Question 1

When we measure the impact of exchange rate changes on a nation's trade balance, the bilateral exchange rates explain only part of the change. To assess the overall change, we need to calculate:
A) the home multilateral exchange rate, or real effective exchange rate.
B) a nation's income versus income changes in the rest of the world.
C) a nation's marginal propensity to consume imports.
D) the movement over time of the trade balance along with long-run expectations of the exchange rate.

Accepted Answer

Bilateral exchange rates only provide a partial explanation of the impact of exchange rate changes on a nation's trade balance. To assess the overall change, we need to calculate the home multilateral exchange rate, also known as the real effective exchange rate. This takes into account the trade-weighted average of a nation's bilateral exchange rates with other countries and adjusts for inflation.

Question 2

If we assume sticky prices in both foreign and domestic trading nations, the rate of pass-through from the nominal to the real exchange rate falls as:
A) the percentage of traded goods priced in foreign currencies rises.
B) the percentage of traded goods priced in the domestic currency rises.
C) the percentage change in the exchange rate exceeds the percentage increase in inflation.
D) traders find new markets and are able to avoid nations with currency depreciations.

Accepted Answer

The percentage of traded goods priced in foreign currencies rises means that the price of imported goods is less affected by changes in the exchange rate, so the pass-through from the nominal to the real exchange rate falls.

Question 3

Data on the relationship between the U.S. multilateral real exchange rate and the U.S. trade balance show:
A) a surprising result that the decrease in the trade balance is correlated with an increase (depreciation) of the U.S. dollar multilateral real exchange rate.
B) a predictable result that the increase in the trade balance is correlated with an increase (depreciation) of the U.S. dollar multilateral real exchange rate.
C) a correlation that is so weak it cannot be used to support the theory that the trade balance is related to the real effective exchange rate of the U.S. dollar.
D) a surprising result that the increase in the U.S. trade balance occurs with a decrease (appreciation) in the real effective exchange rate of the dollar.

Accepted Answer

The increase in the trade balance being correlated with an increase (depreciation) of the U.S. dollar multilateral real exchange rate is predictable because a weaker dollar makes U.S. exports cheaper and imports more expensive, potentially improving the trade balance.

Question 4

Suppose that the dollar real exchange rate falls by 10% against the euro, 20% against the pound, and 25% against the yen. If the United States trades equally with each country, what is the percentage decline in the real effective exchange rate?
A) 22.5%
B) 18.3%
C) 15.1%
D) 20.3%

Accepted Answer

To calculate the real effective exchange rate (REER) we need to take the weighted average of the exchange rates with each country, where the weights represent the share of trade with each country. Since the United States trades equally with each country, the weights will be equal. Therefore, the REER can be calculated as:

REER = (1/3)*(0.9*1 + 0.8*1 + 0.75*1)

where 0.9, 0.8, and 0.75 represent the new exchange rates for the euro, pound, and yen respectively (note that we multiply by 1 to convert from a percentage decline to the new exchange rate).

Simplifying the expression we get:

REER = (1/3)*(2.45) = 0.8167

The percentage decline in the REER is then:

100*(1 - 0.8167) = 18.33%

Therefore, the correct answer is B, 18.3%.

Question 5

Full pass-through means that a 10% rise in the overseas price of an imported good leads to:
A) a 100% rise in the domestic price.
B) a greater than 10% rise in the domestic price.
C) a 10% rise in the domestic price.
D) a less than 10% rise in the domestic price.

Accepted Answer

Full pass-through means that the entire change in the foreign price is passed onto the domestic price. Therefore, a 10% rise in the overseas price of an imported good leads to a 10% rise in the domestic price.

Question 6

Sometimes a change in the real effective multilateral exchange rate has the opposite result from what one would expect. One explanation may be that:
A) buying habits are very strong and firms and consumers continue their behavior despite large changes in prices of imports.
B) price changes do not bring about immediate responses in import or export volume because of contracts, or firms' difficulty in changing suppliers quickly.
C) the theory is fundamentally flawed and does not predict well.
D) there are other factors we are not considering that affect the trade balance.

Accepted Answer

Contracts and difficulty in changing suppliers quickly can delay the response to price changes, leading to unexpected outcomes in the trade balance.

Question 7

In order to assess the relationship between the real exchange rate and total exports for any nation, one must construct a real effective exchange rate that measures:
A) a composite of each trading partner's real exchange rate change weighted by the share of trade.
B) the exchange rate that would exist with no inflation and balanced trade.
C) the average of all nominal exchange rates since we assume no inflation.
D) nominal trade adjusted for inflation.

Accepted Answer

The real effective exchange rate should be a composite of each trading partner's real exchange rate change weighted by the share of trade. This takes into account the different trade relationships that a country has and how the real exchange rate affects each of those relationships.

Question 8

The J curve effect in reference to the trade balance may persist:
A) for up to one year after the depreciation.
B) permanently.
C) for a few weeks only.
D) for up to 10 years after the depreciation.

Accepted Answer

The J curve effect typically persists for a short to medium term, often up to one year, as it takes time for the trade balance to initially worsen and then improve following a currency depreciation.

Question 9

Suppose the MPC is 0.8 in Canada and the MPC_his 0.55. If income increases by $100 million in Canada, then the increase in consumption of foreign goods will be: A) $35 million. B) $25 million. C) $80 million. D) $100 million.

Accepted Answer

MPC (marginal propensity to consume) in Canada is 0.8, meaning that for every $1 increase in income, Canadian consumers will spend $0.8. MPC_h is the marginal propensity to consume foreign goods, meaning for every $1 increase in income, consumers will spend $0.55 on foreign goods. Therefore, if income increases by $100 million in Canada: - Canadian consumers will spend $0.8 * $100 million = $80 million on domestic goods - Canadian consumers will spend $0.2 * $100 million = $20 million on foreign goods - The increase in consumption of foreign goods will be $20 million * 0.55 = $11 million - Converted to CAD: $11 million / 1.33 (let's assume CAD/USD exchange rate of 1.33) = $8.27 million Therefore, the increase in consumption of foreign goods is $8.27 million which is closest to answer B, $25 million.

Question 10

In 2009, there was an unlikely boom in British cross-Channel grocery deliveries to France because of:
A) an increase in French income.
B) an increase in French preferences for British food items.
C) crop failures in France due to a year-long drought.
D) a dramatic weakening of the British pound against the euro over the previous 18 months.

Accepted Answer

The dramatic weakening of the British pound against the euro over the previous 18 months made British products cheaper for French consumers to purchase, leading to a boom in cross-Channel grocery deliveries to France.

Question 11

In 2004, retailers and exporters in the United States were happy, as were their customers from abroad, because of:
A) a reduction in import tariffs by the EU.
B) the lifting of an embargo on U.S. exports to Germany.
C) the high value of the U.S. dollar compared with other currencies.
D) the low value of the U.S. dollar compared with other currencies.

Accepted Answer

A low value of the U.S. dollar compared to other currencies would make U.S. exports cheaper for foreign buyers, increasing demand for U.S. goods and potentially boosting sales for U.S. retailers and exporters.

Question 12

The J curve effect means that import prices are higher, thus revenues paid out increase while export prices are lower and incoming revenues decrease. Therefore, after a currency depreciation:
A) the trade balance will improve, then decline, then improve, and then decline, appearing to be a series of J shapes.
B) the trade balance will increase, then decrease, then jump higher, which economists call the J curve effect.
C) the nation will cut back on imports immediately causing the trade balance to improve, which gives the curve an inverted J shape.
D) the trade balance decreases and then increases over time giving the curve a J shape.

Accepted Answer

The J curve effect refers to the initial decrease in the trade balance followed by an increase over time. This creates a J-shaped curve on a graph plotting the trade balance against time. Option D describes this phenomenon accurately.

Question 13

Suppose that the United States does  of its trade with Canada,  with the United Kingdom, and  with Mexico. If the dollar real exchange rate rises by 10% with Canada, rises by 20% for the United Kingdom, and falls by 10% for Mexico, what is the percentage change in the real effective exchange rate?
A) 11.5%
B) 10%
C) 7.5%
D) -2.5%

Accepted Answer

The answer of Suppose that the United States does ...

Question 14

The devaluation of a currency results in a(n):
A) initial increase in trade balance, but an eventual decline in the trade balance.
B) permanent decline in the trade balance.
C) permanent increase in the trade balance.
D) initial decrease in trade balance, but an eventual increase in the trade balance.

Accepted Answer

When a currency is devalued, its exports become cheaper while its imports become more expensive, which should lead to an increase in exports and a decrease in imports, resulting in an initial decrease in the trade balance. However, over time, the increased competitiveness of exports should lead to an increase in demand for the devalued currency, causing it to appreciate and eventually leading to an increase in the trade balance. Therefore, while there may be an initial decrease, there should be an eventual increase in the trade balance.

Question 15

When a depreciation in the nation's real effective exchange rate initially lowers the trade balance and then increases it, economists refer to the phenomenon as:
A) the K curve effect.
B) the J curve effect.
C) the real balances effect.
D) the marginal propensity to import.

Accepted Answer

The J curve effect refers to the phenomenon where a depreciation in the real effective exchange rate initially leads to a worsened trade balance (as imports become more expensive and exports take time to adjust), but eventually leads to an improved trade balance (as exports become more competitive and imports become more expensive). This phenomenon is named after the J-shaped curve that can depict the trade balance over time.

Question 16

The final market price of imports may not reflect 100% of changes in the real effective exchange rate because:
A) exchange rates in many nations are fixed.
B) there are restrictions on capital inflows.
C) domestic price distortions, such as markups or taxes, reduce the impact of the exchange rate change.
D) the government has instituted price controls.

Accepted Answer

Domestic price distortions, such as markups or taxes, reduce the impact of the exchange rate change, therefore the final market price of imports may not reflect 100% of changes in the real effective exchange rate. This is because these price distortions affect the final price that the consumer pays for the imported good, making it less sensitive to exchange rate changes. Options A, B, and D are not relevant to the given scenario, as they do not directly address the impact of price distortions on the final market price of imports.

Question 17

Consider the following information on Mexico's trade. Thirty percent of the trade is conducted with country A, 55% of trade with country B, and 15% of trade with country C. If the peso appreciates 10% against country A, depreciates 30% against country B, and depreciates 10% against country C, then the effective trade-weighted real exchange rate experiences a:
A) 15% appreciation.
B) 15% depreciation.
C) 25% depreciation.
D) 20% appreciation.

Accepted Answer

The effective trade-weighted real exchange rate is calculated as a weighted average of the relative exchange rates between the peso and the countries involved in the trade. The weights are the percentages of trade conducted with each country, namely 30% for A, 55% for B, and 15% for C. 
The change in the exchange rate with each country (given in the problem) is multiplied by the corresponding weight and then they are all summed up. 
So, the effective exchange rate change can be calculated as: 
(0.3 x 10%) + (0.55 x -30%) + (0.15 x -10%) = -15%
This means that the effective exchange rate depreciates by 15%. Therefore, the answer is B, 15% depreciation.

Question 18

If a nation trades with another nation in a foreign currency (such as some commodities sold that are priced in U.S. dollars), then, when nominal exchange rates change, the real effective exchange rate will:
A) change by more.
B) change by less.
C) change in exactly the same proportion.
D) not change at all.

Accepted Answer

The real effective exchange rate adjusts for differences in price levels between countries, so it changes by less than the nominal exchange rate when nominal exchange rates change.

Question 19

Suppose the MPC is 0.8 in Canada and the MPC is 0.55 at Home. If income increases by $100 million in Canada, then the increase in consumption of domestic goods will be:
A) $25 million.
B) $80 million.
C) $55 million.
D) $35 million.

Accepted Answer

MPC (marginal propensity to consume) represents the proportion of additional income that will be spent on consumption. 
In Canada: 
∆C = MPC x ∆Y 
∆C = 0.8 x $100 million 
∆C = $80 million

In Home: 
∆C = MPC x ∆Y 
∆C = 0.55 x $100 million 
∆C = $55 million

Therefore, the increase in consumption of domestic goods in Canada will be $80 million, and in Home it will be $55 million.

Question 20

Trade dollarization refers to:
A) the practice of insisting on trade in U.S. dollars.
B) the fact that many international commodities are traded in U.S. dollars only.
C) the fact that many dollars have flowed out of the U.S. and are used in other nations as their national currency.
D) the falling dollar combined with a rising trade balance.

Accepted Answer

Trade dollarization refers to the practice where many international commodities, such as oil and gold, are traded in U.S. dollars, making it the dominant currency for global trade transactions.

Quiz 18: Balance of Payments II: Output, Exchange Rates, and Macroeconomic Policies in the Short Run

When we measure the impact of exchange rate changes on a nation's trade balance, the bilateral exchange rates explain only part of the change. To assess the overall change, we need to calculate:

If we assume sticky prices in both foreign and domestic trading nations, the rate of pass-through from the nominal to the real exchange rate falls as:

Data on the relationship between the U.S. multilateral real exchange rate and the U.S. trade balance show:

Suppose that the dollar real exchange rate falls by 10% against the euro, 20% against the pound, and 25% against the yen. If the United States trades equally with each country, what is the percentage decline in the real effective exchange rate?

Full pass-through means that a 10% rise in the overseas price of an imported good leads to:

Sometimes a change in the real effective multilateral exchange rate has the opposite result from what one would expect. One explanation may be that:

In order to assess the relationship between the real exchange rate and total exports for any nation, one must construct a real effective exchange rate that measures:

The J curve effect in reference to the trade balance may persist:

Suppose the MPC is 0.8 in Canada and the MPC_his 0.55. If income increases by $100 million in Canada, then the increase in consumption of foreign goods will be:

In 2009, there was an unlikely boom in British cross-Channel grocery deliveries to France because of:

In 2004, retailers and exporters in the United States were happy, as were their customers from abroad, because of:

The J curve effect means that import prices are higher, thus revenues paid out increase while export prices are lower and incoming revenues decrease. Therefore, after a currency depreciation:

Suppose that the United States does of its trade with Canada, with the United Kingdom, and with Mexico. If the dollar real exchange rate rises by 10% with Canada, rises by 20% for the United Kingdom, and falls by 10% for Mexico, what is the percentage change in the real effective exchange rate?

The devaluation of a currency results in a(n) :

When a depreciation in the nation's real effective exchange rate initially lowers the trade balance and then increases it, economists refer to the phenomenon as:

The final market price of imports may not reflect 100% of changes in the real effective exchange rate because:

If a nation trades with another nation in a foreign currency (such as some commodities sold that are priced in U.S. dollars) , then, when nominal exchange rates change, the real effective exchange rate will:

Suppose the MPC is 0.8 in Canada and the MPC is 0.55 at Home. If income increases by $100 million in Canada, then the increase in consumption of domestic goods will be:

Trade dollarization refers to: