that Mexico decides to depreciate its peso. Which situation will MOST likely occur?

Accepted Answer

Depreciation of the peso will make Mexican goods cheaper for foreigners to buy, stimulating exports, and reducing the demand for imports. Export-oriented Mexican businesses will benefit from increased international competitiveness, while Mexican businesses that rely on imports will suffer. This is because they will have to pay more for imported goods and services, reducing their profit margins, and potentially leading to higher prices for consumers. Therefore, Mexican businesses in export-oriented industries benefit, while Mexican businesses that rely on imports face difficulties.

Question 11

The concept of purchasing power parity implies that the

Accepted Answer

Purchasing power parity states that the exchange rate between two countries should adjust to equalize the price of a basket of goods and services, including goods like the Big Mac. Therefore, the cost of a Big Mac should be relatively similar across countries if purchasing power parity holds true.

Question 12

Which statement(s) is/are TRUE? I. Money sent to the United Nations in New York by the United States is considered a transfer.
II) The purchase of Apple stock by German investors is considered income received.
III) A U.S. student's purchase of a restaurant meal in Spain while on vacation is considered a U.S. export.

Accepted Answer

I is true because a transfer refers to money or resources leaving one country to be used in another country.
II is false because the purchase of Apple stock is not considered as income received, it is classified as a financial investment.
III is false because a U.S. student's purchase of a restaurant meal in Spain while on vacation is considered a service import for the U.S., not an export.

Question 13

If the yen is appreciating relative to the British pound, then the

Accepted Answer

If the yen is appreciating relative to the British pound, it means that it now takes fewer yen to buy a pound. This implies that the pound is now worth fewer yen, or in other words, the pound is depreciating relative to the yen.

Question 14

Let the nominal exchange rate between the United States and Canada be CAN$0.88 for US$1. A tourist will be able to buy a souvenir on the Canadian side of Niagara Falls that costs CAN$10 when she has US$13 in her wallet.

Accepted Answer

The tourist has US$13, which can be exchanged for CAN$11.44 (US$13 x CAN$0.88). This is more than enough to buy the souvenir that costs CAN$10. Therefore, the statement is true.

Question 15

A country decides to depreciate its currency. In the short run _____, but in the long run _____.

Accepted Answer

Depreciating the currency will make exports cheaper and more attractive, leading to an increase in demand for exports and an increase in aggregate demand. However, this will also cause an increase in the cost of imported inputs, leading to a decrease in aggregate supply. In the long run, as the economy adjusts to the new exchange rate, prices will reach a new equilibrium, but the effects on exports and imports will persist.

Question 16

If the United States has a current account surplus, it

Accepted Answer

A current account surplus implies that a country exports more than it imports, leading to an inflow of foreign currency. To balance this, there must be a net outflow in the capital account, meaning the country invests more abroad than foreign entities invest in it, resulting in a capital account deficit.

Question 17

If Productovia has exports of $50 billion and imports of $40 billion, it has a trade

Accepted Answer

Productovia has exports of $50 billion (money earned from selling goods to other countries) and imports of $40 billion (money spent on buying goods from other countries). The difference between exports and imports is called the balance of trade. In this case, the balance of trade is $10 billion, which means that Productovia has a trade surplus.

Question 18

The increase of disposable income in a country typically leads to appreciation of the country's currency relative to other currencies.

Accepted Answer

An increase in disposable income can lead to higher spending on both domestic and imported goods. If the increase in spending on imports is significant, it can lead to a deterioration of the trade balance, potentially causing the country's currency to depreciate rather than appreciate, as more of the currency is exchanged for foreign currencies to pay for imports.

Question 19

Assume that capital is perfectly mobile and substitutable and that the interest rate in the United States and the European Union is currently 5%. Investors expect the euro to rise against the dollar by 2% and they thus demand a _____ in the _____.

Accepted Answer

Given the expectation that the euro will rise against the dollar by 2%, investors would demand a higher return in the United States to compensate for the expected depreciation of the dollar. This is because, with capital mobility, investors can choose to invest in the currency area offering the highest expected return. If they expect the euro to appreciate, the return on investments in the euro area effectively increases when measured in dollars. To attract or retain capital in the United States, a higher return would be necessary, making the correct answer a higher return equal to 7% in the United States.

Question 20

Flexible exchange rates hamper fiscal policy but reinforce monetary policy.

Accepted Answer

When a country has flexible exchange rates, its fiscal policy is limited because changes in government spending and taxation do not directly affect the exchange rate. However, flexible exchange rates reinforce monetary policy because changes in interest rates can affect the exchange rate and trade balance.

Quiz 16: Open Economy Macroeconomics