Problem Set 8

Chapter 8: Macroeconomics in the Open Economy

1. What happens to Vietnam's real exchange rate in each of the following cases? Explain.
a. The nominal exchange rate remains unchanged, but prices in Vietnam rise faster than
abroad.
b. The nominal exchange rate remains unchanged, but prices abroad rise faster than in
Vietnam.
c. The Vietnam dong depreciated while prices in Vietnam and abroad remained
unchanged.
d. The Vietnam dong appreciated while prices both in Vietnam and abroad remained
unchanged.
2. A country has a current account surplus of $10 billion, but a capital account deficit of $6
billion.
a. Is the country's balance of payments surplus or deficit?
b. Does the country's foreign exchange reserves increase or decrease?
c. Is the central bank buying or selling the local currency? Explain.
3. Assume that after the US lifts its trade embargo against Vietnam, Vietnam's exports to
the US increase faster than its imports from the US.
a. How will the exchange rate of Vietnamese dong in terms of US dollars change?
Illustrated graphically.
b. How will the exchange rate of the dollar in terms of Vietnamese dong change?
Illustrated graphically.
c. How would such a change in trade affect Vietnam's output and price levels? Illustrate
with AD-AS graph.
4. Suppose an IBM laptop costs US$2000 in the US and C$3000 in Canada.
a. Where would you buy a computer if the exchange rate between the Canadian dollar
and the US dollar was 0.8US$/C$. Where would you sell computers if you wanted to
make a profit?

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 b. If many speculators act like you, and if the exchange rate is fixed, what will happen
to the price of computers in each country?
c. If many speculators act like you, and if the exchange rate is floating, what will
happen to the exchange rate? Determine the new equilibrium exchange rate to ensure
purchasing power parity for computers, if the price in US dollars and the price in
Canadian dollars do not change.
5. Assume the interest rate in Japan is 4% a year and the interest rate in Canada is 9% a
year. The current exchange rate is 100 yen/dollar, but you predict the exchange rate after
a year will be 95 yen/dollar. So you expect the Canadian dollar to depreciate against the
Japanese yen. Today you want to make a loan of $100 and you want to know the
expected return on the loan after a year in Japan or in Canada.
a. If you lend $100 in Canada, how many dollars will you receive at the end of year
one?
b. If you convert $100 into Japanese yen and lend it out in Japan, how many yen will
you get at the end of your first year? How many dollars do you expect to receive?
c. Where does a loan have a higher expected return?
d. Is there interest rate parity?
6. Figure 8.1 shows the exchange market between the US dollar and the Vietnamese dong:
D is the demand curve and S is the supply curve for US dollars. Assume that there are
only 2 countries in the world, the US and Vietnam.
a. What factors can shift the demand and supply curves to US dollars?
b. Determine the exchange rate in fully floating terms.
c. To fix the exchange rate at OA, how will the State bank of Vietnam intervene?
Please show the impact of this activity on the foreign exchange reserves of the
central bank and the base money.
d. To fix the exchange rate at OC, how will the central bank intervene? Please show the
impact of this activity on the foreign exchange reserves of the central bank and the
base money.

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EVND/USD
SUSD
C D E

B
A G H
DUSD

QUSD

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 MULTIPLE CHOICES

1. Suppose that a country exports $300 million of goods and services and imports $180
million of goods and services. What is the value of that country's net exports?
A) $-120 million B) $120 million 300-180
C) $300 million D) $380 million
2. In 2015, Denmark had net exports of $100 billion and sold $600 billion of goods and
services abroad. What were Denmark's components of net exports?
A) $500 billion of exports and $600 billion of imports
B) $500 billion of exports and $700 billion of imports
C) $600 billion of exports and $500 billion of imports
D) $700 billion of exports and $500 billion of imports
3. What is the formula for an open economy's GDP?
A) Y = C + I + G B) Y = (C - T) + I + G
C) Y = C + I + G + S D) Y = C + I + G + NX
4. What is the formula for investment in an open economy?
A) I = Y - C B) I = Y - C - NX
C) I = S - NCO D) I = S + NX
5. A country has $100 million of saving and domestic investment of $30 million. What are
net exports? 100-30
A) -$70 million B) $70 million C) $100 million D) $130
million
6. What does a trade deficit imply?
A) saving is greater than domestic investment and Y > C + I + G
B) saving is greater than domestic investment and Y < C + I + G
C) saving is less than domestic investment and Y > C + I + G
D) saving is less than domestic investment and Y < C + I + G
7. Starting from a trade surplus, what would create a trade deficit?
A) a decline in saving and investment
B) a rise in saving and investment

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 C) a decline in saving and a rise in investment
D) a rise in saving and a decline in investment
8. If a country has business opportunities that become relatively attractive to other
countries, what best predicts the effects of this change?
A) Both net exports and net capital outflow increase.
B) Both net exports and net capital outflow decrease.
C) Net exports increase, but net capital outflow decreases.
D) Net exports decrease, but net capital outflow increases.
9. If the exchange rate is 175 yen = $1, what is the cost of a bottle of rice wine that costs
7875 yen? 7875 : 175
A) $40 B) $45 C) $52 D) $54
10. If the Canadian real exchange rate appreciates, what will most likely happen?
A) Net exports increase, and net capital outflow decreases.
B) Net exports decrease, and net capital outflow increases.
C) Net exports and net capital outflow both increase.
D) Net exports and net capital outflow both decrease.
11. What does purchasing-power parity imply?
A) that real incomes should be the same in all countries
B) that the nominal exchange rates should be equal to 1 for all currencies
C) that the price of a standard hamburger should be the same everywhere
D) that the rent for an apartment should be the same everywhere
12. If P = domestic prices, P* = foreign prices, and e is the nominal exchange rate, what is
implied by purchasing-power parity?
A) P = e/P* B) 1 = e/P* C) e = P*/P D) P/P*=1
13. When a country's central bank decreases the money supply, which statement best
predicts the consequences?
A) Its price level rises, and its currency appreciates relative to other currencies in the
world. B) Its price level falls, and its currency appreciates relative to other currencies in
the world. C) Its price level rises, and its currency depreciates relative to other currencies

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 in the world. D) Its price level falls, and its currency depreciates relative to other
currencies in the world.
14. What kind of country would most likely have a "small open economy"?
A) a country that trades with other countries and consistently has a trade surplus
B) a country that trades with other countries and consistently has a trade deficit
C) a country that trades with other countries and has a significant effect on world prices
D) a country that trades with other countries, but has a negligible effect on world prices
15. Suppose the nominal exchange rate is 95 yen/dollar, the price of beef in Japan is ¥1200,
and the price of beef in Canada is $14. Using the purchasing-power parity theory,
approximately how much should you expect the exchange rate to change by?
A) -9 yen/dollar . B) -1.1 yen/dollar
C) 1.1 yen/dollar= 95x ( 14/1200) D) 9 yen/dollar.
16. What equation is the GDP identity in an open economy?
A) Y = C + I + G + NCO B) NX = - NCO
C) NCO = S - I + NX D) Y = C + I + G – NX
17. A country has $80 million of domestic investment and net capital outflow of -$20
million. What is saving? 80 + (-20)
A) -$80 million B) -$60 million
C) $60 million D) $80 million
18. A country has $50 million of domestic investment and net capital outflow of -$80
million. What is saving?
A) -$80 million B) -$30 million
C) $50 million D) $130 million
19. In which situation must domestic saving equal investment?
A) when NX is negative B) when NX is zero
C) when NCO is negative D) when imports are zero
20. What does a trade surplus imply?
A) saving is greater than domestic investment and Y > C + I + G
B) saving is greater than domestic investment and Y < C + I + G
C) saving is less than domestic investment and Y > C + I + G
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 D) saving is less than domestic investment and Y < C + I + G
21. If citizens of a country are not saving much, which action should that country's
government take?
A) force citizens to save
B) reduce investment
C) have foreigners invest in the domestic economy
D) prevent opportunities for citizens to buy capital assets abroad
22. If the exchange rate changes from 40 Thai baht per dollar to 25 Thai baht per dollar,
what has happened to the dollar?
A) It has appreciated and so buys more Thai goods.
B) It has appreciated and so buys fewer Thai goods.
C) It has depreciated and so buys more Thai goods.
D) It has depreciated and so buys fewer Thai goods.
23. Exchange rates are 0.75 U.S. dollars per Canadian dollar, 170 yen per Canadian dollar,
0.8 euro per Canadian dollar, and 20 pesos per Canadian dollar. A bottle of beer in New
York costs 6 U.S. dollars, 1200 yen in Tokyo, 7 euros in Munich, and 100 pesos in
Cancun. Where is the most expensive beer?
A) Cancun B) New York C) Tokyo D) Munich
24. In Ireland, a pint of beer costs 4 Irish punts. In Australia, a pint of beer costs 6
Australian dollars. If the exchange rate is 0.8 punts per Australian dollar, what is the real
exchange rate?
A) 0.53 pints of Irish beer per pint of Australian beer
B) 0.8 pints of Irish beer per pint of Australian beer
C) 1.11 pints of Irish beer per pint of Australian beer
D) 1.2 pints of Irish beer per pint of Australian beer
25. If the nominal exchange rate e is foreign currency per dollar, the domestic price is P, and
the foreign price is P*, what is the definition of the real exchange rate?
A) e(P*/P) B) e(P/P*) C) e + P/P D) e - P/P*
(Be careful: here dollar is domestic currency)
26. If the Canadian dollar gets weaker relative to the Japanese yen, what might happen?
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 A) Canadian trade surplus will fall.
B) Canadian trade deficit will fall.
C) Japanese trade surplus will rise.
D) Japanese trade deficit will fall.
(Explain: Canadian dollar gets weaker means export from Canada to Japan will increase
=> Canada’s NX will increase. Concerning Japan, Japanese yen appreciates => Japan’s
import will increase, export will decrease => Japan’s NX will decrease)
27. Country A buys $250 of wine from country B, and B buys $130 of wool from A. Which
of the following correctly indicates the two countries' net exports (in the order A, B)?
A) -$120, $120 B) $120, -$120
C) $250, $130 D) $330, $0
28. In 2015, Ghana had $4 billion of net exports and bought $1 billion of goods from foreign
countries. What were Ghana's components of net exports?
A) $5 billion in exports and $1 billion in imports
B) $4 billion in imports and $1 billion in exports
C) $3 billion in exports and $1 billion in imports
D) $1 billion in imports and $3 billion in exports
29. Suppose Paul, a Romanian citizen, builds a telescope factory in Israel. What are the
effects of these expenditures?
A) They increase Romanian and Israeli net capital outflow.
B) They increase Romanian net capital outflow, but decrease Israeli net capital outflow.
C) They decrease Romanian net capital outflow, but increase Israeli net capital outflow.
D) They increase Romanian net capital outflow, but Israeli net capital outflow remains
unchanged.

30. Suppose the price of a standard pair of sport shoes is €60 in Spain and $85 in Canada,
and the current exchange rate is 0.75 euro for one dollar. What is the purchasing-power
parity exchange rate of the dollar? PPP= Cost of Good X in Currency 1 / Cost of Good X
in Currency 2. =60/85
A) 0.40 euro/dollar B) 0.53 euro/dollar
C) 0.71 euro/dollar D) 1.53 euro/dollar

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