Question 1

Suppose a country has the following balance of payments data:
Merchandise exports 100
Merchandise imports 130
Service exports 60
Service Imports 50
Investment income receipts 75
Investment income payments 100
Transfers to other countries 15
Increase in home country assets abroad 130
Increase in foreign assets in home country 190
a. Calculate the current account balance.
b. Calculate the capital account balance.
c. Calculate the trade balance.
d. Calculate net factor payments.

Accepted Answer

The answer of Suppose a country has the following balance...

Question 2

Real domestic interest rates would increase in a large open economy if
A) there were a temporary negative domestic supply shock.
B) the government imposed capital controls and the capital account had been in deficit.
C) foreigners were more willing to save.
D) there were a temporary negative supply shock abroad in a small open economy.

Accepted Answer

The answer of Real domestic interest rates would increase in...

Question 3

Assume that an increase in Costa Rica's government budget deficit reduced desired national saving by 10 million colon. Assuming Costa Rica is a small open economy, you would expect the government's action to
A) increase the current account balance by exactly 10 million colon.
B) increase the current account balance by less than 10 million colon.
C) reduce the current account balance by exactly 10 million colon.
D) reduce the current account balance by more than 10 million colon.

Accepted Answer

In a small open economy, the government's budget deficit increases the demand for loanable funds, which leads to an increase in the interest rate. As a result, the currency appreciates, making exports more expensive and imports cheaper, leading to a reduction in net exports. The reduction in net exports is precisely equal to the increase in national saving, which is 10 million colon in this case. Therefore, the current account balance would reduce by 10 million colon, as stated in option C.

Question 4

Consider a small open economy with desired national saving of S^d = 20 + 200 r^w and desired investment of I^d = 30 - 200 r^w.Calculate national saving, investment, and the current account balance in equilibrium when the real world interest rate is a. r^w = 0.025 b. r^w = 0.05 c. r^w = 0.0 d. Now suppose something causes desired national saving to increase by 10, so that it is now S^d = 30 + 200 r^w. Repeat parts a, b, and c. e. Suppose, with desired national saving at its original level of S^d = 20 + 200 r^w, something causes desired investment to rise by 10, I^d = 40 - 200 r^w. Repeat parts a, b, and c.

Accepted Answer

The answer of Consider a small open economy with desired...

Question 5

Assuming no change in the effective tax rate on capital, an increase in the government budget deficit will raise the current account deficit if and only if the increase in the budget deficit
A) reduces desired national saving.
B) increases desired national saving.
C) reduces desired national investment.
D) increases desired national investment.

Accepted Answer

An increase in the government budget deficit will lead to a decrease in desired national saving because the government will need to borrow more to finance the deficit. This increase in borrowing will lead to an increase in interest rates, which will discourage private saving and investment. As a result, there will be a decrease in the current account balance, as imports will increase and exports will decrease.

Question 6

In a small open economy, S^d = $20 billion + ($100 billion) r% I^d = $30 billion - ($100 billion) r% Y = $70 billion G = $20 billion r^w = .04. a. Calculate the current account balance. b. Calculate net exports. c. Calculate desired consumption. d. Calculate absorption.

Accepted Answer

The answer of In a small open economy, S^d = $20...

Question 7

Due to a change in the regulatory structure of a small open economy, the desired capital stock becomes higher for both private investment and government investment. Increased government investment spending is financed by borrowing, not by higher taxes. If both desired investment and government spending rise at the same time, will there be "twin deficits"?

Accepted Answer

The answer of Due to a change in the regulatory...

Question 8

Briefly discuss the idea of "twin deficit." In your answer, include historical evidence, if any, and explain why some economists do not agree with the idea. Is Ricardian equivalence proposition consistent with the idea of twin deficit? Why?

Accepted Answer

The answer of Briefly discuss the idea of "twin deficit."...

Question 9

If Ricardian equivalence proposition is true, a budget deficit resulting from a tax cut will have
A) no effect on government expenditures.
B) no effect on current account because it does not affect national saving.
C) no effect on current account because people expect to pay lower taxes in the future.
D) no effect on current account because people expect to increase their consumption.

Accepted Answer

Ricardian equivalence proposition suggests that when taxes are cut, households increase their saving in anticipation of future tax increases to finance the budget deficit. Therefore, the tax cut does not increase consumption and subsequently does not affect national saving. As a result, it has no effect on the current account.

Question 10

Consider a small open economy in equilibrium with a zero current account balance. What happens to national saving, investment, and the current account balance in equilibrium if
a. future income rises?
b. business taxes rise?
c. government expenditures decline temporarily?
d. the future marginal product of capital rises?

Accepted Answer

The answer of Consider a small open economy in equilibrium...

Question 11

A large open economy has desired national saving of S^d= 20 + 200 r^w and desired national investment of I^d = 30 - 200 r^w. The foreign economy has desired national saving of S^d = 40 + 100 r^w and desired national investment of I^d_For = 75 - 400 r^w. a. Calculate the equilibrium values of r^w, CA, CA_For, S, I, S_For, and I_For. b. Suppose S^d rises by 45, so that now S^d = 65 + 200 r^w. Calculate the equilibrium values of r^w CA, CA_For, S, I, S_For, and I_For. c. Suppose with S^d back to S^d = 20 + 200 r^w as in part a, that I^d rises by 45, to I^d = 75 - 200 r^w. Calculate the equilibrium values of r^w, CA, CA_For, S, I, S_For and I_For.

Accepted Answer

The answer of A large open economy has desired national...

Question 12

Show where each of the following transactions belongs on the Canadian balance of payments table, using an exchange rate of 100 Japanese yen per Canadian dollar.
a. A Japanese firm spends 5 billion yen to buy personal computers from IBM (a Canadian firm).
b. A wealthy Japanese businessman gives $100 thousand to the San Diego Zoo.
c. A Canadian firm buys 1 million Sony Walkmans at 6000 yen each (Sony is a Japanese firm).
d. A Japanese investment banking firm buys 500 million dollars worth of newly issued Canadian government Treasury bills.
e. Canadian steel firms send 2000 executives to Japan to take courses in the Japanese method of steel production and Japanese management techniques, paying 2 million yen per executive.
f. Repeat parts a. - e. for the balance of payments table of Japan.

Accepted Answer

The answer of Show where each of the following transactions...

Question 13

Suppose the government of a large open economy announces a major expansion of government spending to dig a tunnel to the earth's core, to be financed entirely by borrowing. What effect does this have on the world real interest rate, national saving, investment, and the current account balance in equilibrium?

Accepted Answer

The answer of Suppose the government of a large open...

Question 14

The government of a small open economy announces a tax cut of $100 this year, combined with a tax increase of $110 next year, when the interest rate is 10%. What are the effects of this change on the world real interest rate, national saving, investment, and the current account balance in equilibrium when
a. Ricardian equivalence holds?
b. Ricardian equivalence does not hold?

Accepted Answer

The answer of The government of a small open economy...

Question 15

In a large open economy like the United States, an increased government budget deficit that reduces national saving
A) reduces investment and improves the current account balance.
B) reduces investment and reduces the current account balance.
C) has no effect on investment, but reduces the current account balance.
D) has no effect on either investment or the current account balance.

Accepted Answer

An increased government budget deficit reduces national saving through increased government spending and decreased taxes. With a reduction in national saving, the investment will decrease since there are fewer funds available for investment. The reduced investment will also reduce the productivity of the economy, which will lead to a reduction in the current account balance. Therefore, an increased government budget deficit reduces investment and reduces the current account balance.

Question 16

The term "twin deficits" refers to a situation in which there exists
A) a budget deficit as well as a current account deficit.
B) a budget deficit as well as a capital account deficit.
C) a budget deficit as well as a balance of payment deficit.
D) a current account deficit as well as a capital account deficit.

Accepted Answer

"Twin deficits" refers to a situation where both the budget deficit and current account deficit exist simultaneously. A budget deficit arises when the government is spending more than it is earning through revenues like taxes or bond issuances. A current account deficit arises when a country's imports exceed its exports or when it is paying out more money to foreign entities than it is receiving. Therefore, a twin deficit situation refers to a scenario where a country is experiencing both a budget deficit and a current account deficit.

Question 17

Assume that Costa Rica, a small open economy, has increased the government budget deficit by 10 million colon, reducing the current account balance in the process. All else being equal, you would expect this action to cause
A) an increase in desired saving in Costa Rica.
B) an increase in the real world interest rate.
C) an increase in exports by Costa Rica.
D) an increase in Costa Rica's absorption.

Accepted Answer

When the government increases its budget deficit, it is essentially increasing its absorption or demand for goods and services. This puts pressure on the economy's resources and can lead to higher inflation and a higher real interest rate to dampen demand. This, in turn, can discourage saving and increase imports, reducing the current account balance. As a result, we would expect Costa Rica's absorption to increase, which would cause a reduction in the current account balance. Hence, option D is correct. Option A is incorrect because an increase in the deficit is typically associated with a reduction in saving. Option B is incorrect because a higher real interest rate would tend to reduce domestic demand and, therefore, reduce absorption. Option C is incorrect because a reduction in the current account balance is typically associated with an increase in imports, not exports.

Question 18

Consider a large open economy that has a zero current account balance. What are the effects on the world real interest rate, national saving, investment, and the current account balance in equilibrium if
a. future income rises?
b. business taxes decline?
c. government purchases decline?
d. the future marginal product of capital declines?

Accepted Answer

The answer of Consider a large open economy that has...

Question 19

If business taxes rise in a large open economy, it causes the current account to ________ and saving to ________.
A) fall; fall
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; fall

Accepted Answer

An increase in business taxes will lead to a decrease in the after-tax profit of firms, resulting in a decrease in their investment. The reduction in investment will lead to a decrease in national saving, as fewer resources are allocated towards saving. A fall in national saving will reduce the supply of funds available to borrow, leading to an increase in the interest rates. The higher interest rates will, in turn, attract more foreign investment, which will appreciate the exchange rate. A higher exchange rate will make exports more expensive and imports cheaper, leading to an increase in imports and a decrease in exports. The combination of a decreased supply of domestic goods and an increase in cheaper foreign goods will lead to an increase in the current account deficit.

Quiz 5: Saving and Investment in the Open Economy

Real domestic interest rates would increase in a large open economy if

Assume that an increase in Costa Rica's government budget deficit reduced desired national saving by 10 million colon. Assuming Costa Rica is a small open economy, you would expect the government's action to

Assuming no change in the effective tax rate on capital, an increase in the government budget deficit will raise the current account deficit if and only if the increase in the budget deficit

In a small open economy, S^d = $20 billion + ($100 billion) r% I^d = $30 billion - ($100 billion) r% Y = $70 billion G = $20 billion r^w = .04. a. Calculate the current account balance. b. Calculate net exports. c. Calculate desired consumption. d. Calculate absorption.

Briefly discuss the idea of "twin deficit." In your answer, include historical evidence, if any, and explain why some economists do not agree with the idea. Is Ricardian equivalence proposition consistent with the idea of twin deficit? Why?

If Ricardian equivalence proposition is true, a budget deficit resulting from a tax cut will have

In a large open economy like the United States, an increased government budget deficit that reduces national saving

The term "twin deficits" refers to a situation in which there exists

Assume that Costa Rica, a small open economy, has increased the government budget deficit by 10 million colon, reducing the current account balance in the process. All else being equal, you would expect this action to cause

If business taxes rise in a large open economy, it causes the current account to and saving to .

Quiz 5: Saving and Investment in the Open Economy

Real domestic interest rates would increase in a large open economy if

Assume that an increase in Costa Rica's government budget deficit reduced desired national saving by 10 million colon. Assuming Costa Rica is a small open economy, you would expect the government's action to

Assuming no change in the effective tax rate on capital, an increase in the government budget deficit will raise the current account deficit if and only if the increase in the budget deficit

In a small open economy, Sd = $20 billion + ($100 billion) r% Id = $30 billion - ($100 billion) r% Y = $70 billion G = $20 billion rw = .04. a. Calculate the current account balance. b. Calculate net exports. c. Calculate desired consumption. d. Calculate absorption.

Briefly discuss the idea of "twin deficit." In your answer, include historical evidence, if any, and explain why some economists do not agree with the idea. Is Ricardian equivalence proposition consistent with the idea of twin deficit? Why?

If Ricardian equivalence proposition is true, a budget deficit resulting from a tax cut will have

In a large open economy like the United States, an increased government budget deficit that reduces national saving

The term "twin deficits" refers to a situation in which there exists

Assume that Costa Rica, a small open economy, has increased the government budget deficit by 10 million colon, reducing the current account balance in the process. All else being equal, you would expect this action to cause

If business taxes rise in a large open economy, it causes the current account to ________ and saving to ________.

In a small open economy, S^d = $20 billion + ($100 billion) r% I^d = $30 billion - ($100 billion) r% Y = $70 billion G = $20 billion r^w = .04. a. Calculate the current account balance. b. Calculate net exports. c. Calculate desired consumption. d. Calculate absorption.

If business taxes rise in a large open economy, it causes the current account to and saving to .