D) surplus; negative. 9. The law of one price is enforced by: A) governments. B) producers. C) consumers. D) arbitrageurs.

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1 1. An open economy is one in which: A) the level of output is fixed. B) government spending exceeds revenues. C) the national interest rate equals the world interest rate. D) there is trade in goods and services with the rest of the world. 2. A country's exports may be written as equal to: A) GDP minus consumption minus investment minus government spending. B) GDP minus consumption of domestic goods and services minus investment of domestic goods and services minus government purchases of domestic goods and services. C) imports. D) GDP minus imports. 3. If net capital outflow is positive, then: A) exports must be positive. B) exports must be negative. C) the trade balance must be positive. D) the trade balance must be negative. 4. If domestic saving is less than domestic investment, then net exports are and net capital outflows are. A) positive; positive B) positive; negative C) negative; negative D) negative; positive 5. If a U.S. corporation purchases a product made in Europe and the European producer uses the proceeds to purchase a U.S. government bond, then U.S. net exports and net capital outflows. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease 6. In a small open economy, starting from a position of balanced trade, if the government increases the income tax, this produces a tendency toward a trade and net capital outflow. A) deficit; negative B) surplus; positive C) deficit; positive

2 D) surplus; negative 7. In a small open economy, when the government reduces national saving, the equilibrium real exchange rate: A) rises and net exports fall. B) rises and net exports rise. C) falls and net exports fall. D) falls and net exports rise. 8. In a small open economy, if the government adopts a policy that lowers imports, then that policy: A) raises the real exchange rate and increases net exports. B) raises the real exchange rate and does not change net exports. C) raises the real exchange rate and decreases net exports. D) lowers the real exchange rate. 9. The law of one price is enforced by: A) governments. B) producers. C) consumers. D) arbitrageurs. 10. Net capital outflow in a large country: A) rises as the real domestic interest rate rises. B) declines as the domestic interest rate rises. C) depends on the foreign interest rate. D) depends only on domestic saving. 11. If the real exchange rate depreciates from 1 Japanese good per U.S. good to 0.5 Japanese good per U.S. good, then U.S. exports and U.S. imports. A) increase; increase B) decrease; decrease C) increase; decrease D) decrease; increase 12. If the purchasing-power parity theory is true, then: A) the net exports schedule is very steep. B) all changes in the real exchange rate result from changes in price levels. C) all changes in the nominal exchange rate result from changes in price levels. D) changes in saving or investment influence only the real exchange rate.

3 13. For a closed economy, when net capital outflow is measured along the horizontal axis and the real interest rate is measured along the vertical axis, net capital outflow is drawn as a: A) vertical line at 0. B) horizontal line at the world real interest rate. C) line that slopes up and to the right. D) line that slopes down and to the right. 14. One consequence of high inflation is a(n): A) appreciating nominal exchange rate. B) decrease in the price of goods measured in terms of money. C) depreciating nominal exchange rate. D) decrease in the price of foreign currencies measured in terms of the domestic currency. 15. Assume that in a small open economy where full employment always prevails, national saving is 300. a. If domestic investment is given by I = r, 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? 16. In times of great economic uncertainty and potential job loss, many consumers may increase their saving as a precautionary measure. What is the predicted impact of an increase in national saving on the domestic interest rate and exchange rate in a large open economy, holding other factors constant. Illustrate your answer graphically and explain in words. 17. If the money supply in Mexico is increasing much more rapidly than the money supply in the United States, holding other factors constant, what would you predict will happen to the nominal exchange rate between the Mexican peso and the United States dollar? Explain. Answer Key - Untitled Exam-1 1. D 2. B 3. C

4 4. C 5. D 6. B 7. A 8. B 9. D 10. B 11. C 12. C 13. A 14. C percent a. b. 200 c. The trade surplus will be The increase in national saving will decrease the domestic interest rate. The lower interest rate will increase the amount of net capital outflows, which will decrease the domestic exchange rate as the supply of the domestic currency in the foreign exchange market increases.

5 17. According to the quantity theory, the faster growth rate of money will result in a higher rate of inflation in Mexico than in the United States. If there is purchasingpower parity, then the percentage change in the nominal exchange rate equals the percentage change in the real exchange rate plus the difference in the inflation rates (foreign inflation minus domestic inflation). The higher Mexican inflation will increase the nominal exchange rate (pesos per dollar), holding other factors constant.

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