Question 1

Net foreign investment represents the quantity of dollars demanded in the foreign-currency exchange market.

Accepted Answer

Net foreign investment refers to the difference between the domestic country's investments abroad and foreign investments in the domestic country, not the quantity of dollars demanded in the foreign-currency exchange market.

Question 2

The price of imports will increase on the domestic market if two conditions are fulfilled: a strong local currency and a shortage of supply.

Accepted Answer

The statement is incorrect. The price of imports will increase on the domestic market if there is a weak local currency and/or a shortage of supply. A strong local currency would actually lead to lower import prices, all other things being equal.

Question 3

In an open economy, a rise in government budget deficit will cause the dollar to appreciate and push the trade balance towards surplus.

Accepted Answer

In an open economy, a rise in government budget deficit will lead to increased government borrowing, which in turn increases demand for loans, driving up domestic interest rates. This appreciation of domestic interest rates attracts foreign capital and increases the demand for domestic currency, resulting in a short-term appreciation of the currency. However, in the long run, the trade balance may not necessarily move towards surplus, as the appreciation of the currency also makes exports more expensive and imports cheaper, which could potentially worsen the trade balance.

Question 4

For given risk levels, a relatively higher return in one country will lead to capital inflow to that country.For given returns, a relatively higher degree of risk in one country will lead to capital outflows from that country.

Accepted Answer

This is a basic principle of international finance known as the "risk-return tradeoff." Investors seek to maximize their returns while minimizing their risk, so they will generally invest in countries that offer higher returns for a given level of risk and avoid countries with higher risk for a given level of return. This can lead to capital flows between countries as investors seek out the most attractive investment opportunities.

Question 5

The supply of loanable funds comes from:

Accepted Answer

The supply of loanable funds comes from national saving, which includes the savings of households, businesses, and the government. Domestic investment and foreign sources can also impact the supply of loanable funds, but they are not the direct source of the funds.

Question 6

According to the theory of purchasing-power parity, the demand curve is horizontal at the level of the real exchange rate that ensures parity of purchasing power at home and abroad.

Accepted Answer

According to the theory of purchasing-power parity, the demand curve is horizontal at the level of the real exchange rate that ensures parity of purchasing power at home and abroad. This means that at the equilibrium level of the real exchange rate, the quantity of money demanded is equal to the quantity of money supplied, which results in purchasing power parity between countries.

Question 7

In an open economy, domestic investment equals:

Accepted Answer

In an open economy, domestic investment can be financed by two sources: domestic saving and net capital inflows. Therefore, domestic investment equals domestic saving plus net capital inflows. Choice A (net capital inflows) only represents one of the two sources, while Choice B (net capital outflows) represents a reduction in domestic investment. Choice C (domestic saving) only represents one of the two sources and does not take into account any inflows from abroad. Therefore, choice D (domestic saving plus net capital inflows) is the only correct answer.

Question 8

Net foreign investment must be equal to current balance.

Accepted Answer

Net foreign investment is equal to the current account balance, which is the difference between a country's exports and imports of goods and services plus net income from abroad.

Question 9

If exports are greater than imports, the country is said to have a:

Accepted Answer

A trade surplus occurs when a country's exports exceed its imports, meaning it is exporting more than it is importing. This results in a positive balance of trade and a surplus of foreign currency.

Question 10

The concept of income elasticity of demand is also an explanation of how nations behave when the cost of luxury imports increase in price.

Accepted Answer

Income elasticity of demand measures the responsiveness of demand for a good to a change in income, and luxury imports are often income elastic. Therefore, when the price of luxury imports increases, demand for these goods may decrease as consumers may be less willing or able to purchase them, leading to changes in trade patterns and behavior at the national level.

Question 11

In the market for foreign-currency exchange, supply comes from net foreign investment, demand comes from the current account balance, and the real exchange rate balances supply and demand.

Accepted Answer

This is a basic representation of the monetary approach to exchange rates, where the supply of a currency comes from net foreign investment and the demand for a currency comes from the current account balance. The real exchange rate is the price that balances supply and demand in the foreign exchange market.

Question 12

One way to stop capital flight is for that country's central bank to raise interest rates above and beyond foreign investors' expectation.

Accepted Answer

By raising interest rates, the central bank makes it more attractive for investors to keep their money within the country rather than moving it abroad to seek higher returns. This can help to stem capital flight.

Question 13

The demand for loanable funds comes from domestic investment and net foreign investment.

Accepted Answer

Domestic investment and net foreign investment require financing, which leads to a demand for loanable funds. Therefore, the statement is true.

Question 14

Because trade policies do not affect a country's overall trade balance, they also do not affect specific firms, industries and foreign countries.

Accepted Answer

Trade policies can have a significant impact on specific firms and industries, as well as on the trading relationships between countries. For example, imposing tariffs on imports can make it more difficult and expensive for foreign firms to sell their products in a particular market, while subsidies can make it easier and less expensive for domestic firms to sell their products abroad. These policies can also lead to retaliation from other countries, affecting their own industries and trade relationships. Overall, trade policies can have far-reaching effects on the economy, beyond just the overall trade balance.

Question 15

A strong domestic dollar, ceteris paribus, may have minimal impact on export industries.

Accepted Answer

A strong domestic currency makes exports more expensive for foreign buyers, which can lead to a decrease in exports. However, if the demand for exports is inelastic, then the decrease in exports will be minimal.

Question 16

The current account is defined as that part of the balance of payments that records transactions leading to a change of ownership of commodities, or a direct flow of income or similar payment.

Accepted Answer

This is the correct definition of the current account in the balance of payments.

Question 17

Whereas in the long-run macroeconomic model of a closed economy, monetary changes affect only nominal variables, in the long-run macroeconomic model of an open economy, monetary changes also affect real variables.

Accepted Answer

In the long-run macroeconomic model, whether in a closed or open economy, monetary changes primarily affect nominal variables, such as prices and wages, rather than real variables like output or employment, according to the classical dichotomy and neutrality of money.

Question 18

At the equilibrium real interest rate, the amount that people (including government) want to save exactly balances the desired quantity of net foreign investment.

Accepted Answer

At the equilibrium real interest rate, the amount that people (including government) want to save exactly balances the desired quantity of investment, not net foreign investment. Net foreign investment is a separate concept related to a country's external financial activities.

Question 19

In recent times China overtook Germany to become the world's biggest exporter.On one measure it now looks likely to become the world's biggest economy within 10 years.

Accepted Answer

According to various economic projections and estimates, China is expected to surpass the United States to become the world's biggest economy within 10 years.

Question 20

In an open economy, a government budget deficit raises real interest rates, crowds out domestic investment, causes the currency to appreciate and pushes the trade balance towards deficit.

Accepted Answer

A government budget deficit leads to an increase in demand for loanable funds, which raises real interest rates, reduces domestic investment as resources are diverted towards government borrowing, and leads to an appreciation of the exchange rate as foreign investors move funds to take advantage of higher returns. The higher exchange rate makes exports relatively more expensive and imports cheaper, resulting in a deterioration of the trade balance.

Quiz 32: A Macroeconomic Theory of the Open Economy