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Business

Quiz 13 :
Economic Interdependence

Quiz 13 :
Economic Interdependence

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Why does an oil price shock cause the business cycles of different countries to be synchronized?
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Oil price shock causes the business cycles of different countries to be synchronized because a recession in one country often coincides with a recession in other countries and also the changes in one economic variable directly affects all the business related countries.
Example : In 1990 when there is uncertainty in the supply of oil, it drove the raise of price automatically. Then the countries which are dependent mostly on it have to pay higher prices to it, whereas, some countries have alternative methods to meet their demands.

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Why did the business cycles of major industrial countries become unsynchronized in the 1990s?
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In 1990s, events unique to each region had a greater impact on the business cycle in different economies. A weak banking system in the United States, combined with weak growth of construction caused by excess capacity of office space and apartment buildings, led to very slow growth in the early 1990s. Other countries' economies were stronger in this period and did not falter till a decade later. The European economies faced crises in which interest rates rose sharply, causing investment spending on physical capital to be curtailed and sending their economies into recessions. This had some effect on the United States as well keeping U.S. growth lower than it might have been otherwise.

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What mechanisms lead to the international transmission of economic shocks? Explain the basic means by which the transmission occurs.
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The mechanisms that lead to the international transmission of economic shocks are
1) Trade affects
2) Interest-rate effects
3) Exchange rate effects
The basic means by which the transmission occurs are
Trade effects: The shocks to one country are transmitted through the trade of goods and services between countries.
Ex: If one country is hit with the shock that reduces its income, it will demand fewer imports of goods and services from other counties which reduces the aggregate demand in other countries
Interest-rate effects: The shocks can be also transmitted through interest rate. When the people of one country are investing in another country the investments rates in one country affects the flow of investment between the countries.
Ex: If the interest rate in country 'A' rises because of a change in the monetary policy in country 'B' that raises the 'A's interest rate and reduces 'A's output
Exchange-rate effects : Here the rates of one country trade for currency of another country. Changes in exchange rates affect the demand and supply of both imports and exports of goods and services and also influence how investors decide to invest their savings.

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What is the difference between the law of one price and purchasing-power parity?
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Why do investors care about what happens to the exchange rate?
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What is the difference between the nominal exchange rate and the real exchange rate?
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How does absolute purchasing-power parity differ from relative purchasing-power parity?
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What is interest-rate parity?
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What is the relationship between a country's savings, its government budget defi cit, its domestic investment in physical capital, and its foreign investment?
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What were the main causes of the Asian fi nancial crisis in 1997? What role did exchange rates play in the crisis?
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Based on the data in Table 1, did the dollar depreciate or appreciate against the pound, the Canadian dollar, the franc, the yen, and the mark between 1970 and 1980? Between 1980 and 1990? Between 1990 and 2000? Between 2000 and 2011? Table 1 Exchange Rates Since 1970 img
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Table 1 shows the exchange rates of various currencies versus the dollar. Use the information in the table to show how you could have profi ted by trading currencies if the exchange rate be-tween French francs and German marks was 3 francs per mark on January 1, 1990. Suppose that you began with 10,000 marks. Show what trades you could have made buying or selling francs, marks, and dollars to generate a profi t and how much money you could make. Table 1 Exchange Rates Since 1970 img
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Suppose that you are an investor who is considering buying a one-year U.S. government bond that has a 5 percent interest rate or a one-year Japanese government bond with a 1 percent interest rate. The exchange rate today is 110 yen per dollar, and you expect the exchange rate to be 105 yen per dollar one year from now a Which bond would you purchase? Why? b Suppose that the exchange rate today is 107 yen instead of 110 yen. Would you change your decision about which bond to buy? c Suppose that the exchange rate is 110 yen today, and you think that there is a 20 percent chance that the exchange rate will be 100 yen in one year and an 80 percent chance that the exchange rate will be 108 yen in one year. Would you change your decision about which bond to buy?
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Suppose that the exchange rate adjusts so that interest-rate parity holds. Suppose also that the interest rate on a one-year German bond is 7 percent and the interest rate on a one-year U.S. bond is 4 percent. a Suppose that you expect the exchange rate in one year to be 1.2 dollars per euro. What is the exchange rate today? b Suppose that relative purchasing-power parity holds and that the infl ation rate in Germany is expected to be 2 percent over the next year. What is the expected infl ation rate in the United States?
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Because business cycles across countries have become less correlated recently, should we expect synchronized or unsynchronized business cycles across countries in the future?
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Some U.S. presidents have pursued a strong dollar policy, taking actions that cause the dollar to appreciate against other currencies. Other presidents have cared less about the value of the dollar, allowing it to depreciate against other currencies. What are the benefi ts and costs to a nation of appreciation and depreciation?
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Suppose that you were a politician in a small country that owed millions of dollars (in dollardenominated loans) to U.S. banks that had lent your country money for investment over the past decade. Most of the investments failed because they went to political cronies rather than to legitimate business fi rms. Now foreign investors are getting nervous and starting to pull their money out, causing your country's exchange rate to depreciate. What actions should you consider taking to save your country's economy? Will it help to pass a law forbidding foreign investment?
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