Deck 12: Production and Growth

Question 1

Under a floating system, the exchange rate:

A)fluctuates in response to changing economic conditions.
B)is maintained at a predetermined level by the central bank.
C)is changed at regular intervals by the central bank.
D)fluctuates in response to changes in the price of gold.

Answer 1

A

Question 2

In a small open economy with a floating exchange rate, the exchange rate will depreciate if:

A)the money supply is decreased.
B)import quotas are imposed.
C)government spending is increased.
D)taxes are decreased.

Answer 2

D

Question 3

The intersection of the IS* and LM* curves shows the and the at which both the goods market and the money market are in equilibrium.

A)interest rate; price level price
B)level; exchange rate level of
C)output; exchange rate level of
D)output; price level

Answer 3

C

Question 4

The Mundell-Fleming model assumes that:

A)prices are flexible, whereas the IS-LM model assumes that prices are fixed.
B)prices are fixed, whereas the IS-LM model assumes that prices are flexible.
C)as in the IS-LM model, prices are fixed.
D)as in the IS-LM model, prices are flexible.

Question 5

In the Mundell-Fleming model on a Y - e graph, the curves labeled IS* and LM* are labeled that way as a reminder that:

A)the price level is held constant at the world price level p*.
B)the interest rate is held constant at the world interest rate r*.
C)the exchange rate is held constant at the world exchange rate e*.
D)output is held constant at the full employment level.

Question 6

If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the LM* curve:

A)slopes upward and to the right because at a higher income a higher interest rate is needed to increase velocity.
B)is vertical because monetary velocity is independent of the interest rate.
C)is vertical because the exchange rate does not enter into the LM* equation.
D)slopes upward and to the right because a higher exchange rate leads to a higher income.

Question 7

In the Mundell-Fleming model, the domestic interest rate is determined by the:

A)intersection of the LM and IS curves.
B)domestic rate of inflation.
C)world rate of inflation.
D)world interest rate.

Question 8

In the Mundell-Fleming model:

A)the exchange rate system must have a floating exchange rate.
B)the exchange rate system must have a fixed exchange rate.
C)it makes no difference whether the exchange rate system has a floating or a fixed exchange rate.
D)the behavior of the economy depends on whether the exchange rate system has a floating or a fixed exchange rate.

Question 9

In a small open economy with a floating exchange rate, the exchange rate will appreciate if:

A)the money supply is increased. the
B)money supply is decreased.
C)government spending is decreased.
D)taxes are decreased.

Question 10

If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the IS* curve:

A)slopes downward and to the right because the higher the exchange rate, the lower the level of net exports and, therefore, of short-run equilibrium income in the goods market.
B)is vertical because there is only one investment level that is consistent with the world interest rate.
C)is vertical because the exchange rate does not enter into the IS* equation.
D)slopes downward and to the right because the higher the exchange rate, the higher the level of net exports and, therefore, of short-run equilibrium income in the goods market.

Question 11

In the Mundell-Fleming model, the exogenous variables are the:

A)world interest rate, the price level, and the exchange rate.
B)level of government spending, taxes, and income.
C)exchange rate and level of income.
D)price level, world interest rate, monetary policy, and fiscal policy.

Question 12

Compared to a closed economy, an open economy is one that:

A)allows the exchange rate to float.
B)fixes the exchange rate.
C)trades with other countries.
D)does not trade with other countries.

Question 13

In a small open economy with perfect capital mobility, if the domestic interest rate were to rise above the world interest rate, then would drive the domestic interest rate back to the level of the world interest rate.

A)capital inflow
B)capital outflow
C)the central bank
D)a decline in domestic saving

Question 14

In a small open economy, a decrease in its exchange rate will net exports and shift the curve.

A)increase; IS
B)decrease; IS
C)increase; LM
D)decrease; LM

Question 15

Assuming there is perfect capital mobility, compared to a large open economy, a small open economy is one in which the:

A)exchange rate is fixed.
B)exchange rate is floating.
C)domestic interest rate equals the world interest rate.
D)domestic interest rate is not equal to the world interest rate.

Question 16

In a small open economy with a floating exchange rate, an effective policy to increase equilibrium output is to:

A)increase government spending.
B)increase taxes.
C)increase the money supply.
D)decrease the money supply.

Question 17

In a small open economy with a floating exchange rate, if the government adopts an expansionary fiscal policy, in the new short-run equilibrium:

A)income and the exchange rate will both rise.
B)the exchange rate will rise, but income will remain unchanged.
C)income will rise, but the exchange rate will remain unchanged.
D)both income and the interest rate will rise.

Question 18

-In a small open economy with a floating exchange rate, a rise in government spending in the new short-run equilibrium:

A)chokes off investment, but not by as much as the new government spending.
B)chokes off an amount of investment just equal to the new government spending.
C)attracts foreign capital, thus raising the exchange rate and reducing net exports, but not by as much as the new government spending.
D)attracts foreign capital, thus raising the exchange rate and reducing net exports by an amount just equal to the new government spending.

Question 19

In a small open economy with a floating exchange rate, an effective policy to decrease equilibrium output is to:

A)decrease government spending.
B)decrease taxes.
C)increase the money supply.
D)decrease the money supply.

Question 20

The Mundell-Fleming model is a model for a open economy.

A)short-run; small
B)short-run; large
C)long-run; large
D)long-run; small

Question 21

Macroland is a small open economy with perfect capital mobility and a flexible exchange-rate system. Macroland is initially in equilibrium at the natural level of output with balanced trade. Compare the impact of a tax cut in the short run (when prices are fixed) and in the long run (when prices are flexible) on: a) output, b) consumption, c) investment, d) net exports, and e) the exchange rate.

Question 22

In early 1994, Mexico was adhering to a fixed-exchange-rate system. Use the Mundell-Fleming model to illustrate graphically the short-run impact on the exchange rate and level of output of increased country risk caused by the Chiapas uprising and the assassination of presidential candidate Colosio. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question 23

In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, then in the new short-run equilibrium:

A)imports will decrease while exports remain constant, leading to a rise in net exports.
B)imports will decrease and exports will increase, leading to a rise in net exports.
C)imports will decrease and exports will decrease by an equal amount.
D)both imports and exports will remain unchanged.

Question 24

Suppose Congress cuts government spending in order to balance the budget. Use the Mundell-Fleming model with floating exchange rates to illustrate graphically the short-run impact of the cuts in government spending on the dollar exchange rate and output in the United States. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question 25

In a small open economy with a floating exchange rate, if the government decreases the money supply, then in the new short-run equilibrium:

A)income falls and the exchange rate rises.
B)the exchange rate falls and income rises.
C)income remains unchanged but the exchange rate rises.
D)the exchange rate remains unchanged but income falls.

Question 26

In a small open economy with a floating exchange rate, if the government imposes an import quota, then in the new short-run equilibrium the IS* curve shifts to the right, raising the exchange rate:

A)but not raising net exports or income.
B)and net exports but not income.
C)and income but not net exports.
D)net exports and income.

Question 27

In a small open economy with a floating exchange rate, the supply of real money balances is fixed and a rise in government spending:

A)raises the interest rate, so that income must rise to maintain equilibrium in the money market.
B)raises the interest rate so that net exports must fall to maintain equilibrium in the goods market.
C)cannot change the interest rate so that net exports must fall to maintain equilibrium in the goods market.
D)cannot change the interest rate so income must rise to maintain equilibrium in the money market.

Question 28

In a small open economy with a floating exchange rate, if the government increases the money supply, then in the new short-run equilibrium the:

A)interest rate falls and the level of investment rises.
B)exchange rate falls and net exports increase.
C)interest rate falls but the level of investment does not rise.
D)exchange rate falls but net exports do not increase.

Question 29

Explain how net capital outflows change in a large open economy when there is a:
a. monetary contraction, and b. fiscal contraction.

Question 30

Assume that the LM curve for a small open economy with a floating exchange rate is given by Y = 200r - 200 + 2(M/P), while the IS curve is Y = 400 + 3G - 2T + 3NX - 200r. The function for the net exports is NX = 200 - 100e, where e is the exchange rate. The price level (P) is fixed at 1.0. The international interest rate is r* = 2.5 percent.
a.Using the LM curve, find the equilibrium level of Y in the small open economy, if M = 100. b.Given this value of Y, if G = 100 and T = 100, what must be the equilibrium value of NX? c.If this value of NX is to be achieved, what must be the equilibrium exchange rate, e?

Question 31

Assume that the LM curve for a small open economy with a fixed exchange rate is given by Y = 200r - 200 + 2(M/P). This IS curve is given by Y = 400 + 3G - 2T + 3NX - 200r. The function for the net exports is NX = 200 - 100e, where e is the exchange rate. The price level is fixed at 1.0, the world interest rate is r* = 2.0 percent, and the exchange rate is initially 1.0.
a. If M = 100, G = 100, and T = 100, solve for the equilibrium short-run values of Y and NX. Is the initially given exchange rate equal to the equilibrium exchange rate?
b. If the Fed buys bonds in order to raise the money supply, will equilibrium Y increase?

Question 32

Economic expansion throughout the rest of the world raises the world interest rate. Use the Mundell-Fleming model to illustrate graphically the impact of an increase in the world interest rate on the exchange rate and level of output in a small open economy with a floating-exchange-rate system. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question 33

a. You are the chief economic adviser in a small open economy with a floating-exchange-rate system. Your boss, the president of the country, wishes to increase the level of output in the short run in order to win reelection. Do you recommend using expansionary or contractionary, monetary or fiscal policy?
b. Use the Mundell-Fleming model to illustrate graphically your proposed policy. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question 34

Two small open economies, Fixed and Flex, can be described by the Mundell-Fleming model. The countries are otherwise identical except that Fixed maintains a fixed exchange rate, while Flex maintains a flexible exchange-rate regime. The governments of both countries increase spending by the same amount. Compare what happens in the two countries to:
a. the exchange rate,
b. equilibrium output, and c. net exports.

Question 35

The "impossible trinity" refers to the idea that a country can simultaneously pursue only two of the three following policies: free international-capital flows, monetary policy for domestic stabilization, and a fixed exchange rate. For each of the following combinations indicate what the economy gives up by selecting the combination and why the omitted policy cannot be achieved:
a. a fixed exchange rate and free international-capital flows
b. a monetary policy for domestic stabilization and a fixed exchange rate
c. a monetary policy for domestic stabilization and free international-capital flows

Question 36

Suppose the government of a small open economy with a floating exchange rate imposes 50 percent tariffs on all imports. Use the Mundell-Fleming model to illustrate graphically the short-run impact of the tariffs on the exchange rate and output in the country. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question 37

According to the Mundell-Fleming model for a small open economy with flexible exchange rates, if the Federal Reserve cannot alter domestic interest rates, changes in the money supply could still influence aggregate income through changes in the:

A)exchange rate.
B)price level.
C)level of government spending.
D)tax rates.