Question 1

In a long-run model of a small open economy,deficit reduction 
I: leads to higher living standards.
II: leads to a fall in the country's real exchange rate once the new full-equilibrium level of foreign debt is reached.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

The answer of In a long-run model of a small...

Question 2

If a small open economy is in long-run equilibrium with no foreign debt:
A) its balance of trade is positive.
B) its balance of trade is zero.
C) its balance of trade is negative.
D) not enough information is given to determine the sign of the trade balance.

Accepted Answer

If a small open economy is in long-run equilibrium with no foreign debt, it means that its savings and investments are equal, which implies that its balance of trade is zero. The value of its exports is therefore equal to the value of its imports, resulting in a balance of trade of zero.

Question 3

Consider a small open economy whose demand and domestic supply of capital relationships are R = 30 - (1/2)K and K = 7R,respectively (where K and R denote capital and its marginal product).Capital is perfectly mobile internationally,and the yield on capital (R)in the rest of the world is 6.Starting from this situation,suppose that an increase in national savings changes the domestic supply of capital relationship to K = 8R.
I: This country's GNP increases by 36.
II: Labour's share of GNP falls.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

We can start by finding the equilibrium level of capital and output in the initial situation:
K = 7R
R = 30 - (1/2)K
Substituting the first equation into the second equation, we get:
R = 30 - (1/2)(7R) = 26.5
K = 7(26.5) = 185.5
GNP = R*K = 4,917.25

Next, we can find the new equilibrium level of capital and output after the increase in national savings, which changes the domestic supply of capital relationship to K = 8R:
K = 8R
R = 30 - (1/2)K
Substituting the first equation into the second equation, we get:
R = 30 - (1/2)(8R) = 26
K = 8(26) = 208
GNP = R*K = 5,408

Therefore, the increase in national savings leads to an increase in GNP by:
5,408 - 4,917.25 = 490.75

As for the second statement, we can use the Cobb-Douglas production function to see whether labor's share of GNP falls or not:
GNP = A(K^α)(L^(1-α))
where A is a constant, α is the share of capital in output, and (1-α) is the share of labor in output.

In the initial situation, we have:
GNP = (185.5^(1/2))(L^(1/2))
Taking the derivative of GNP with respect to L, we get:
dGNP/dL = 0.5*(185.5^(1/2))*(L^(-1/2))
This means that labor's marginal productivity is decreasing as L increases, i.e., diminishing returns to labor. Therefore, labor's share of GNP is falling.

In the new situation, we have:
GNP = (208^(1/2))(L^(1/2))
Taking the derivative of GNP with respect to L, we get:
dGNP/dL = 0.5*(208^(1/2))*(L^(-1/2))
Once again, labor's marginal productivity is decreasing as L increases, and therefore labor's share of GNP is falling.

Hence, both statements I and II are true.

Question 4

In a long-run model of a small open economy,deficit reduction 
I: leads initially to increased net exports.
II: eventually leads to lower foreign debt and increased consumption.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

Deficit reduction in a small open economy initially increases net exports by reducing domestic consumption and investment, leading to a trade surplus. Over time, this surplus helps pay down foreign debt, eventually allowing for increased consumption as the economy stabilizes.

Question 5

A small open economy is in long-run equilibrium; it has some foreign debt outstanding; and its interest rate exceeds its growth rate.
I: The country has a trade surplus.
II: The world interest rate exceeds the country's growth rate.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

The country has a trade surplus because it is in long-run equilibrium and its interest rate exceeds its growth rate. The world interest rate does not exceed the country's growth rate.

Question 6

In September 1995,Patrick Buchanan,a Republican candidate for U.S.president,proposed a 10 percent tariff on Japanese imports to the United States,a 20 percent tariff on Chinese imports to the United States,and an unspecified "social" tariff on imports from third-world countries.
a.Use the long-run model of a small open economy to illustrate graphically the impact of these trade policies on the U.S.exchange rate and the trade balance.Assume that the country starts from a position of trade balance,i.e.,exports equal imports.Be sure to label:
i.the axes
ii.the curves
iii.the initial equilibrium values
iv.the direction the curves shift
v.the new long-run equilibrium values.
b.Based on your graphical analysis,explain the predicted impact of Mr.Buchanan's proposed policies.Specifically state what happens to the exchange rate,the trade balance,the volume of imports,and the volume of exports.

Accepted Answer

The answer of In September 1995,Patrick Buchanan,a Republican candidate for...

Question 7

Compare the impact of an increase in the government's budget deficit on investment spending in a small open economy with an otherwise comparable closed economy.Assume prices are flexible and that factors of production are fully employed in both economies.Use the basic version of the open-economy model that abstracts from foreign debt accumulation.

Accepted Answer

The answer of Compare the impact of an increase in...

Question 8

Suppose that governments around the world begin to engage in expansionary fiscal policy (run large budget deficits)in order to stimulate economic activity in their countries.
a.Use the basic version of the long-run model of a small open economy to illustrate graphically the impact of this expansionary fiscal policy by foreigners on the Canadian exchange rate and the Canadian trade balance.Assume that the country starts from a position of trade balance,i.e.,exports equal imports.Be sure to label:
i.the axes
ii.the curves
iii.the initial equilibrium values
iv.the direction the curves shift
v.the new long-run equilibrium values.
b.Based on your graphical analysis,explain the predicted impact of the foreign expansionary fiscal policy on the Canadian exchange rate and the Canadian trade balance.

Accepted Answer

The answer of Suppose that governments around the world begin...

Question 9

Assume that in a small open economy where full employment always prevails,national saving is 300.a.If domestic investment is given by I = 400 - 20r,where r is the real interest rate in percent,what would the equilibrium interest rate be if the economy were closed?
b.If the economy is open and the world interest rate is 10 percent,what will investment be?
c.What will the current account surplus or deficit be? What will net capital outflow be?

Accepted Answer

The answer of Assume that in a small open economy...

Question 10

In the long-run,increased national saving must 
I: increase the income of the owners of capital in a closed economy.
II: increase the income of the domestic owners of capital in a small open economy.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

The answer of In the long-run,increased national saving must 
I:...

Question 11

In April 1995,Michel Camdessus,managing director of the International Monetary Fund (IMF),criticized U.S.economic policy for allowing the dollar exchange rate to fall too low.He recommended that the United States reduce its budget deficit in order to raise the exchange rate.
a.Use the long-run model of a small open economy to illustrate graphically the impact of reducing the government's budget deficit on the exchange rate and the trade balance.Be sure to label:
i.the axes
ii.the curves
iii.the initial equilibrium values
iv.the direction the curves shift
v.the new long-run equilibrium values.
b.Based on your graphical analysis,explain whether Mr.Camdessus's policy recommendation will work.Specifically state what happens to the exchange rate and the trade balance as a result of the government budget deficit reduction.

Accepted Answer

The answer of In April 1995,Michel Camdessus,managing director of the...

Question 12

Assume that in a small open economy with full employment,consumption depends only on disposable income.National saving is 300,investment is given by I = 400 - 20r,where r is the real interest rate in percent,and the world interest rate is 10 percent.a.If government spending rises by 100,does investment change? What is the level of investment after the change?
b.Does the trade balance change if G rises by 100? If it changes,does it increase or decrease,and by how much?
c.Does net capital outflow change if G rises by 100? If it changes,does it increase or decrease,and by how much?
d.Will the real exchange rate rise,fall,or remain constant as a result of the change in G?

Accepted Answer

The answer of Assume that in a small open economy...

Question 13

Suppose that the large industrial countries of the world are concerned about the depreciating currencies of a number of small open economies.a.What type of fiscal policies must the large industrial countries undertake in order to promote currency appreciation in the small open economies?
b.Illustrate graphically the impact of the industrial countries' policies on the exchange rate of the small open economies.c.What will happen to the trade balance of the typical small open economy,assuming that it starts from a position of balanced trade?

Accepted Answer

The answer of Suppose that the large industrial countries of...

Question 14

In the long-run,increased national saving must 
I: increase total labour income in a closed economy.
II: increase total labour income in a small open economy.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

In the long run, increased national saving will increase the capital stock, which will increase the marginal product of labor and thus increase total labor income. This is true in both closed and small open economies.

Question 15

Tax breaks for capitalists "trickle down" to labourers in:
A) closed economies but not necessarily in small open economies.
B) small open economies but not necessarily in closed economies.
C) both closed and small open economies.
D) neither closed nor small open economies.

Accepted Answer

The answer of Tax breaks for capitalists "trickle down" to...

Question 16

Consider a small open economy whose demand and domestic supply of capital relationships are R = 30 - (1/2)K and K = 7R,respectively (where K and R denote capital and its marginal product).Capital is perfectly mobile internationally,and the yield on capital (R)in the rest of the world is 6.
I: GNP exceeds 90 percent of GDP in this country.
II: Labour's share of GDP in this country is two-thirds.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

The answer of Consider a small open economy whose demand...

Question 17

If corporate downsizing and lack of job security cause consumers to spend less and save more,what will be the impact on the exchange rate and trade balance?
a.Use the basic version of the long-run model of a small open economy to illustrate graphically the impact of this decline in consumer confidence on the exchange rate and the trade balance.Assume the country starts from a position of trade balance,i.e.,exports equal imports.Be sure to label:
i.the axes
ii.the curves
iii.the initial equilibrium values
iv.the direction the curves shift
v.the new long-run equilibrium values.b.Based on your graphical analysis,explain the predicted impact of a decline in consumer confidence on the exchange rate and the domestic economy's trade balance.

Accepted Answer

The answer of If corporate downsizing and lack of job...

Question 18

Consider a small open economy whose demand and domestic supply of capital relationships are R = 30 - (1/2)K and K = 7R,respectively (where K and R denote capital and its marginal product).Capital is perfectly mobile internationally,and the yield on capital (R)in the rest of the world is 6.
I: This country's GDP exceeds 900.
II: This country's GNP exceeds 800.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

The equilibrium yield on capital is R = 6. Using the supply equation K = 7R, we find K = 42. GDP is R * K = 6 * 42 = 252, which is less than 900. GNP includes net factor income from abroad, which is the difference between the world yield and domestic yield times the capital stock. Since capital is perfectly mobile, GNP is higher than GDP, but without specific values for net factor income, we can't definitively say it exceeds 800. However, given the context, II is more likely true than I.

Question 19

Suppose that the International Monetary Fund (IMF)is concerned about currency depreciation in a small open economy.Use the basic version of our exchange-rate model for your answers.a.What type of fiscal policy should the IMF propose to the government of the small open economy to generate a currency appreciation?
b.Illustrate graphically the impact of the IMF proposal on the exchange rate of the small open economy.c.What will happen to the trade balance of the small open economy,assuming that it started from a position of balanced trade?

Accepted Answer

The answer of Suppose that the International Monetary Fund (IMF)is...

Question 20

The government of a small open economy wishes to promote trade policies that will result in currency appreciation.
a.Would protectionist policies (higher tariffs and more quotas)or freer trade policies (tariff reductions and quota eliminations)be more effective in generating currency appreciation?
b.Using the basic version of the long-run exchange-rate model to illustrate graphically the impact of the trade policy on the exchange rate of the small open economy.
c.What will happen to the trade balance of the small open economy as a result of the trade policies,assuming that the country started from a position of free trade?
d.What will happen to the quantity of exports and imports as a result of the trade policies?

Accepted Answer

The answer of The government of a small open economy...

Quiz 5: The Open Economy

In a long-run model of a small open economy,deficit reduction I: leads to higher living standards. II: leads to a fall in the country's real exchange rate once the new full-equilibrium level of foreign debt is reached.

If a small open economy is in long-run equilibrium with no foreign debt:

In a long-run model of a small open economy,deficit reduction I: leads initially to increased net exports. II: eventually leads to lower foreign debt and increased consumption.

A small open economy is in long-run equilibrium; it has some foreign debt outstanding; and its interest rate exceeds its growth rate. I: The country has a trade surplus. II: The world interest rate exceeds the country's growth rate.

In the long-run,increased national saving must I: increase the income of the owners of capital in a closed economy. II: increase the income of the domestic owners of capital in a small open economy.

In the long-run,increased national saving must I: increase total labour income in a closed economy. II: increase total labour income in a small open economy.

Tax breaks for capitalists "trickle down" to labourers in: