Deck 32: A Macroeconomic Theory of the Open Economy

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.

Answer 1

False

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.

Answer 2

False

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.

Answer 3

True

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.

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.

Question 6

The supply of loanable funds comes from:

A) the government
B) national saving
C) domestic investment
D) foreign sources

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.

Question 8

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

Question 9

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

Question 10

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

A) the real interest rate
B) exports
C) imports
D) none of the above

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.

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.

Question 13

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

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.

Question 15

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

Question 16

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

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.

Question 18

Net foreign investment represents 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.

Question 20

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

A) trade advantage
B) trade balance
C) trade surplus
D) trade deficit

Question 21

In the market for foreign-currency exchange, the supply curve represents:

A) national saving
B) private saving
C) domestic investment
D) net foreign investment
E) none of the above

Question 22

Graph 32-1

In Graph 32-1, an increase in the government budget deficit causes the equilibrium in the economy to move from:

A) A to B in panel (a) and from E₁ to E₂ in panel (c)
B) B to A in panel (a) and from E₂ to E₁ in panel (c)
C) A to B in panel (a) and from E₂ to E₁ in panel (c)
D) B to A in panel (a) and from E₁ to E₂ in panel (c)

Question 23

If the interest rate were below the equilibrium level, the quantity of loanable funds supplied would _____ the quantity demanded.

A) be greater than
B) exactly equal
C) be less than
D) be independent of

Question 24

The theory of purchasing-power parity implies that the demand curve for foreign-currency exchange is:

A) downward-sloping
B) upward-sloping
C) vertical
D) horizontal
E) the theory doesn't imply anything about the shape of the demand curve

Question 25

An appreciation of the Australian real exchange rate _____ the quantity of dollars demanded in the market for foreign-currency exchange.

A) reduces
B) increases
C) leaves unchanged
D) could have any effect on

Question 26

Ceteris paribus, if the Australian real interest rate were to increase, Australian net foreign investment would:

A) rise
B) be unaffected
C) fall
D) it is impossible to tell

Question 27

The key determinant of net foreign investment is:

A) the real exchange rate
B) the nominal interest rate
C) the real interest rate
D) the nominal exchange rate

Question 28

The real exchange rate is:

A) the nominal price of domestic goods
B) the relative price of domestic and foreign goods
C) the absolute price of foreign goods
D) none of the above

Question 29

In the macroeconomic model of the open economy developed in the text, if the central bank increases the money supply, the price level will:

A) rise, the real interest rate will rise, the nominal interest rate will rise, the real exchange rate will rise and the nominal exchange rate will rise
B) rise, the real interest rate will be unaffected, the nominal interest rate will rise, the real exchange rate will be unaffected and the nominal exchange rate will rise
C) rise, the real interest rate will be unaffected, the nominal interest rate will be unaffected, the real exchange rate will be unaffected and the nominal exchange rate will be unaffected
D) rise, the real interest rate will be unaffected, the nominal interest rate will rise, the real exchange rate will be unaffected and the nominal exchange rate will fall

Question 30

The demand for loanable funds comes from:

A) domestic investment
B) net foreign investment
C) national saving
D) both A and B
E) A, B and C

Question 31

In the market for foreign-currency exchange, the demand curve represents:

A) national saving
B) private saving
C) net foreign investment
D) domestic investment
E) none of the above

Question 32

In the open economy:

A) Net foreign investment = Exports
B) Net foreign investment = Imports
C) Net foreign investment = Net exports
D) Net foreign investment = Exports - Imports
E) both C and D

Question 33

In an open economy, a government budget deficit:

A) lowers net foreign investment and pushes the trade balance towards deficit
B) raises net foreign investment and pushes the trade balance towards surplus
C) raises net foreign investment and pushes the trade balance towards deficit
D) lowers net foreign investment and pushes the trade balance towards surplus

Question 34

In using the open-economy macroeconomic model to analyse an event, the first step is to:

A) determine which of the supply and demand curves the event affects
B) determine which way the curves shift
C) use the supply-and-demand diagrams to examine how the shifts alter the economy's equilibrium
D) it doesn't matter in which order the steps are taken

Question 35

If the real exchange rate were above the equilibrium level, the currency would:

A) not change
B) appreciate
C) depreciate
D) fluctuate

Question 36

At the equilibrium real exchange rate, the demand for dollars to buy:

A) foreign assets exactly balances the supply of dollars to be exchanged into foreign currency to buy domestic assets
B) net exports exactly balances the supply of dollars to be exchanged into foreign currency to buy net imports
C) foreign assets exactly balances the supply of dollars to be exchanged into foreign currency to buy net exports
D) net exports exactly balances the supply of dollars to be exchanged into foreign currency to buy foreign assets

Question 37

In the graph below, if the real interest rate is R₁, the quantity of loanable funds demanded is:

A) Q₀ and the quantity supplied is Q₀
B) Q₂ and the quantity supplied is Q₀
C) Q₂ and the quantity supplied is Q₁
D) Q₀and the quantity supplied is Q₁
E) Q₁ and the quantity supplied is Q₂

Question 38

Graph 32-1

In Graph 32-1, an increase in the government budget deficit causes the equilibrium interest rate to:

A) be unchanged
B) increase from r₁ to r₂ in panel (a)
C) increase from E₁ to E₂ in panel (c)
D) decrease from r₂ to r₁ in panel (a)
E) both B and C

Question 39

In the market for foreign-currency exchange, E1 is:

A) the price of goods and services in the present relative to goods and services in the future
B) the price of goods and services in the future relative to goods and services in the present
C) the price of foreign goods and services relative to domestic goods and services
D) the price of domestic goods and services relative to foreign goods and services

Question 40

In the market for loanable funds, r0 is:

A) the price of goods and services in the present relative to goods and services in the future
B) the price of domestic goods and services relative to foreign goods and services
C) the price of goods and services in the future relative to goods and services in the present
D) the price of foreign goods and services relative to domestic goods and services

Question 41

A large and sudden movement of funds out of a country is called:

A) capital mobility
B) capital outflow
C) liquidity preference
D) capital flight

Question 42

NARRBEGIN 32-2
Graph 32-2

Trade policies:

A) directly affect a country's overall trade balance
B) affect specific firms and industries in countries
C) do not affect specific firms and industries in countries
D) both A and C

Question 43

NARRBEGIN 32-2
Graph 32-2

Which of the following statements is correct when the Australian government runs a budget deficit?

A) The supply of loanable funds increases
B) The interest rate falls
C) The dollar appreciates
D) It causes a trade balance surplus

Question 44

If a country experienced a large and sudden movement of funds out of it, the interest rate would:

A) increase
B) decrease
C) be unaffected
D) fluctuate

Question 45

NARRBEGIN 32-2
Graph 32-2

When capital flows out of Country A to Country B, Country A's net foreign investment will:

A) fall, and Country B's net investment will rise
B) rise, and Country B's net investment will rise
C) rise, and Country B's net investment will fall
D) fall, and Country B's net investment will fall

Question 46

Suppose that the government imposes a quota on imports. Explain why the result is a fall in imports and an equal fall in exports. (Hint: Think about what happens to net exports, and about what happens to the exchange rate.)

Question 47

NARRBEGIN 32-2
Graph 32-2

In Graph 32-2, capital flight from Indonesia causes the supply of rupiah in the foreign-currency exchange market to:

A) decrease from S₀ to S₁
B) increase from S₁ to S₀
C) be unaffected
D) it is impossible to tell what happens to the supply of pesos

Question 48

NARRBEGIN 32-2
Graph 32-2

What is the difference between the supply of loanable funds in a closed economy and that in an open economy?

Question 49

NARRBEGIN 32-2
Graph 32-2

In Graph 32-2, capital flight from Indonesia causes the demand for loanable funds in Indonesia to:

A) decrease from D₀ to D₁
B) increase from D₁ to D₀
C) be unaffected
D) it is impossible to tell what happens to net foreign investment

Question 50

NARRBEGIN 32-2
Graph 32-2

Which of the following statements is not correct when the government runs a budget deficit?

A) The supply of loanable funds decreases
B) The interest rate rises
C) Net foreign investment increases
D) The real exchange rate appreciates

Question 51

A tax on imported goods is called a(n):

A) excise tax
B) goods and services tax
C) import quota
D) tariff

Question 52

Commentators often refer to government budget deficits and trade deficits as 'twin deficits'. Explain how the two types of deficit are related.

Question 53

A removal of trade restrictions:

A) reduces the interference upon gains from trade and therefore increases overall economic wellbeing
B) alters a country's balance of trade and therefore are fully justified
C) can be used to punish other countries and therefore are fully justified
D) protect domestic jobs and therefore are fully justified

Question 54

Suppose that the government of the small nation of Stabilia is overturned by a military coup (the new ruling junta restores the country's old name of Instabilia). What would you expect to happen to Instabilia's real interest rate and real exchange rate?

Question 55

NARRBEGIN 32-2
Graph 32-2

Capital flight from a country:

A) decreases its interest rates and increases the value of its currency in the foreign exchange market
B) decreases its interest rates and decreases the value of its currency in the foreign exchange market
C) increases its interest rates and increases the value of its currency in the foreign exchange market
D) increases its interest rates and decreases the value of its currency in the foreign exchange market

Question 56

Trade policies that directly affect exports or imports:

A) also affect net exports
B) also affect net foreign investment
C) also affect real interest rates
D) also affect national saving and domestic investment
E) none of the above

Question 57

NARRBEGIN 32-2
Graph 32-2

If money is neutral, the nominal exchange rate must _____ when the domestic price level rises.

A) fall
B) rise
C) not change
D) none of the above

Question 58

NARRBEGIN 32-2
Graph 32-2

An appreciation of the Australian real exchange rate:

A) reduces the quantity of dollars demanded in the market for foreign-currency exchange
B) makes Australian goods become more expensive relative to foreign goods
C) makes Australian goods more attractive to consumers at home and abroad
D) reduces Australian exports and increases Australian imports

Question 59

Explain how net foreign investment is part of the demand for loanable funds and simultaneously part of the supply of dollars in the foreign exchange market.

Question 60

NARRBEGIN 32-2
Graph 32-2

When a government imposes a tariff on imports, the current account for a given real exchange rate:

A) rises
B) falls
C) does not change
D) fluctuates

Question 61

Citing a recent example, describe how a loss of overseas confidence due to political/financial instability may cause that country's exchange rate to depreciate.

Question 62

Economists have argued that removing trade restrictions benefits Australian industries that
produce goods for export. Explain why this may be the case.

Question 63

How does an increase in the money supply affect the nominal exchange rate if the real exchange rate is not affected by the monetary shock?

Question 64

Explain why the Australian dollar may appreciate owing to a change in interest rates?