Eco 305 week 9 quiz – strayer
- 1. ECO 305 Week 9 Quiz – Strayer Click on the Link Below to Purchase A+ Graded Course Material http://budapp.net/ECO-305-Week-9-Quiz-Strayer-366.htm Quiz 8 Chapter 12 and 13 EXCHANGE-RATE DETERMINATION MULTIPLE CHOICE 1. The relationship between the exchange rate and the prices of tradable goods is known as the: a. Purchasing-power-parity theory b. Asset-markets theory c. Monetary theory d. Balance-of-payments theory 2. If the exchange rate between Swiss francs and British pounds is 5 francs per pound, then the number of pounds that can be obtained for 200 francs equals: a. 20 pounds b. 40 pounds c. 60 pounds d. 80 pounds 3. Low real interest rates in the United States tend to: a. Decrease the demand for dollars, causing the dollar to depreciate b. Decrease the demand for dollars, causing the dollar to appreciate c. Increase the demand for dollars, causing the dollar to depreciate d. Increase the demand for dollars, causing the dollar to appreciate 4. High real interest rates in the United States tend to: a. Decrease the demand for dollars, causing the dollar to depreciate b. Decrease the demand for dollars, causing the dollar to appreciate c. Increase the demand for dollars, causing the dollar to depreciate d. Increase the demand for dollars, causing the dollar to appreciate
- 2. 5. Assume that the United States faces an 8 percent inflation rate while no (zero) inflation exists in Japan. According to the purchasing-power parity theory, the dollar would be expected to: a. Appreciate by 8 percent against the yen b. Depreciate by 8 percent against the yen c. Remain at its existing exchange rate d. None of the above 6. In the presence of purchasing-power parity, if one dollar exchanges for 2 British pounds and if a VCR costs $400 in the United States, then in Great Britain the VCR should cost: a. 200 pounds b. 400 pounds c. 600 pounds d. 800 pounds 7. If wheat costs $4 per bushel in the United States and 2 pounds per bushel in Great Britain, then in the presence of purchasing-power parity the exchange rate should be: a. $.50 per pound b. $1.00 per pound c. $2.00 per pound d. $8.00 per pound 8. A primary reason that explains the appreciation in the value of the U.S. dollar in the 1980s is: a. Large trade surpluses for the United States b. Relatively high inflation rates in the United States c. Lack of investor confidence in the U.S. monetary policy d. Relatively high interest rates in the United States 9. The high foreign exchange value of the U.S. dollar in the early 1980s can best be explained by: a. Additional investment funds made available from overseas b. Lack of investor confidence in U.S. fiscal policy c. Market expectations of rising inflation in the United States d. American tourists overseas finding costs increasing
- 3. 10. When the price of foreign currency (i.e., the exchange rate) is below the equilibrium level: a. An excess demand for that currency exists in the foreign exchange market b. An excess supply of that currency exists in the foreign exchange market c. The demand for foreign exchange shifts outward to the right d. The demand for foreign exchange shifts backward to the left 11. When the price of foreign currency (i.e., the exchange rate) is above the equilibrium level: a. An excess supply of that currency exists in the foreign exchange market b. An excess demand for that currency exists in the foreign exchange market c. The supply of foreign exchange shifts outward to the right d. The supply of foreign exchange shifts backward to the left 12. The appreciation in the value of the dollar in the early 1980s is explained by all of the following except: a. The United States being considered a safe haven by foreign investors b. Relatively high real interest rates in the United States c. Confidence of foreign investors in the U.S. economy d. Relatively high inflation rates in the United States 13. Suppose Mexico and the United States were the only two countries in the world. There exists an excess supply of pesos on the foreign exchange market. This suggests that: a. Mexico's current account is in surplus b. Mexico's current account is in deficit c. The U.S. current account is in deficit d. The U.S. current account is in equilibrium 14. If Canada runs a trade surplus with Mexico and exchange rates are floating: a. The peso will depreciate relative to the dollar b. The dollar will depreciate relative to the peso c. The prices of all foreign goods will fall for Canadians
- 4. d. The prices of all foreign goods will rise for Canadians 15. If Mexico's labor productivity rises relative to Europe's labor productivity: a. The peso tends to depreciate against the euro in the short run b. The peso tends to appreciate against the euro in the short run c. The peso tends to depreciate against the euro in the long run d. The peso tends to appreciate against the euro in the long run 16. The international exchange value of the U.S. dollar is determined by: a. The rate of inflation in the United States b. The number of dollars printed by the U.S. government c. The international demand and supply for dollars d. The monetary value of gold held at Fort Knox, Kentucky 17. For the United States, suppose the annual interest rate on government securities equals 8 percent while the annual inflation rate equals 4 percent. For Japan, suppose the annual interest rate on government securities equals 10 percent while the annual inflation rate equals 7 percent. These variables would cause investment funds to flow from: a. The United States to Japan, causing the dollar to depreciate b. The United States to Japan, causing the dollar to appreciate c. Japan to the United States, causing the yen to depreciate d. Japan to the United States, causing the yen to appreciate 18. For the United States, suppose the annual interest rate on government securities equals 12 percent while the annual inflation rate equals 8 percent. For Japan, suppose the annual interest rate equals 5 percent. These variables would cause investment funds to flow from: a. The United States to Japan, causing the dollar to depreciate b. The United States to Japan, causing the dollar to appreciate c. Japan to the United States, causing the yen to depreciate d. Japan to the United States, causing the yen to appreciate
- 5. 19. Given a system of floating exchange rates, stronger U.S. preferences for imports would trigger: a. An increase in the demand for imports and an increase in the demand for foreign currency b. An increase in the demand for imports and a decrease in the demand for foreign currency c. A decrease in the demand for imports and an increase in the demand for foreign currency d. A decrease in the demand for imports and a decrease in the demand for foreign currency 20. Given a system of floating exchange rates, weaker U.S. preferences for imports would trigger: a. An increase in the demand for imports and an increase in the demand for foreign currency b. An increase in the demand for imports and a decrease in the demand for foreign currency c. A decrease in the demand for imports and an increase in the demand for foreign currency d. A decrease in the demand for imports and a decrease in the demand for foreign currency 21. Under a system of floating exchange rates, relatively low productivity and high inflation rates in the United States result in: a. An increase in the demand for foreign currency, a decrease in the supply of foreign currency, and a depreciation in the dollar b. An increase in the demand for foreign currency, an increase in the supply of foreign currency, and an appreciation in the dollar c. A decrease in the demand for foreign currency, a decrease in the supply of foreign currency, and a depreciation in the dollar d. A decrease in the demand for foreign currency, an increase in the supply of foreign currency, and an appreciation in the dollar 22. Under a system of floating exchange rates, relatively high productivity and low inflation rates in the United States result in: a. An increase in the demand for foreign currency, a decrease in the supply of foreign currency, and a depreciation in the dollar b. An increase in the demand for foreign currency, an increase in the supply of foreign currency, and an appreciation in the dollar c. A decrease in the demand for foreign currency, a decrease in the supply of foreign currency, and a depreciation in the dollar
- 6. d. A decrease in the demand for foreign currency, an increase in the supply of foreign currency, and an appreciation in the dollar 23. Which example of market expectations causes the dollar to appreciate against the yen--expectations that the U.S. economy will have: a. Faster economic growth than Japan b. Higher future interest rates than Japan c. More rapid money supply growth than Japan d. Higher inflation rates than Japan 24. Which example of market expectations causes the dollar to depreciate against the yen--expectations that the U.S. economy will have: a. Faster economic growth than Japan b. Higher future interest rates than Japan c. Less rapid money supply growth than Japan d. Lower inflation rates than Japan 25. For an American investor, the expected rate of return on European securities depends on all of the following factors except the: a. Rate of return on equivalent American securities b. The current exchange rate between the dollar and the pound c. Exchange rate anticipated to prevail when the securities mature d. Interest rate paid on European securities 26. Which of the following is likely to result in long-run depreciation of the U.S. dollar relative to the euro? a. Relatively low interest rates in the United States b. Relatively high labor productivity in the United States c. Tariffs levied by the United States on steel imports from Europe d. Stronger American preferences for goods produced in Europe 27. Which of the following is likely to result in long-run appreciation of the U.S. dollar relative to the peso? a. Relatively high interest rates in Mexico b. Relatively high labor productivity in Mexico
- 7. c. Tariffs applied by Mexico on computer imports from the United States d. Stronger Mexican preferences for goods produced in the United States 28. Long-run determinants of the dollar's exchange value include all of the following except: a. Preferences of Americans for foreign produced goods b. U.S. tariffs placed on imports of foreign produced goods c. Productivity of the American worker d. Interest rates in U.S. financial markets 29. Which theory of exchange-rate determination best views the foreign exchange market as being similar to a stock exchange where future expectations are important and prices are volatile? a. Balance-of-payments approach b. Purchasing-power-parity approach c. Asset-markets approach d. Monetary approach 30. According to the purchasing-power-parity theory, the U.S. dollar maintains its purchasing-power parity if it depreciates by an amount equal to the excess of: a. U.S. interest rates over foreign interest rates b. Foreign interest rates over U.S. interest rates c. U.S. inflation over foreign inflation d. Foreign inflation over U.S. inflation 31. An exchange rate is said to ____ when its short-run response to a change in market fundamentals is greater than its long-run response. a. Overshoot b. Undershoot c. Depreciate d. Appreciate 32. Concerning exchange rate forecasting, ____ is a common sense approach based on a wide array of political and economic data.
- 8. a. Econometric analysis b. Technical analysis c. Judgmental analysis d. Sunspot analysis 33. Concerning exchange rate forecasting, ____ involves the use of historical exchange rate data to estimate future values, while ignoring the economic determinants of exchange rate movements. a. Econometric analysis b. Judgmental analysis c. Technical analysis d. Sunspot analysis 34. Concerning exchange rate forecasting, ____ relies on econometric models which are based on macroeconomic variables likely to affect currency values. a. Fundamental analysis b. Technical analysis c. Judgmental analysis d. Sunspot analysis 35. Concerning exchange-rate determination, "market fundamentals" include all of the following except: a. Monetary policy and fiscal policy b. Profitability and riskiness of investments c. Speculative opinion about future exchange rates d. Productivity changes affecting production costs 36. In the short run, exchange rates respond to market forces such as: a. Inflation rates b. Expectations of future exchange rates c. Investment profitability d. Government trade policy 37. Long-run exchange rate movements are governed by all of the following except:
- 9. a. National productivity levels b. Consumer tastes and preferences c. Rates of inflation d. Interest rate levels 38. Exchange rate determination in the short run is underlied by which of the following assumptions: a. Tariffs and quotas affect trade patterns only in the short run b. Prices of goods and services affect trade patterns only in the short run c. Expected returns on financial assets affect investment flows in the short run d. Preferences for goods and services affect trade flows only in the short run 39. That identical goods should cost the same in all nations, assuming it is costless to ship goods between nations and there are no barriers to trade, is a reflection of the: a. Monetary approach to exchange-rate determination b. Law of one price c. Fundamentalist approach to exchange-rate determination d. Exchange-rate-overshooting principle 40. The Canadian dollar would depreciate on the foreign exchange market if: a. Canadian consumer tastes change in favor of goods produced domestically b. The profitability of assets in Canada rises relative to the profitability of assets abroad c. Canada experiences a disastrous wheat-crop failure, leading to imports of more wheat d. Canada realizes technological improvements in the production of manufactured goods, leading to relatively low costs for Canada 41. The demand in the United States for yen will increase if, other things remaining equal: a. Labor costs rise in Japan b. Income rises in Japan c. Prices rise in Japan d. Interest rates rise in Japan
- 10. 42. The quantity of Canadian dollars supplied to the foreign exchange market would increase if, other things remaining equal: a. Preferences for imports rise in Canada b. Labor productivity increases in Canada c. Prices of goods and services decrease in Canada d. Import tariffs rise in Canada 43. The U.S. demand for pesos would shift to the right if there occurred a (an): a. Change in preferences toward U.S. manufactured goods b. Increase in the dollar/peso exchange rate c. Decrease in the U.S. population d. Increase in the U.S. price level 44. The supply of francs, would shift to the right for all of the following reasons except: a. An increase in Swiss real income b. An increase in Swiss prices c. An increase in the Swiss population d. An increase in Swiss interest rates The figure below illustrates the supply and demand schedules of Swiss francs in a market of freely-floating exchange rates. Figure 12.1 The Market for Francs 45. Refer to Figure 12.1. Should preferences for imports rise in the United States and fall in Switzerland, there would occur a (an): a. Increase in the demand for francs--decrease in the supply of francs- depreciation of the dollar b. Increase in the demand for francs--decrease in the supply of francs- appreciation of the dollar c. Decrease in the demand for francs--decrease in the supply of francs- appreciation of the dollar d. Decrease in the demand for francs--increase in the supply of francs- depreciation of the dollar
- 11. 46. Refer to Figure 12.1. Should real interest rates in the United States rise relative to real interest rates in Switzerland, there would occur a (an): a. Increase in the demand for francs--decrease in the supply of francs- depreciation of the dollar b. Increase in the demand for francs--decrease in the supply of francs- appreciation of the dollar c. Decrease in the demand for francs--increase in the supply of francs- appreciation of the dollar d. Decrease in the demand for francs--decrease in the supply of francs- depreciation of the dollar 47. Refer to Figure 12.1. Should the U.S. price level rise relative to the Swiss price level, there would occur a (an): a. Increase in the demand for francs--increase in the supply of francs- appreciation of the dollar b. Decrease in the demand for francs--decrease in the supply of francs- depreciation of the dollar c. Increase in the supply of francs--decrease in the demand for francs- appreciation of the dollar d. Decrease in the supply of francs--increase in the demand for francs- depreciation of the dollar 48. Refer to Figure 12.1. Should the United States impose tariffs on imports from Switzerland, there would occur a (an): a. Increase in the demand for francs and a depreciation of the dollar b. Decrease in the demand for francs and an appreciation of the dollar c. Decrease in the supply of francs and an appreciation of the dollar d. Increase in the supply of francs and a depreciation of the dollar 49. Refer to Figure 12.1. Should Swiss labor productivity rise, leading to a decrease in Swiss manufacturing costs, there would occur a (an): a. Increase in the supply of francs and a depreciation of the dollar b. Increase in the supply of francs and an appreciation of the dollar c. Decrease in the demand for francs and an appreciation of the dollar d. Increase in the demand for francs and a depreciation of the dollar
- 12. 50. Refer to Figure 12.1. If Switzerland experienced a disastrous wheat- crop failure, leading to additional wheat imports from the United States, there would occur an: a. Increase in the supply of francs and an appreciation of the dollar b. Increase in the supply of francs and a depreciation of the dollar c. Increase in the demand for francs and a depreciation of the dollar d. Increase in the demand for francs and an appreciation of the dollar 51. Given floating exchange rates, if Japan increases its demand for Canadian goods at the same time that Canada increases its demand for Japanese goods, then we would expect the yen's exchange value to: a. Appreciate against the dollar b. Depreciate against the dollar c. Remain constant against the dollar d. Appreciate, depreciate, or remain constant against the dollar 52. Given floating exchange rates, assume that the Swiss decrease their import purchases from Italy while at the same time the Italians increase their purchases of Swiss government securities. The first action by itself would lead to a (an) ____ of the franc against the lira while the second action by itself would lead to a (an) ____ of the franc against the lira. a. Appreciation, appreciation b. Depreciation, depreciation c. Appreciation, depreciation d. Depreciation, appreciation 53. Given floating exchange rates, a simultaneous decrease in the Canadian demand for British products and increase in the British desire to invest in Canadian government securities would cause a (an): a. Appreciation of the pound against the dollar b. Depreciation of the pound against the dollar c. Unchanged pound/dollar exchange rate d. None of the above 54. Assume a system of floating exchange rates. Due to a high savings rate, suppose the level of savings in Japan is in excess of domestic investment needs.
- 13. If Japanese residents invest abroad, the yen's exchange value will ____ and the Japanese trade balance will move toward ____. a. Appreciate, deficit b. Appreciate, surplus c. Depreciate, deficit d. Depreciate, surplus 55. Given a system of floating exchange rates, assume that Boeing Inc. of the United States places a large order, payable in yen, with a Japanese contractor for jet engine parts. The immediate effect of this transaction will be a shift in the: a. Supply curve of yen to the left which causes the dollar to appreciate against the yen b. Supply curve of yen to the right which causes the dollar to depreciate against the yen c. Demand curve for yen to the left which causes the dollar to appreciate against the yen d. Demand curve for yen to the right which causes the dollar to depreciate against the yen 56. For purchasing-power parity to exist: a. Flows of currency in the trade account must be offset by flows of currency in the capital account b. The nominal interest rate must be equal to the real interest rate in all countries c. Converting a sum of funds from one currency to another does not alter its purchasing power d. A country's trade account must always be in balance 57. Assume that interest rates in the United States and Britain are the same. If a U.S. resident anticipates that the exchange value of the dollar is going to appreciate against the pound, she should: a. Borrow needed funds from British banks rather than U.S. banks b. Borrow needed funds from U.S. banks rather than British banks c. Convert U.S. dollars into British pounds d. Any of the above 58. Given a system of floating exchange rates, if Canada's labor productivity rises relative to the labor productivity of its trading partners: a. Canadian imports will fall and the dollar will appreciate
- 14. b. Canadian imports will fall and the dollar will depreciate c. Canadian imports will rise and the dollar will appreciate d. Canadian imports will rise and the dollar will depreciate 59. Assume that labor productivity growth is slower in the United States than in its trading partners. Given a system of floating exchange rates, the impact of this growth differential for the United States will be: a. Increased exports and an appreciation of the dollar b. Increased exports and a depreciation of the dollar c. Increased imports and an appreciation of the dollar d. Increased imports and a depreciation of the dollar 60. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar. According to purchasing-power parity, if the price of traded goods rises by 10 percent in the United States and remains constant in Japan, the exchange rate will become a. 72 yen per dollar b. 81 yen per dollar c. 99 yen per dollar d. 108 yen per dollar 61. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar. According to purchasing-power parity, if the price of traded goods rises by 5 percent in the United States and 15 percent in Japan, the exchange rate will become: a. 72 yen per dollar b. 81 yen per dollar c. 99 yen per dollar d. 108 yen per dollar 62. Suppose the exchange rate between the U.S. dollar and the Japanese yen is initially 90 yen per dollar. According to purchasing power parity, if the price of traded goods falls by 5 percent in the United States and rises by 5 percent in Japan, the exchange rate will become: a. 72 yen per dollar b. 81 yen per dollar c. 99 yen per dollar d. 108 yen per dollar
- 15. 63. Suppose that the yen-dollar exchange rate changes from 85 yen per dollar to 80 yen per dollar. One can say that the: a. Yen has appreciated against the dollar and the dollar has depreciated against the yen b. Yen has depreciated against the dollar and the dollar has appreciated against the yen c. Yen has appreciated against the dollar and the dollar has appreciated against the yen d. Yen has depreciated against the dollar and the dollar has depreciated against the yen 64. Given a floating exchange rate system an increase in ____ would cause the dollar to appreciate against the euro. a. U.S. labor costs b. The U.S. money supply c. U.S. prices of goods d. U.S. real interest rates 65. Under a system of floating exchange rates, a Japanese trade surplus against Canada would result in a (an): a. Rise in the dollar price of the yen b. Fall in the dollar price of the yen c. Rise in the yen price of the dollar d. Unchanged dollar/yen exchange rate 66. When deciding between U.S. and British government securities, an American investor typically considers: a. U.S. and British interest rates and anticipated changes in the exchange rate b. Budget deficits of the U.S. government and British government c. Shifts in the demand for U.S. goods and British goods d. U.S. and British inflation rates and anticipated changes in the exchange rate 67. In the long run, exchange rates are primarily determined by: a. Agreements among governments of the world's industrial countries
- 16. b. Relative interest rates in developing countries and industrial countries c. Economic fundamentals such as relative productivity levels d. The rate at which country's currencies exchange for gold 68. Increased tariffs on U.S. steel imports cause the dollar to ____ in the ____. a. Appreciate, long run b. Depreciate, long run c. Appreciate, short run d. Depreciate, short run 69. Lower tariffs on U.S. agricultural imports cause the dollar to ____ in the ____. a. Appreciate, long run b. Depreciate, long run c. Appreciate, short run d. Depreciate, short run 70. Relatively high interest rates in the United States causes the dollar to ____ in the ____. a. Appreciate, long run b. Depreciate, long run c. Appreciate, short run d. Depreciate, short run 71. The asset market theory of exchange rate determination suggests that the most important factor influencing the demand for domestic and foreign securities is: a. Expected return on these assets relative to one another b. Ability of these assets to easily be converted into cash c. Riskiness of these assets relative to one another d. Level of government restrictions on trade and investment flows 72. With floating exchange rates, easy credit and low short term interest rates lead to
- 17. a. Exchange rate depreciation in the short run b. Exchange rate appreciation in the short run c. Exchange rate depreciation in the long run d. Exchange rate appreciation in the long run 73. With floating exchange rates, relatively high productivity growth for a nation leads to a. Exchange rate depreciation in the short run b. Exchange rate appreciation in the short run c. Exchange rate depreciation in the long run d. Exchange rate appreciation in the long run 74. All of the following are important long-run determinants of exchange rates except a. Consumer tastes b. Trade policy c. Labor productivity d. Interest rates 75. The purchasing-power parity theory suffers from the problem a. Of choosing the appropriate price index b. That it overlooks the influence of capital flows c. That government policy may modify exchange rates d. All of the above TRUE/FALSE 1. In a free market, exchange rates are determined by market fundamentals and market expectations. 2. Concerning exchange-rate determination, market fundamentals include inflation rates, productivity levels, and speculative opinion about future exchange rates.
- 18. 3. Market expectations include news about market fundamentals, speculative opinion about future exchange rates, and profitability and riskiness of investments. 4. In a free market, the equilibrium exchange rate occurs at the point where the quantity demanded of a foreign currency equals the quantity of that currency supplied. 5. Exchange rates are determined by the unregulated forces of supply and demand for foreign currencies as long as central banks do not intervene in the foreign exchange markets. 6. Over the long run, foreign exchange rates are determined by transfers of bank deposits that respond to differences in real interest rates and to shifting expectations of future exchange rates. The figure below illustrates the supply and demand schedules of Swiss francs under a system of floating exchange rates. Figure 12.2. The Market for Swiss Francs 7. Refer to Figure 12.2. If the United States decreases tariffs on imports from Switzerland, there would occur a decrease in the demand for francs and a decrease in the dollar price of the franc. 8. Refer to Figure 12.2. If Swiss manufacturing costs increase relative to those of the United States, there would occur an increase in the supply of francs and an appreciation in the dollar's exchange value. 9. Refer to Figure 12.2. If the Federal Reserve adopts a restrictive monetary policy that leads to relatively high interest rates in the United States, the demand for francs would decrease, the supply of francs would increase, and the dollar's exchange value would appreciate.
- 19. 10. Refer to Figure 12.2. As the profitability of assets in Switzerland rises relative to the profitability of assets in the United States, U.S. residents make additional investments in Switzerland; this leads to an increased demand for francs and a depreciation of the dollar's exchange value. 11. Refer to Figure 12.2. If the rate of inflation in the United States is higher than the rate of inflation in Switzerland, the demand for francs decreases, the supply of francs increases, and the dollar's exchange value appreciates. 12. Under floating exchange rates, short-run exchange rates are primarily determined by national differences in real interest rates and shifting expectations of future exchange rates. 13. Day-to-day influences on foreign exchange rates always cause rates to move in the same direction as changes in long-term market fundamentals. 14. With floating exchange rates, a country experiencing faster economic growth than its trading partners find its currency's exchange value appreciating. 15. If U.S. labor productivity growth is 2 percent per annum and Swiss labor productivity growth is 6 percent per annum, the dollar will depreciate against the franc under a system of floating exchange rates. 16. In 1985 and 1986 U.S. interest rates fell relative to interest rates in Japan. Under floating exchange rates, this would lead to the dollar's exchange value depreciating against the yen. 17. A country having stronger preferences for imports than its trading partners have for its exports finds its demand for foreign exchange rising more rapidly than its supply of foreign exchange. 18. Economies with relatively high growth rates in labor productivity tend to find their currencies' exchange values appreciating under a floating exchange-rate system.
- 20. 19. Under floating exchange rates, relatively low domestic interest rates tend to promote depreciation of a currency's exchange value while relatively high domestic interest rates lead to currency appreciation. 20. Suppose expansionary monetary policy in the United States leads to interest rates falling to 2 percent while tight monetary policy in Switzerland leads to interest rates rising to 8 percent. With floating exchange rates, the dollar would appreciate against the franc. 21. The purchasing-power-parity theory is used to predict exchange-rate movements in the short run. 22. According to the law of one price, identical goods should cost the same in all nations, assuming there are no shipping costs nor trade barriers. 23. The purchasing- power-parity theory predicts that if the U.S. inflation rate exceeds the Japanese inflation rate by 4 percent, the dollar's exchange value will appreciate by 4 percent against the yen. 24. Assume the initial yen/dollar exchange rate to be 100 yen per dollar. If the U.S. inflation rate is 2 percent and the Japanese inflation rate is 7 percent, the exchange rate should move to 105 yen per dollar according to the purchasing-power- parity theory. 25. Assume the initial dollar/pound exchange rate to be $2 per pound. If the U.S. inflation rate is 8 percent and the U.K. inflation rate is 3 percent, the exchange rate should move to $2.10 per pound according to the purchasing-power- parity theory. 26. If consumer tastes in the United States change in favor of goods produced in France, the demand for francs will increase which causes an appreciation of the dollar against the franc under a floating exchange rate system.
- 21. 27. As the profitability of Japanese assets rises relative to the profitability of Australian assets, Australian residents will make additional investments in Japan; this results in an increased demand for yen and a depreciation of the dollar under a system of floating exchange rates. 28. If the United States experiences an enormous wheat crop failure, it will have to import more wheat and the dollar's exchange value will depreciate under a system of floating exchange rates. 29. If Japan realizes technological improvements in the production of automobiles, which lowers its production costs relative to foreign producers, Japanese exports will rise and the yen's exchange value will appreciate under a system of floating exchange rates. 30. If Mexico applies tariffs to imports of manufactured goods, Mexico's demand for foreign exchange will rise and the peso will depreciate under a system of floating exchange rates. 31. According to the "Big Mac" index, if a Big Mac costs $2.28 in the United States and 25.75 krone in Denmark (equivalent to $4.25), the Danish krone is an undervalued currency. 32. According to the "Big Mac" index, if a Big Mac costs $2.28 in the United States and 48 baht in Thailand (equivalent to $1.91), the baht is an undervalued currency. 33. Long-run determinants of exchange rate include labor productivity levels, inflation rates, consumer preferences for goods and services, and trade barriers. 34. In the short run, exchange rates are primarily determined by investor expectations of returns on assets such as government securities and bank accounts.
- 22. 35. Changes in market expectations have their greatest impact on exchange-rate changes over the long run as opposed to the short run. 36. If it is widely expected that the British economy will experience more rapid inflation than the Australian economy, the pound will depreciate against the dollar under a system of floating exchange rates. 37. According to the asset-markets approach, adjustments among financial assets are a key determinant of long-run movements in exchange rates. 38. The asset-markets approach views exchange-rate determination as similar to the stock market in which prices are volatile and expectations are important. 39. According to the principle of exchange-rate overshooting, a short-run depreciation of a currency is likely to be greater than a long-run depreciation of that currency. 40. Exchange-rate overshooting is based on the notion that the supply schedule of a currency is more elastic in the short run than in the long run. 41. According to exchange-rate overshooting, an appreciation of the Australian dollar is likely to be greater over a long time period than over a short time period. 42. Concerning exchange rate forecasting, fundamental analysis involves consideration of a variety of macroeconomic variables and policies that tend to affect currency values. 43. Econometric models are best suited for forecasting long-run exchange rates rather than short-run exchange rates.
- 23. 44. Concerning exchange rate forecasting, technical analysis extrapolates from past exchange-rate trends while ignoring economic and political determinants of exchange rates. 45. Given an efficient foreign exchange market, the spot rate is the rational approximation of the markets expectation of the forward rate that will exist at the end of the forward period. 46. A forward premium on the British pound serves as a rough benchmark of the expected rate of appreciation in the pound's spot rate. 47. A forward discount on Mexico's peso serves as a rough benchmark of the expected appreciation in the peso's spot rate. 48. If you were considering hiring a forecasting firm to predict future spot rates of the yen, you would hope that the firm could predict better what would be implied by the yen's forward rate. 49. Although the law of one price predicts that identical goods should cost the same in all nations, transportation costs and tariffs tend to prevent this prediction from actually occurring. 50. If real interest rates decline in the United States relative to real interest rates abroad, the dollar's exchange value will appreciate under a floating exchange- rate system. SHORT ANSWER 1. What is the purchasing power parity approach to exchange rate determination? 2. What is exchange rate overshooting?
- 24. ESSAY 1. In a free market, what determines exchange rates in the long run and the short run? 2. What is the asset market approach to exchange rate determination? CHAPTER 13—BALANCE-OF-PAYMENTS ADJUSTMENTS MULTIPLE CHOICE 1. Which of the following does not represent an automatic adjustment in balance-of-payments disequilibrium? Variations in: a. Domestic income b. Foreign prices c. Domestic prices d. Foreign par values 2. The balance-of-payments adjustment mechanism developed during the 1700s by the English economist David Hume is the: a. Income-adjustment mechanism b. Flexible-exchange-rate-adjustment mechanism c. Price-adjustment mechanism d. Rank-reserve-adjustment mechanism 3. Which chain of events would promote payments equilibrium for a surplus nation, according to the price-adjustment mechanism? a. Increasing money supply--increasing domestic prices--rising imports--falling exports b. Increasing money supply--falling domestic prices--rising imports--falling exports c. Decreasing money supply--increasing domestic prices--falling imports--rising exports d. Decreasing money supply--decreasing domestic prices--falling imports--rising exports
- 25. 4. Which chain of events would promote payments equilibrium for a deficit nation, according to the price-adjustment mechanism? a. Increasing money supply--increasing domestic prices--rising imports--falling exports b. Increasing money supply--falling domestic prices--rising imports--falling exports c. Decreasing money supply--increasing domestic prices--falling imports--rising exports d. Decreasing money supply--decreasing domestic prices--falling imports--rising exports 5. During the gold standard era, central bankers agreed to react positively to international gold flows so as to reinforce the automatic adjustment mechanism. Which of the following best represents the above statement? a. Income-adjustment mechanism b. Price-adjustment mechanism c. Rules of the game d. Discretionary fiscal policy 6. During the gold standard era, the "rules of the game" suggested that: a. Surplus countries should increase their money supplies b. Deficit countries should increase their money supplies c. Surplus and deficit countries should increase their money supplies d. Surplus and deficit countries should decrease their money supplies 7. Which of the following balance-of-payments adjustment mechanisms is most closely related to the quantity theory of money? a. Income-adjustment mechanism b. Price-adjustment mechanism c. Interest-rate-adjustment mechanism d. Output-adjustment mechanism 8. Under the gold standard, a surplus nation facing a gold inflow and an increase in its money supply would also experience a: a. Rise in its interest rate and a short-term financial inflow b. Rise in its interest rate and a short-term financial outflow c. Fall in its interest rate and a short-term financial inflow d. Fall in its interest rate and a short-term financial outflow
- 26. 9. Under the gold standard, a deficit nation facing a gold outflow and a decrease in its money supply would also experience a: a. Rise in its interest rate and a short-term financial inflow b. Rise in its interest rate and a short-term financial outflow c. Fall in its interest rate and a short-term financial inflow d. Fall in its interest rate and a short-term financial outflow 10. Assume that Canada initially faces payments equilibrium in its merchandise trade account as well as in its capital and financial account. Now suppose that Canadian interest rates increase to levels higher than those abroad. For Canada, this tends to promote: a. Net financial inflows b. Net financial outflows c. Net merchandise exports d. Net merchandise imports 11. Assume that Canada initially faces payments equilibrium in its merchandise trade account as well as in its capital and financial account. Now suppose that Canadian interest rates fall to levels below those abroad. For Canada, this tends to promote: a. Net financial inflows b. Net financial outflows c. Net merchandise exports d. Net merchandise imports 12. Suppose the United States levies an interest equalization tax, which taxes Americans on dividend and interest income from foreign securities. Such a tax would be intended to: a. Encourage financial movements from the United States to overseas b. Discourage financial movements from the United States to overseas c. Discourage financial movements from overseas to the United States d. None of the above
- 27. 13. Assume that interest rates on comparable securities are identical in the United States and foreign countries. Now suppose that investors anticipate that in the future the U.S. dollar will appreciate against foreign currencies. Investment funds would thus be expected to: a. Flow from the United States to foreign countries b. Flow from foreign countries to the United States c. Remain totally in foreign countries d. Not be affected by the expected dollar appreciation 14. Suppose Japan increases its imports from Sweden, leading to a rise in Sweden's exports and income level. With a higher income level, Sweden imports more goods from Japan. Thus a change in imports in Japan results in a feedback effect on its exports. This process is best referred to as the: a. Monetary approach to balance-of-payments adjustment b. Discretionary income adjustment process c. Foreign repercussion effect d. Price-specie flow mechanism Exhibit 13.1 Assume the marginal propensity to consume for U.S. households equals 0.9, and the marginal propensity to import for the United States equals 0.1. Suppose there occurs an increase in investment of $10 billion at each level of income. 15. Refer to Exhibit 13.1. The value of the multiplier for the United States equals: a. 2 b. 3 c. 4 d. 5 16. Refer to Exhibit 13.1. The change in the level of U.S. income resulting from the additional investment spending equals a. $20 billion b. $30 billion c. $40 billion d. $50 billion
- 28. 17. Refer to Exhibit 13.1. The change in the level of U.S. imports resulting from the rise in U.S. income equals: a. $5 billion b. $10 billion c. $15 billion d. $20 billion 18. The monetary approach to balance-of-payments adjustments suggests that all payments deficits are the result of: a. Too high interest rates in the home country b. Too low interest rates in the home country c. Excess money supply over money demand in the home country d. Excess money demand over money supply in the home country 19. The monetary approach to balance-of-payments adjustments suggests that all payments surpluses are the result of: a. Too high interest rates in the home country b. Too low interest rates in the home country c. Excess money supply over money demand in the home country d. Excess money demand over money supply in the home country 20. Starting from a position where the nation's money demand equals the money supply, and its balance of payments is in equilibrium, economic theory suggests that the nation's balance of payments would move into a deficit position if there occurred in the nation a: a. Decrease in the money supply b. Increase in the money demand c. Decrease in the money demand d. None of the above 21. Which approach to balance-of-payments adjustment suggests that balance-of-payments surpluses are the result of excess money demand in the home country? a. Absorption approach b. Elasticities approach c. Monetary approach d. Purchasing-power-parity approach
- 29. 22. According to the "rules of the game" of the gold standard era, a country's central bank agreed to react to international gold flows so as to: a. Officially devalue a currency during eras of payments surpluses b. Officially revalue a currency during eras of payments deficits c. Offset the automatic-adjustment mechanism (e.g., prices) d. Reinforce the automatic-adjustment mechanism 23. According to the quantity theory of money, a change in the domestic money supply will bring about: a. Inverse and proportionate changes in the price level b. Inverse and less-than-proportionate changes in the price level c. Direct and proportionate changes in the price level d. Direct and less-than-proportionate changes in the price level 24. The formulation of the so-called income adjustment mechanism is associated with: a. Adam Smith b. David Ricardo c. David Hume d. John Maynard Keynes 25. The value of the foreign trade multiplier equals the reciprocal of the sum of the marginal propensities to: a. Save plus import b. Import plus invest c. Consume plus export d. Save plus import 26. Starting from a position where the nation's money demand equals the money supply and its balance of payments is in equilibrium, economic theory suggests that the nation's balance of payments would move into a deficit position if there occurred in the nation: a. An increase in the money supply b. A decrease in the money supply c. An increase in money demand
- 30. d. None of the above 27. Starting from a position where the nation's money demand equals the money supply and its balance of payments is in equilibrium, economic theory suggests that the nation's balance of payments would move into a surplus position if there occurred in the nation: a. A decrease in the money supply b. An increase in the money supply c. A decrease in the money demand d. None of the above 28. Starting from a position where the nation's money demand equals the money supply and its balance of payments is in equilibrium, economic theory suggests that the nation's balance of payments would move into a surplus position if there occurred in the nation: a. An increase in the money demand b. A decrease in the money demand c. An increase in the money supply d. None of the above 29. Assume identical interest rates on comparable securities in the United States and foreign countries. Suppose investors anticipate that in the future the U.S. dollar will depreciate against foreign currencies. Investment funds would tend to: a. Flow from the United States to foreign countries b. Flow from foreign countries to the United States c. Remain totally in foreign countries d. Remain totally in the United States 30. Suppose that rising U.S. income leads to higher sales and profits in the United States. This would likely result in: a. Increasing portfolio investment into the United States b. Decreasing portfolio investment into the United States c. Increasing direct investment into the United States d. Decreasing direct investment into the United States
- 31. Figure 13.1. U.S. Capital and Financial Account 31. Refer to Figure 13.1. Upward movements along U.S. capital and financial account schedule CA0 would be caused by: a. U.S. interest rates rising relative to foreign interest rates b. U.S. interest rates falling relative to foreign interest rates c. Taxes placed on income earned by U.S. residents from their foreign investments d. Taxes placed on income earned by foreign residents from their U.S. investments 32. Refer to Figure 13.1. Downward movements along U.S. capital and financial account schedule CA0 would be caused by: a. U.S. interest rates rising relative to foreign interest rates b. U.S. interest rates falling relative to foreign interest rates c. Taxes placed on income earned by U.S. residents from their foreign investments d. Taxes placed on income earned by foreign residents from their U.S. investments 33. Refer to Figure 13.1. The U.S. capital and financial account schedule would shift upward from CA0 to CA1 if: a. U.S. interest rates exceeded foreign interest rates b. Foreign interest rates exceeded U.S. interest rates c. Taxes were placed on income earned by U.S. residents from their foreign investments d. Taxes were placed on income earned by foreign residents from their U.S. investments 34. Refer to Figure 13.1. The U.S. capital and financial account schedule would shift upward from CA0 to CA1 if: a. U.S. residents receive subsidies to invest in foreign nations b. U.S. interest rates rise relative to foreign interest rates c. Taxes are reduced on income earned by U.S. residents from their foreign investments d. Expected profits decline on U.S. investments in foreign manufacturing
- 32. 35. Refer to Figure 13.1. The U.S. capital and financial account schedule would shift upward from CA0 to CA1 for all of the following reasons except: a. U.S. political stability improves relative to foreign political stability b. U.S. interest rates fall relative to foreign interest rates c. Taxes are placed on income earned by U.S. residents from foreign investments d. Restrictions are imposed on foreign loans granted by U.S. banks 36. Refer to Figure 13.1. U.S. capital and financial account schedule CA0 would shift upwards, or downwards, for all of the following reasons except: a. U.S. residents being taxed on income earned from foreign investments b. U.S. banks being restricted on loans that can be made abroad c. U.S. political stability changing relative to foreign political stability d. U.S. interest rates changing relative to foreign interest rates Table 13.1. Canada's Saving, Investment, Import, and Export Functions (in billions of dollars) Under a System of Fixed Exchange Rates Export Function X = 3000 Investment Function I = 1000 Saving Function S = -1000 + 0.2Y Import Function M = 500 + 0.25Y 37. Referring to Table 13.1, if Canada's income rises by $200 billion, saving would rise by: a. $10 billion b. $20 billion c. $30 billion d. $40 billion 38. Referring to Table 13.1, if Canada's income rises by $200 billion, imports would rise by: a. $50 billion b. $75 billion c. $100 billion d. $125 billion
- 33. 39. Referring to Table 13.1, Canada's foreign trade multiplier equals: a. 1.75 b. 2.05 c. 2.22 d. 2.64 40. Referring to Table 13.1, Canada's equilibrium level of income is: a. $8000 billion b. $9000 billion c. $10,000 billion d. $11,000 billion 41. Refer to Table 13.1. If improved business optimism leads to increases in Canada's planned investment spending from $1000 billion to $1200 billion, Canada's equilibrium income rises by approximately: a. $444 billion b. $555 billion c. $666 billion d. $777 billion 42. Refer to Table 13.1. If weak economic conditions abroad result in Canada's exports falling from $3000 billion to $2500 billion, Canada's equilibrium income falls by approximately: a. $888 billion b. $990 billion c. $1110 billion d. $1220 billion Figure 13.2. Australian Economy Under a Fixed Exchange Rate System 43. Refer to Figure 13.2. The slope of the (X-M) schedule and (S-I) schedule indicates that Australia's foreign trade multiplier is: a. 0.5 b. 1.0 c. 1.5 d. 2.0
- 34. 44. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that improving economic conditions abroad lead to an autonomous increase in Australian exports of $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____. a. Rises to $60 billion, surplus of $2.5 billion b. Rises to $60 billion, surplus of $5 billion c. Falls to $40 billion, deficit of $2.5 billion d. Falls to $40 billion, deficit of $5 billion 45. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S- I)0 intersects (X-M)0, suppose that worsening economic conditions abroad lead to an autonomous decrease in Australian exports of $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____. a. Rises to $60 billion, surplus of $2.5 billion b. Rises to $60 billion, surplus of $5 billion c. Falls to $40 billion, deficit of $2.5 billion d. Falls to $40 billion, deficit of $5 billion 46. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that improving profit expectations lead to an autonomous increase in Australian investment of $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____. a. Rises to $60 billion, deficit of $2.5 billion b. Rises to $60 billion, deficit of $5 billion c. Falls to $40 billion, surplus of $2.5 billion d. Falls to $40 billion, surplus of $5 billion 47. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that worsening profit expectations lead to an autonomous decrease in Australian investment of $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____. a. Rises to $60 billion, deficit of $2.5 billion b. Rises to $60 billion, deficit of $5 billion c. Falls to $40 billion, surplus of $2.5 billion d. Falls to $40 billion, surplus of $5 billion
- 35. 48. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that increased thriftiness leads to an autonomous increase in Australian saving of $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____. a. Rises to $60 billion, deficit of $2.5 billion b. Rises to $60 billion, deficit of $5 billion c. Falls to $40 billion, surplus of $2.5 billion d. Falls to $40 billion, surplus of $5 billion 49. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that dwindling thriftiness leads to an autonomous decrease in Australian saving to $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____. a. Rises to $60 billion, deficit of $2.5 billion b. Rises to $60 billion, deficit of $5 billion c. Falls to $40 billion, surplus of $2.5 billion d. Falls to $40 billion, surplus of $5 billion 50. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that changing preferences lead to an autonomous increase in Australian imports of $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____. a. Rises to $60 billion, surplus of $2.5 billion b. Rises to $60 billion, surplus of $5 billion c. Falls to $40 billion, deficit of $2.5 billion d. Falls to $40 billion, deficit of $5 billion 51. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0, suppose that changing preferences lead to an autonomous decrease in Australian imports of $5 billion. Australian income thus ____ which leads to Australia's trade account moving to a ____. a. Rises to $60 billion, surplus of $2.5 billion b. Rises to $60 billion, surplus of $5 billion c. Falls to $40 billion, deficit of $2.5 billion d. Falls to $40 billion, deficit of $5 billion
- 36. 52. In explaining balance-of-payments adjustments, the classical economists a. Focused on interest rates exclusively b. Remained aware of the role of interest rates c. Only focused their attention on short-term interest rates d. Paid exclusive attention to long-tem interest rates 53. J. M. Keynes suggested that a trade deficit nation a. Would experience a fall in income b. Would experience a decline in imports c. Would require active intervention by the government d. Both a and b 54. The classical gold standard a. Existed from early 1800's to early 1900's b. Did not allow for imports and exports of gold c. Led to the outflow of gold from surplus nations d. Led to the inflow of gold to deficit nations 55. The classical economists assumed a. That the volume of final output is fixed at the full-employment level in the long-run b. The velocity of money is constant c. The velocity of money depends on physical, structural, and institutional factors d. All of the above TRUE/FALSE 1. Under a fixed exchange rate system, adjustment mechanisms work for the automatic return to current-account balance after the initial balance has been disrupted. 2. When a country's current account moves into disequilibrium, automatic adjustments in tariffs and quotas occur which move the current account back into equilibrium.
- 37. 3. Prices, interest rates, and income are the automatic adjustment variables that help restore current-account equilibrium under a system of fixed exchange rates. 4. That the balance of payments could be adjusted by prices and interest rates, under a fixed exchange rate system, originated with Keynesian theory during the 1930s. 5. David Hume's price-adjustment mechanism supported the mercantilist view that a nation could maintain a trade surplus indefinitely. 6. Under the price-adjustment mechanism, a government's efforts to maintain a current-account surplus is self defeating over the long run because a nation's current account automatically moves toward equilibrium. 7. Under the gold standard of the 1800s, exchange rates were allowed to float freely in the currency markets. 8. Under the gold standard, each participating nation defined the mint price of gold in terms of its national currency was prepared to buy and sell gold at that price. 9. Under the gold standard, a nation with a current-account surplus would realize gold outflows, a decrease in its money supply, and a fall in its domestic price level. 10. The essence of the classical price-adjustment mechanism is embodied in the quantity theory of money. 11. According to the equation of exchange, the total expenditures on final goods equals the monetary value of the final goods sold.
- 38. 12. Regarding the equation of exchange, the classical economists assumed that final output was below its maximum level while the velocity of money was volatile. 13. According to the quantity theory of money, a change in the money supply will induce an inverse and less-than-proportionate change in the price level. 14. Under the price-adjustment mechanism, a trade-surplus nation would realize gold inflows, an increase in its money supply, and a loss of international competitiveness. 15. The price-adjustment mechanism's relevance to the real world has been questioned on the grounds that national output is generally not at the full-employment level and that the velocity of money is not always constant. 16. According to the price-adjustment mechanism, trade deficits can occur only in the long run rather than in the short run. 17. Under the price-adjustment mechanism, trade-deficit nations realize price inflation and a loss of competitiveness while trade surplus nations realize price deflation and an improvement in competitiveness. 18. Under the classical gold standard, adjustments in domestic prices and short-term interest rates automatically promoted balance-of-payments equilibrium over the long run. 19. Under the classical gold standard, a trade surplus nation would realize gold inflows, an increase in its money supply, rising interest rates, and net investment inflows.
- 39. 20. The gold standard's "rules of the game" required central bankers in a surplus country to initiate contractionary monetary policies which lead to higher interest rates and net investment inflows. 21. The gold standard's "rules of the game" required central bankers in a trade deficit nation to expand the money supply, leading to falling interest rates and net investment outflows. 22. The "rules of the game" served to reinforce and speed up the interest- rate-adjustment mechanism under a system of fixed exchange rates. Figure 13.3. U.S. Capital and Financial Account Under a Fixed Exchange Rate System 23. Refer to Figure 13.3. As U.S. interest rates rise relative to foreign interest rates, the U.S. slides upward along schedule CA0, thus moving towards capital and financial account surplus. 24. Refer to Figure 13.3. Decreases in U.S. interest rates relative to foreign interest rates would shift U.S. capital and financial account schedule CA0 downward toward CA1, resulting in net financial outflows from the United States. 25. Refer to Figure 13.3. Falling investment profitability in the United States, relative to investment profitability abroad, would shift the U.S. capital and financial account schedule downward from CA0 to CA1, resulting in net financial outflows from the United States. 26. Refer to Figure 13.3. As the U.S. government decreases taxes on income earned by U.S. residents from foreign investments, the U.S. capital and financial account schedule shifts downward from CA0 to CA1 and the United States realizes net financial outflows. 27. Refer to Figure 13.3. If the political and economic stability of foreign countries worsens relative to that of the United States, the U.S. capital and financial
- 40. account schedule would shift downward from CA0 to CA1, resulting in net financial outflows from the United States. 28. According to the Keynesian income-adjustment mechanism, income differentials among nations guarantee current-account equilibrium in a world of fixed exchange rates. 29. Keynesian theory asserts that, under a system of fixed exchange rates, the influence of income changes in surplus and deficit countries will automatically promote current-account equilibrium. 30. The Keynesian income-adjustment mechanism contends that a trade- surplus nation tends to realize falling income and falling imports, thus accentuating the trade surplus. 31. The foreign-trade multiplier equals the sum of the marginal propensity to import and the marginal propensity to save. 32. If the marginal propensity to save equals 0.2 and the marginal propensity to import equals 0.3, the foreign-trade multiplier equal 2.0. 33. For an open economy subject to international trade, equilibrium income occurs where saving plus investment equals imports plus exports. 34. If the marginal propensity to save equals 0.1 and the marginal propensity to import equals 0.3, an autonomous increase in exports of $1,000 would expand domestic income by $2,500 which leads to an increase in imports of $750. 35. If the marginal propensity to save equals 0.2 and the marginal propensity to import equals 0.3, an autonomous decrease in investment spending of $1 million leads to a $2 million decrease in domestic income and a $600,000 decrease in imports.
- 41. 36. For the income adjustment mechanism to reverse a trade deficit, economic policymakers must be willing to permit domestic income to increase which leads to rising imports. 37. Reliance on an automatic adjustment process tends to be unacceptable in trade-deficit nations since it requires them to accept price deflation and/or falling income as a cost of reducing imports. 38. An "automatic" adjustment mechanism would require a trade-surplus nation to accept price deflation and/or falling income as the cost of increasing imports. Figure 13.4. Canadian Economy Under a Fixed Exchange Rate System 39. Referring to Figure 13.4, Canada's marginal propensity to save equals 0.25 and marginal propensity to import equal 0.5. 40. Referring to Figure 13.4, Canada's foreign-trade multiplier equals 2.0. 41. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S - I)0 intersects (X - M)0, an autonomous decrease in Canadian imports of $10 billion leads to a $20 billion decrease in income and a trade deficit of $5 billion. 42. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S - I)0 intersects (X - M)0, an autonomous increase in Canadian investment of $10 billion leads to a $20 billion increase in income and no change in the country's trade account. 43. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S - I)0 intersects (X - M)0, an autonomous decrease in saving of $10 billion leads to a $20 billion increase in income and a trade deficit of $5 billion.
- 42. 44. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S - I)0 intersects (X - M)0, an autonomous decrease in Canadian exports of $10 billion leads to a $20 decrease in income and a trade deficit of $5 billion. 45. According to the monetary approach, balance-of-payments disequilibriums are the result of imbalances in a country's money supply and money demand. 46. The monetary approach contends that, under a fixed exchange rate system, an excess supply of money leads to a trade surplus. 47. The monetary approach contends that, under a fixed exchange rate system, an excess demand for money leads to a trade deficit. 48. The monetary approach contends that, under a fixed exchange rate system, policies that increase the supply of money relative to the demand for money lead to a trade surplus. SHORT ANSWER 1. Compared to classical economists, how did Keynesian economics change the discussion of trade adjustment? 2. What is the foreign repercussion effect? ESSAY 1. Explain David Hume's theory of automatic adjustment for balance of payments disequilibria. 2. Is the monetary approach to the balance-of-payments part of the traditional adjustment theories?