I. Multiple Choice

  1. Which one of the following decreases the price of the US dollar relative to the British pound?

A)An increase in the supplyof dollars.

B)An increase in the demand for pounds.

C)A decrease in the demand for dollars.

D)All of the above.

  1. Any transaction that causes foreign exchange to leave a country is a

A)credit item in that country’s balance of trade.

B)debit item in that country’s balance of payments.

C)credit item in that country’s balance of payments.

D)debit item in that country’s balance of trade.

  1. A tariff imposed on imported shoes will cause the domestic price of shoes to ______and the domestic production of shoes to ______.

A)increase; increase.

B)increase; decrease.

C)decrease; increase.

D)decrease; decrease.

  1. An increase in US imports from Mexico will ______the supply of dollars and ______the demand for pesos

A)decrease; decrease.

B)increase; increase.

C)increase; decrease.

D)decrease; increase.

  1. Japan imports over 90% of its consumption of oil. If the price of oil increases, Japan’s

A)aggregate demand curve shifts to the right.

B)aggregate supply curve shifts to the right.

C)aggregate supply curve shifts to the left.

D)aggregate planed expenditures increase.

  1. A US firm builds a factory in South Africa. This will be entered as

A)debit in the US capital account.

B)debit in the US current account.

C)credit in the US capital account.

D)credit in the US current account.

II. Short Questions

  1. Explain how the following situations affect the United States' balance of payments.
  1. A U.S. defense contractor sells its consulting services to a company in France.

Ans:

This would bring foreign exchange into the country, thus there would be a credit on the balance of payments current account and a debit on the capital account (since it would increase the amount of foreign exchange US citizens hold).

  1. A Belgian investor buys securities from a US firm.

Ans:

This means that the Belgian investor sold Euros to get the US dollars to buy the US securities. After this the foreign private assets in the US increase (because the Belgian investor has the US securities), and the US assets abroad increase too (because there are more Euros in the US).

  1. A consortium of European investors decides to build a large manufacturing facility in Montana.

Ans:

This transaction is an increase in the foreign private assets in the US (a credit in the capital account), and it is also recorded as an increase in the US private assets abroad because now some Americans own foreign currency due to the fact that the European investors sell their Euros in exchange for thedollars they need to build the facility. This last transaction enters with a minus sign in the capital account.

  1. Identify whether each of the following would lead to an appreciation or depreciation of the dollar. In each case, briefly explain why the currency either appreciates or depreciates.
  1. U.S. citizens start making plans to go on holidays to the United Kingdom.

Ans:

This depreciates the US Dollar because Americans demand more British pounds and offer more dollars in exchange.

  1. TheUS economy enters into a recession.

Ans:

This appreciates the US Dollar because as the economy enters into a recession imports fall, hence the demand of foreign currency falls and the supply of US dollars (in exchange for the foreign currency) also falls.

  1. The money supply is decreased in the United States.

Ans:

This appreciates the US dollar because a decrease in the money supply decreases output and hence imports (see b above). Also it increases the US interest rates making more attractive investment in US securities. Foreigners will demand more US dollars and Americans will offer less of them.

  1. Speculators stop being confident inthe UK’scurrency.

Ans:

This appreciates the US dollar because speculators expecting a depreciation of the UK pounds will shift to US dollars.

  1. Explain the impact of an expansionary monetary policy on output in an economy with flexible exchange rates. Use causal arrows in your explanation.

Ms rI Y

Also because r Demand US Dollars by foreigners  & Supply US Dollars Americans  Depreciation US Dollar  EX & IM 

III. Long Problem

C = 600 + 0.5Yd

I = 400

G = 500

EX = 200

IM = 0.1Yd

Yd = Y-T

T = 500

  1. Y* solves

Y* = AEd = C + I + G + EX – IM

= 1500 + Y*(1/2 – 0.1).

Hence Y* = 2,500

  1. The government expenditure multiplier is given by
  1. At Y*=2,500, imports equal IM = 0.1(Y* - T) = 0.1(2,500 – 500) = 200.

So the balance of trade is EX – IM = 200 – 200 = 0.

  1. Suppose for simplicity that the foreign exchange under consideration is the Euro (). A contractionary fiscal policy will reduce output Y, and hence it will make imports fall. This will affectthe Euro exchange marketsbecause Americans demand less Euros and this will lead to an appreciation of the Dollar.