Question 1

If political instability in Egypt causes capital flight, Egyptian net foreign investment will increase, the demand for loanable funds will increase, the real interest rate will increase and the real exchange rate will appreciate.

Accepted Answer

If there is capital flight due to political instability, Egyptian net foreign investment will decrease, not increase. This would cause a decrease in the demand for loanable funds, a decrease in the real interest rate, and a depreciation of the real exchange rate, as investors seek to sell off Egyptian assets and move their funds abroad.

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 price of imports will increase on the domestic market if there is a strong local currency, but if there is a shortage of supply, there may be no imports available to increase in price. Instead, the price of domestic goods may increase due to the shortage.

Question 3

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 principle in international finance. Supply of a currency comes from net foreign investment, as foreign investors exchange their currency for the domestic currency to invest in the country. The demand for a currency comes from the current account balance, as imports require payment in foreign currency while exports bring in foreign currency. The real exchange rate then balances supply and demand by adjusting the nominal exchange rate for differences in inflation rates between countries.

Question 4

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

This is because the theory of purchasing-power parity suggests that in the long run, the exchange rate will adjust to ensure that the same basket of goods has the same price in different countries, which means that the demand curve is horizontal at that level of real exchange rate.

Question 5

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. If the cost of luxury imports increase, then demand for these goods may decrease as consumers may choose to spend their money on other goods instead. This can impact how nations behave and their overall trade balance.

Question 6

The supply of loanable funds comes from:

Accepted Answer

The supply of loanable funds comes from national saving, which includes both private and public saving. This includes the money that individuals and businesses save, as well as the money that the government saves from collecting taxes that are not spent immediately. Domestic investment (C) is a demand for loanable funds, not a source of supply. Foreign sources (D) may provide loans, but they do not contribute to the domestic supply of loanable funds.

Question 7

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, industries and foreign countries, as they can create barriers or incentives for trade that can affect the flow of goods and services. For example, tariffs on a particular product can make it harder for foreign firms to export it to the country implementing the policy, which can harm those firms and the industries they belong to. Conversely, subsidies or preferential treatment for domestic firms can give them an advantage over their foreign competitors, which can distort trade patterns and harm foreign countries. Overall, trade policies can have complex and far-reaching effects that go beyond the simple question of trade balance.

Question 8

Fears about governments in Europe being able to finance their debts are unfounded, as they have a strong economy.

Accepted Answer

Fears about governments in Europe being able to finance their debts are not entirely unfounded, as some countries have struggled with high levels of debt and low economic growth. While the overall economy of Europe is strong, individual countries can still face challenges in financing their debts.

Question 9

Participants in the market for foreign-currency exchange trade Australian dollars in exchange for foreign currencies.

Accepted Answer

The statement correctly describes the market for foreign currency exchange where individuals, businesses and financial institutions trade one currency for another, including the Australian dollar for foreign currencies.

Question 10

The supply of and demand for loanable funds directly depends on:

Accepted Answer

The real interest rate plays a crucial role in determining the supply of and demand for loanable funds. As the real interest rate increases, the incentive for individuals to save increases, leading to a greater supply of loanable funds. At the same time, a higher real interest rate increases the cost of borrowing, leading to a lower demand for loanable funds. Conversely, a decrease in the real interest rate would decrease the supply of loanable funds and increase the demand for loanable funds. Therefore, the supply of and demand for loanable funds directly depends on the real interest rate.

Question 11

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 increased demand for borrowing, which raises the interest rates in the economy. This increase in interest rates makes borrowing more expensive for domestic investors, leading to a decrease in domestic investment. As the trade balance is the difference between domestic savings and investment, a decrease in domestic investment leads to a decrease in the trade balance, resulting in a trade deficit. Additionally, as foreign investors seek to invest in the country due to the higher interest rates, it increases the demand for the country's currency, leading to its appreciation.

Question 12

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 13

Ceteris paribus, in an open economy, a stable government fiscal policy enables firms to invest more assuredly.

Accepted Answer

In an open economy, the government fiscal policy can have a significant impact on investment decisions by firms. When the government implements a stable fiscal policy, firms can plan their investments more effectively because they have a better understanding of the economic environment they will be operating in. This enables them to invest more assuredly because they can anticipate any changes in tax rates, government spending patterns, or other macroeconomic factors that could affect their operations. As a result, stable government fiscal policy tends to be beneficial for investment in an open economy.

Question 14

The demand curve for foreign-currency exchange slopes downwards because a lower real exchange rate makes the domestic goods more expensive and reduces the quantity of domestic currency demanded to buy those goods.

Accepted Answer

A lower real exchange rate makes domestic goods cheaper for foreigners, increasing the demand for domestic currency to buy those goods, which is why the demand curve for foreign-currency exchange slopes downwards.

Question 15

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

Accepted Answer

The demand for loanable funds comes from domestic investment and net foreign investment, therefore, it is true.

Question 16

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

Accepted Answer

The answer of A strong domestic dollar, ceteris paribus, may...

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

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 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

China's economy has been growing rapidly in recent years and is projected to continue to do so. It is expected to surpass the United States as the world's largest economy in the next decade.

Question 20

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

Accepted Answer

When exports exceed imports, the country has a trade surplus, meaning it is selling more goods and services overseas than it is buying from foreign markets. This can lead to increased economic growth and job creation within the country.

Quiz 32: A Macroeconomic Theory of the Open Economy