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Exercise 10

Chapter 10 discusses the macroeconomic theory of open economies, focusing on the markets for loanable funds and foreign-currency exchange, and their interconnections. It addresses concepts like twin deficits, the effects of domestic policies on trade balances, and the implications of currency appreciation and depreciation. The chapter includes review questions, multiple-choice questions, and problems for application to reinforce understanding of these economic principles.

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Exercise 10

Chapter 10 discusses the macroeconomic theory of open economies, focusing on the markets for loanable funds and foreign-currency exchange, and their interconnections. It addresses concepts like twin deficits, the effects of domestic policies on trade balances, and the implications of currency appreciation and depreciation. The chapter includes review questions, multiple-choice questions, and problems for application to reinforce understanding of these economic principles.

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executivedirector.gppa
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We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 10 A Macroeconomic Theory of the open economy

Questions for Review


1. Describe supply and demand in the market for loanable funds and the market for foreign-currency
exchange. How are these markets linked?
2. Why are budget deficits and trade deficits sometimes called the twin deficits?
3. Suppose that a textile workers’ union encourages people to buy only American-made clothes.
What would this policy do to the trade balance and the real exchange rate? What is the impact on the
textile industry? What is the impact on the auto industry?

Quick Check Multiple Choice


1. Holding other things constant, an increase in a nation’s interest rate reduces
a. national saving and domestic investment.
b. national saving and the net capital outflow.
c. domestic investment and the net capital outflow.
d. national saving only.
2. Holding other things constant, an appreciation of a nation’s currency causes
a. exports to rise and imports to fall.
b. exports to fall and imports to rise.
c. both exports and imports to rise.
d. both exports and imports to fall.
3. The government in an open economy cuts spending to reduce the budget deficit. As a result, the
interest rate __________, leading to a capital __________ and a real exchange rate __________.
a. falls, outflow, appreciation
b. falls, outflow, depreciation
c. falls, inflow, appreciation
d. rises, inflow, appreciation
4. A nation has long banned the export of its highly prized shells. A newly elected president, however,
removes the export ban. This change in policy will cause the nation’s currency to __________,
making the goods imports __________ expensive.
a. appreciate, less
b. appreciate, more
c. depreciate, less
d. depreciate, more
5. A civil war abroad causes foreign investors to seek a safe haven for their funds in the United States,
leading to __________ U.S. interest rates and a __________U.S. dollar.
a. higher, weaker

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b. higher, stronger
c. lower, weaker
d. lower, stronger
6. If business leaders in Great Britain become more confident in their economy, their optimism will
induce them to increase investment, causing the British pound to __________ and pushing the British
trade balance toward __________ .
a. appreciate, deficit
b. appreciate, surplus
c. depreciate, deficit
d. depreciate, surplus

Problems and Applications


1. Japan generally runs a significant trade surplus. Do you think this is most related to high foreign
demand for Japanese goods, low Japanese demand for foreign goods, a high Japanese saving rate
relative to Japanese investment, or structural barriers against imports into Japan? Explain your answer.

2. Suppose that Congress is considering an investment tax credit, which subsidizes domestic
investment.
a. How does this policy affect national saving, domestic investment, net capital outflow, the Interest
rate, the exchange rate, and the trade balance?
b. Representatives of several large exporters oppose the policy. Why might that be the case?

3. The chapter notes that the rise in the U.S. trade deficit during the 1980s was due largely to the rise
in the U.S. budget deficit. On the other hand, the popular press sometimes claims that the increased
trade deficit resulted from a decline in the quality of U.S. Products relative to foreign products.
a. Assume that U.S. products did decline in relative quality during the 1980s. How did this affect net
exports at any given exchange rate?
b. Draw a three-panel diagram to show the effect of this shift in net exports on the U.S. real exchange
rate and trade balance.
c. Is the claim in the popular press consistent with the model in this chapter? Does a decline in the
quality of U.S. products have any effect on our standard of living?

4. Suppose the French suddenly develop a strong taste for California wines. Answer the following
questions in words and with a diagram.
a. What happens to the demand for dollars in the market for foreign-currency exchange?
b. What happens to the value of dollars in the market for foreign-currency exchange?
c. What happens to the quantity of net exports?

5. What is capital flight? When a country experiences capital flight, what is the effect on its interest
rate and exchange rate?

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