Econ 2202 - Ch. 4

If you were an importer or exporter, you might prefer an exchange-rate system like Brenton Woods to the current system because:

Answer: All of the above

What problems can exchange rate fluctuations cause for firms?

Answer: All of the above

According to an article in the Wall Street Journal, "Japan's three largest auto makers are signaling plans to shift more production overseas to deal with the strong yen." What does the article mean by a "strong yen"? What problem does a strong yen cause for Japanese automobile companies? How would moving production overseas help Japanese automobile companies deal with a strong yen?

Answer: All of the above A and B but not C Production inside the markets to which they now export would eliminate the harm their price competitiveness suffers form a strong yen.

Consider the following statement: "Because the percentage of U.S. GDP accounted for by trade is much less than for many other countries, trade is not very important to the U.S." Do you agree with this statement? Briefly explain.

Answer: Disagree. A relatively low ratio of trade-to-GDP, when coupled with the exceptionally large U.S. GDP, still translates into a significant role for trade in the U.S. economy.

An article in the Economist magazine states: "India aims to fund its current-account deficit mainly by attracting ... flows of FDI [foreign direct investment]." Foreign direct investment into a country is best defined as the _____. In what sense can foreign direct investment fund a country's current account deficit?

Answer: Purchase and/or construction of physical capital in the country by foreign investors. Foreign direct investment funds a current account deficit in the sense that it appears as a "credit" or surplus item in the financial account, thus providing an offset to the current account deficit. (The "funding" of current account deficit is simply the presence of an offsetting surplus that must occur in the sum of its capital and financial accounts. Foreign direct investment thus funds a current account deficit in the sense that it appears as a "credit" or surplus item int he financial account, thus providing an offset to the current account deficit.)

A political columnist makes the following assertion: "China has a huge balance of trade surplus with the rest of the world. In addition, the rest of the world is investing huge amounts in China, which is the main way that China is able to fund investments in new factories." Use your knowledge of the balance of payments accounts to analyze the columnist's argument.

Answer: The columnist is incorrect. On the reasonable assumption that the current account closely mirrors the trade balance, a balance of trade surplus for China implies a financial account deficit. A financial account deficit, in turn, means that China is accumulating assets abroad, effectively funding investment in new factories there rather than in China. (Even though the trade balance is only a part of the current account, the two are often viewed synonymously since they are highly correlated. Thus, when a country runs a trade balance surplus, it can be inferred that it must also be running a financial account deficit. A financial account deficit, in turn, means that the country is purchasing more assets abroad than foreigners are purchasing within the country, A country with a balance of trade surplus is accumulating assets abroad, effectively funding investment in new factories there rather than at home.)

Purchasing power parity is the _____. Why doesn't purchasing power parity hold exactly?

Answer: Theory that in the long-run nominal exchange rates adjust to equalize the purchasing power of different currencies. Products differ across countries, barriers to traders often imposed by countries, not all goods are traded internationally.

*The balance-of-payments account measures: The balance of payments consists of _____ separates accounts. Which of the following are recorded in a country's current account: Which of the following is not among the relatively minor transactions that are recorded in the capital account: *The components of the financial account of a country's balance of payments include:

Answer: all flows of private and government funds between domestic economy and all foreign countries (change) Three Net exports, Net transfer, Net investment income Transactions involving physical capital All of the above (change A & B)

An increase in capital outflows form the U.S. will _____.

Answer: decrease the balance of the U.S. financial account.

The domestic interest rate in a small open economy is _____.

Answer: equal to the world real interest rate

When the FED pursues a monetary policy of low interest rates the exchange rate between the dollar and other currencies will tend to ____ generally making it ____ for foreign firms to sell their goods in the U.S.

Answer: fall; more difficult

For each of the items below, indicate in which balance-of-payments account the transaction would occur. An export of goods is recorded in the _____ account. A purchase of stock is recorded in the _____ account. A gift form someone in another country is recorded in the ______ account. Interest received on bonds owned in another country is recorded in the _____ account. An import of services is recorded in the ____ account. A sale of a trademark is recorded in the ____ account. A dividend received on stock owned in another country is recorded in the ____ account. Interest received on bonds owned in another country is recorded in the ____ account.

Current Financial Current Current Current Capital Current Current