During the 1970s, U.S. prices generally rose faster than prices in other parts of the world. Which of the following changes would the open economy effect predict took place in response to these price level changes?
A)Americans reduced the proportion of foreign goods bought since their foreign prices became relatively lower.
B)Americans reduced the amount of investment they undertook because interest rates increased.
C)Americans reduced the amount of goods and services they wanted to purchase for consumption because they felt less wealthy.
D)Americans reduced the fraction of purchases they made from domestic producers of goods and services, since foreign prices became relatively lower.

Question

During the 1970s, U.S. prices generally rose faster than prices in other parts of the world. Which of the following changes would the open economy effect predict took place in response to these price level changes?
A)​Americans reduced the proportion of foreign goods bought since their foreign prices became relatively lower.
B)​Americans reduced the amount of investment they undertook because interest rates increased.
C)​Americans reduced the amount of goods and services they wanted to purchase for consumption because they felt less wealthy.
D)​Americans reduced the fraction of purchases they made from domestic producers of goods and services, since foreign prices became relatively lower.

Quizplus · Accepted Answer

The open economy effect predicts that as prices rise in one country, other countries become relatively cheaper, leading to an increase in imports and a decrease in domestic production. Therefore, Americans would reduce the fraction of purchases they made from domestic producers of goods and services, since foreign prices became relatively lower. Choice A is incorrect because as foreign prices become relatively cheaper, Americans would increase their proportion of foreign goods bought. Choice B is incorrect because higher interest rates would actually encourage more investment. Choice C is incorrect because the feeling of being less wealthy would not directly affect the demand for goods and services.