Macroeconomics Chapter 23 Review Questions

If you observed a country with a rapidly growing trade surplus over a period of a year or so, would you be more likely to believe that the country's economy was in a period of recession or of rapid growth? Explain.

It is more likely for the economy to be in a recession.

Will nations that are more involved in foreign trade tend to have higher trade imbalances, lower trade imbalances, or is the pattern unpredictable?

It really depends, especially on the size of the nation: large nations may have small trade imbalances and small nations may have larger imbalances.

Is it better for your country to be an international lender or borrower?

It would be better for my country should be an international lender because it will increase its currency reserves in foreign countries.

Both the United States and global economies are booming. Will U.S. imports and/or exports increase?

A booming economy will increase the demand for goods in general, so import sales will increase. If our trading partners' economies are doing well, they will buy more of our products and so U.S. exports will increase.

Occasionally, a government official will argue that a country should strive for both a trade surplus and a health inflow of capital from abroad. Is this possible?

A country cannot have a trade surplus along with the inflow of financial capital from abroad because, when a country has a trade surplus, domestic.

Occasionally, a government official will argue that a country should strive for both a trade surplus and a healthy inflow of capital from abroad. Explain why such a statement is economically impossible.

A country cannot have a trade surplus along with the inflow of financial capital from abroad because, when a country has a trade surplus, domestic.

Describe a scenario in which a trade surplus benefits an economy and one in which a trade surplus is occurring in an economy that performs poorly. What key factors are making the difference in the outcome that results from a trade surplus?

A rapidly growing trade surplus could result from a number of factors, so you would not want to be too quick to assume a specific cause. However, if the choice is between whether the economy is in recession or growing rapidly, the answer would have to be recession. In a recession, demand for all goods, including imports, has declined; however, demand for exports from other countries has not necessarily altered much, so the result is a larger trade surplus.

What determines the size of a country's trade deficit?

A trade deficit is determined by a country's level of private and public savings and the amount of domestic investment.

Does a trade surplus help to guarantee strong economic growth?

A trade surplus can create employment and economic growth but may also lead to higher prices and interest rates within an economy. A country's trade balance can also influence the value of its currency in the global markets, as it allows a country to have control of the majority of its currency through trade.

When is a trade deficit likely to work out well for an economy? When is it likely to work out poorly?

All depends on if the corresponding flows of financial capital, and if they are wisely invested.

At one point Canada's GDP was $1,800 billion and its exports were $542 billion. What was Canada's export ratio at this time?

Divide $542 billion by $1,800 billion = 0.301

The GDP for the United States is $18,036 billion and its current account balance is -$484 billion. What percent of GDP is the current account balance?

Divide -$484 billion by $18,036 billion = 2.68%

Some economists warn that the persistent trade deficits and a negative current account balance that the United States has run will be a problem in the long run. Do you agree or not? Explain your answer.

Economic theory suggests that it's likely that today's current account deficits will need to be trimmed or reversed over the long run.

A government official announces a new policy. The country wishes to eliminate its trade deficit, but will strongly encourage financial investment from foreign firms. Explain why such a statement is contradictory.

Eliminating trade deficits with foreign investments is impossible already. The whole purpose of lowering the trade deficit is to minimize outside investments because the profits of production will afterward go to the investors in these countries. So, if we want to have a lower trade deficit, we should encourage domestic production with our finances. If we don't have enough, then at that moment, trade deficit is inevitable.

How did large trade deficits hurt the East Asian countries in the mid 1980s? (Recall that trade deficits are equivalent to inflows of financial capital from abroad)

Foreign investors worried about repayment so they began to pull money out of these countries. The money can be pulled out of stock and bond markets, real estate, and banks.

In what way does comparing a country's exports to GDP reflect its degree of globalization?

GDP is a dollar value of all production of goods and services. Exports are produced domestically but shipped abroad. The percent ratio of exports to GDP gives us an idea of how important exports are to the national economy out of all goods and services produced. For example, exports represent only 14% of U.S. GDP, but 50% of Germany's GDP.

The United States exports 14% of GDP while Germany exports about 50% of its GDP. Explain what that means.

Germany has a higher level of trade than the United States. The United States has a large domestic economy so it has a large volume of internal trade.

Using the national savings and investment identity, explain how each of the following changes (ceteris paribus) will increase or decrease the trade balance: a. A lower domestic savings rate b. The government changes from running a budget surplus to running a budget deficit c. The rate of domestic investment surges

If domestic savings increases and nothing else changes, then the trade deficit will fall. In effect, the economy would be relying more on domestic capital and less on foreign capital. If the government starts borrowing instead of saving, then the trade deficit must rise. In effect, the government is no longer providing savings and so, if nothing else is to change, more investment funds must arrive from abroad. If the rate of domestic investment surges, then, ceteris paribus, the trade deficit must also rise, to provide the extra capital. The ceteris paribus—or "other things being equal"—assumption is important here. In all of these situations, there is no reason to expect in the real world that the original change will affect only, or primarily, the trade deficit. The identity only says that something will adjust—it does not specify what.

Explain the relationship between a current account deficit or surplus and the flow of funds.

If more monies are flowing out of the country (for example, to pay for imports) it will make the current account more negative or less positive, and if more monies are flowing into the country, it will make the current account less negative or more positive.

Why does a recession cause a trade deficit to increase?

Incomes fall during a recession, and consumers buy fewer good, including imports.

If the trade deficit of the United States increases, how is the current account balance affected?

It becomes more negative as imports, which are a negative to the current account, are growing faster than exports, which are a positive.

What are the two main sides of the national savings and investment identity?

Quantity of financial capital supplied = Quantity of financial capital demanded

What are the main components of the national savings and investment identity?

S: Savings by individuals and firms M-X: Trade deficit I: Private sector investment T-G: taxes collected and Government spending

What is more important, a country's current account balance or GDP growth? Why?

The answer is GDP growth. GDP growth is more important than a country's current account balance because the health of an economy is best represented.

What is the difference between trade deficits and balance of trade?

The balance of trade is the calculation of a country's exports minus its imports, while trade deficits is the amount by which the cost of a country 's imports exceeds the value of its exports.

What is included in the current account balance?

The four major components of a current account are goods, services, income, and current transfers.

Many think that the size of a trade deficit is due to a lack of competitiveness of domestic sectors, such as autos. Explain why this is not true.

The fundamental cause of a trade deficit is an imbalance between a country's savings and investment rates. As Harvard's Martin Feldstein explains, the reason for the deficit can be boiled down to the United States as a whole spending more money than it makes, which results in a current account deficit.

If a country is running a government budget surplus, why is (T - G) on the left side of the saving-investment identity?

The government is saving rather than borrowing. The supply of savings, whether private or public, is on the left side of the identity.

If foreign investors buy more U.S. stocks and bonds, how would that show up in the current account balance?

The stock and bond values will not show up in the current account. However, the dividends from the stocks and the interest from the bonds show up as an import to income in the current account.

How does the bottom portion of Figure 23.3, showing the international flow of investments and capital, differ from the upper portion?

The top portion tracks the flow of exports and imports and the payments for those. The bottom portion is looking at international financial investments and capital.

Why does the trade balance and the current account balance track so closely together over time?

The trade balance is the difference between exports and imports. The current account balance includes this number (whether it is a trade balance or a trade surplus), but also includes international flows of money from global investments.

If domestic investment increases, and there is no change in the amount of private and public saving, what must happen to the size of the trade deficit?

The trade deficit must increase. To put it another way, this increase in investment must be financed by an inflow of financial capital from abroad.

What three factors will determine whether a nation has a higher or lower share of trade relative to its GDP?

Three factors strongly influence a nation's level of trade: the size of its economy, its geographic location, and its history of trade.

Does a trade surplus mean an overall inflow of financial capital to an economy, or an overall outflow of financial capital? What about a trade deficit?

Trade surplus means a net outflow of financial capital; another way to put it is when domestic savings (both private and public) is higher than domestic investment. Deficit means a net inflow of financial capital from abroad.

If imports exceed exports, is it a trade deficit or a trade surplus? What about if exports exceed imports?

When exports exceed imports, the net exports figure is positive. This indicates that a country has a trade surplus. When exports are less than imports, the net exports figure is negative. This indicates that the nation has a trade deficit.

If a country is a big exporter, is it more exposed to global financial crises?

Yes, financial crises economically impact export-import participation and products. When a country is hit by a crisis, its access to capital avenues.

If countries reduced trade barriers, would the international flows of money increase?

Yes. If a country reduces trade barriers (quotas and tariffs), it will increase the international flow of money.

Explain briefly whether each of the following would be more likely to lead to a higher level of trade for an economy, or a greater imbalance of trade for an economy. a. Living in an especially large country b. Having a domestic investment rate much higher than the domestic savings rate c. Having many other large economies geographically nearby d. Having an especially large budget deficit e. Having countries with a tradition of strong protectionist legislation shutting out imports

a. A large economy tends to have lower levels of international trade, because it can do more of its trade internally, but this has little impact on its trade imbalance. b. An imbalance between domestic physical investment and domestic saving (including government and private saving) will always lead to a trade imbalance but has little to do with the level of trade. c. Many large trading partners nearby geographically increases the level of trade but has little impact one way or the other on a trade imbalance. d. The answer here is not obvious. An especially large budget deficit means a large demand for financial capital which, according to the national saving and investment identity, makes it somewhat more likely that there will be a need for an inflow of foreign capital, which means a trade deficit. e. A strong tradition of discouraging trade certainly reduces the level of trade. However, it does not necessarily say much about the balance of trade, since this is determined by both imports and exports, and by national levels of physical investment and savings.

State whether each of the following events involves a financial flow to the U.S. economy or away from the U.S. economy: a. Export sales to Germany b. Returns paid on past U.S. financial investments in Brazil c. Foreign aid from the U.S. government to Egypt d. Imported oil from the Russian Federation e. Japanese investors buying U.S. real estate

a. An export sale to Germany involves a financial flow from Germany to the U.S. economy. b. The issue here is not U.S. investments in Brazil, but the return paid on those investments, which involves a financial flow from the Brazilian economy to the U.S. economy. c. Foreign aid from the United States to Egypt is a financial flow from the United States to Egypt. d. Importing oil from the Russian Federation means a flow of financial payments from the U.S. economy to the Russian Federation. e. Japanese investors buying U.S. real estate is a financial flow from Japan to the U.S. economy

For each of the following, indicate which type of government spending would justify a budget deficit and which would not. a. Increased federal spending on Medicare b. Increased spending on education c. Increased spending on the space program d. Increased spending on airports and air traffic control

a. Increased federal spending on Medicare may not increase productivity, so a budget deficit is not justified. b. Increased spending on education will increase productivity and foster greater economic growth, so a budget deficit is justified. c. Increased spending on the space program may not increase productivity, so a budget deficit is not justified. d. Increased spending on airports and air traffic control will increase productivity and foster greater economic growth, so a budget deficit is justified.

State whether each of the following events involves a financial flow to the Mexican economy or a financial flow out of the Mexican economy: a. Mexico imports services from Japan b. Mexico exports goods to Canada c. U.S. investors receive a return from past financial investments in Mexico

a. financial flow out b. financial flow in c. financial flow out

In recent decades, has the U.S. trade balance usually been in deficit, surplus, or balanced?

deficit