Macroeconomics Exchange Rates and Balance of Payments
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Questions and Answers

What does a GDP/GNP ratio greater than 1 for Ireland indicate?

  • Ireland's GNP is completely reliant on external factors.
  • Ireland's economic output exceeds the income generated by its residents. (correct)
  • Ireland has a higher income from abroad than its GDP.
  • Ireland has equal GDP and GNP.

    • What can we conclude about the real exchange rate when E = 30 Thai Baht / 1 USD?

  • It is unaffected by the prices of goods in either country.
  • It will definitely be less than 1.
  • It is always larger than 10 regardless of prices.
  • It cannot be determined without knowing the prices of goods. (correct)

    • Given that the price of a basket of goods is 200 Thai Baht and 10 USD, what does this imply about Thai goods?

  • Thai goods are less competitive than US goods.
  • Thai goods provide a price advantage over US goods. (correct)
  • US goods are significantly cheaper than Thai goods.
  • The prices are equivalent in both countries.

    • What can be said about the Balance of Payments?

    <p>It is always balanced under normal circumstances.</p> Signup and view all the answers

    How many Danish Krone (DNK) are needed to buy 10 Euros given E = 7.5 DNK / EUR?

    <p>75</p> Signup and view all the answers

    What does the real exchange rate measure in economic terms?

    <p>The trade value between the goods of two countries.</p> Signup and view all the answers

    When GDP is larger than GNP, what does that signify about a country's economy?

    <p>The country produces more than the income earned by its residents.</p> Signup and view all the answers

    What inference can be made if the real exchange rate is equal to one?

    <p>Both countries involved have identical pricing strategies.</p> Signup and view all the answers

    What happens to the economy when private households lose trust in the commercial banking sector?

    <p>Real exchange rate decreases, output decreases, and reserve remains constant.</p> Signup and view all the answers

    In the ISZZ-LMZZ model, what overall situation is indicated by a high unemployment rate?

    <p>The economy is in a recession.</p> Signup and view all the answers

    What is the effect on endogenous variables when the central bank decreases the money supply?

    <p>Output decreases, exchange rate appreciates, and reserve remains constant.</p> Signup and view all the answers

    What occurs when the government reduces its spending (G) in an economy that is not capacity constrained?

    <p>Exchange rate rises, output stays constant, and reserve remains constant.</p> Signup and view all the answers

    If the economy is not capacity constrained and the money demand increases, what is the effect on the interest rate?

    <p>Interest rate increases, output decreases, and reserves are constant.</p> Signup and view all the answers

    What happens to the economy if both employment and production fall?

    <p>Economic activity is likely contracting.</p> Signup and view all the answers

    How do changes in reserve levels typically respond to initial increases in money demand?

    <p>Reserves remain constant.</p> Signup and view all the answers

    What is the relationship between real exchange rate and output when the currency appreciates?

    <p>Real exchange rate increases and output decreases.</p> Signup and view all the answers

    What does it indicate if output remains constant while the exchange rate fluctuates?

    <p>Monetary policy is ineffective.</p> Signup and view all the answers

    In the context of an economy not capacity constrained, what is the expected response to a stable interest rate amid increased government spending?

    <p>Output increases and the economy expands.</p> Signup and view all the answers

    How does the domestic interest rate behave when the government increases government spending in a model where output is fixed?

    <p>The domestic interest rate is endogenous, but does not change.</p> Signup and view all the answers

    With the prices given as P*=120 USD, P=110 EUR, and E=1.10 EUR/USD, which statement is true regarding the Law of One Price?

    <p>The Law of One Price does not hold.</p> Signup and view all the answers

    If the Law of One Price does not hold, what will happen to the exchange rate according to the scenario provided?

    <p>Appreciation of EUR</p> Signup and view all the answers

    Which theory is represented by the price of a basket of goods?

    <p>Absolute PPP</p> Signup and view all the answers

    Which theory relates directly to the rate of inflation?

    <p>Relative PPP</p> Signup and view all the answers

    Given the price levels P=100 EUR and P*=150 USD with E=0.8 EUR/USD, how does absolute PPP behave?

    <p>Arbitrage is not possible.</p> Signup and view all the answers

    For a relative PPP regression with an intercept of 0.2 and a standard error of 0.2, what is the 95% confidence interval?

    <p>−0.2 and 0.6</p> Signup and view all the answers

    If the intercept of a relative PPP regression is estimated at 0.2, what can be concluded regarding the hypothesis if the 95% confidence interval is from −0.2 to 0.6?

    <p>Do not reject the H0 hypothesis</p> Signup and view all the answers

    In a relative PPP regression with a slope of −0.88 and a standard error of 0.1, what is the t-statistic?

    <p>−18.8</p> Signup and view all the answers

    If the t-statistic for a slope of −0.88 is −18.8, what conclusion can be drawn about the validity of PPP?

    <p>We reject H0, PPP does not hold.</p> Signup and view all the answers

    In an economy that is not capacity constrained with a floating exchange rate system, which variables are displayed on the axes of the diagram?

    <p>E and Y</p> Signup and view all the answers

    In the same economy, which variables are considered endogenous?

    <p>R, E, Y</p> Signup and view all the answers

    What is the effect on Y, E, and R if the government increases its spending in this economy?

    <p>Y is constant, E is down, R is constant</p> Signup and view all the answers

    Which statement reflects the paradox of the mercantilistic approach?

    <p>Successful countries keep wages low to maintain a competitive advantage.</p> Signup and view all the answers

    What is incorrect about the Ricardo model?

    <p>Absolute advantage guarantees comparative advantage.</p> Signup and view all the answers

    What change is expected in Australia as a result of trade with Singapore?

    <p>Land prices will increase in Australia.</p> Signup and view all the answers

    Which statement accurately reflects the relationship between the Ricardo and Heckscher-Ohlin theories?

    <p>Ricardo's theory predates the Heckscher-Ohlin theory.</p> Signup and view all the answers

    Which reason does not explain why countries trade according to comparative advantage theory?

    <p>Political leverage gained from exports.</p> Signup and view all the answers

    According to the Heckscher-Ohlin theorem, a country will export which type of good?

    <p>The good that employs its abundant production factors.</p> Signup and view all the answers

    Is it always true that trade benefits everyone involved?

    <p>False, trade can lead to uneven benefits among countries.</p> Signup and view all the answers

    What characterizes firms in the Krugman model?

    <p>They have some market power while considering competitors’ prices.</p> Signup and view all the answers

    Which condition is essential for firm optimality in the Krugman model?

    <p>Marginal revenue must equal marginal cost.</p> Signup and view all the answers

    In the Krugman model, what defines industry equilibrium?

    <p>Price equals average cost with no profits.</p> Signup and view all the answers

    What happens to the number of firms in a country relative to free trade when trade is implemented?

    <p>The number of firms increases, but consumers can purchase fewer varieties.</p> Signup and view all the answers

    Which statement about prices and profits in market structures is accurate?

    <p>Both market structures eventually encounter zero economic profits.</p> Signup and view all the answers

    What is the primary reason for trade according to the Krugman model?

    <p>Internal economies of scale.</p> Signup and view all the answers

    What happens to the number of firms in each country when trade is closed in the symmetric Krugman model?

    <p>Firm numbers decrease, and variety of goods increases.</p> Signup and view all the answers

    Who bears the cost of a tariff in a small open economy?

    <p>Domestic consumers.</p> Signup and view all the answers

    Which of the following statements is incorrect when a small country imposes a tariff?

    <p>Overall welfare increases.</p> Signup and view all the answers

    Why does producer surplus increase after a tariff is applied?

    <p>Domestic companies are shielded from competition, allowing price increases.</p> Signup and view all the answers

    When a large country implements a tariff, what difference might be observed compared to a small country?

    <p>Welfare might increase for the large country.</p> Signup and view all the answers

    How does a US tariff impact consumer surplus in Mexico within a large country scenario?

    <p>Consumer surplus increases as US tariffs lower competition.</p> Signup and view all the answers

    Which axes variables are represented in the economic graph discussed?

    <p>Money supply – price – exchange rate.</p> Signup and view all the answers

    Is GDP considered an endogenous variable?

    <p>No, GDP changes are only driven by demand.</p> Signup and view all the answers

    Which of the following groups consists of endogenous variables?

    <p>Domestic interest rate, price, and exchange rate.</p> Signup and view all the answers

    What are likely effects of an expansionary monetary policy?

    <p>Inflation and depreciation of domestic currency.</p> Signup and view all the answers

    What is the impact of increased government spending on domestic currency?

    <p>It often leads to appreciation of domestic currency.</p> Signup and view all the answers

    How is the price multiplier of a monetary expansion characterized?

    <p>It can fluctuate based on monetary policy.</p> Signup and view all the answers

    Which option best describes the exchange rate multiplier of fiscal expansion?

    <p>It can be greater than zero under certain conditions.</p> Signup and view all the answers

    What does it indicate if a country produces more than the income earned by its citizens?

    <p>A country has a trade surplus.</p> Signup and view all the answers

    What does a decrease in the EUR/USD exchange rate from 0.92 to 0.85 imply?

    <p>An appreciation of the Euro.</p> Signup and view all the answers

    If the exchange rate of the British Pound decreased from 1.20 EUR/GBP to 1.10 EUR/GBP, this is indicative of what?

    <p>An appreciation of the Euro.</p> Signup and view all the answers

    What is the price of 1 EUR in Japanese Yen if the exchange rate is 0.008 EUR/1 YEN?

    <p>125</p> Signup and view all the answers

    If the foreign interest rate is greater than the domestic interest rate, what is the implication for the forward rate premium/discount?

    <p>(F - E) / E will be negative.</p> Signup and view all the answers

    If the Turkish Lira is expected to depreciate against the USD, what does it imply regarding the interest rates?

    <p>R_Turkey &gt; R_USA</p> Signup and view all the answers

    In the theoretical UIP model, what does HR stand for?

    <p>Home Return</p> Signup and view all the answers

    On which variables do the axes of the theoretical UIP model plot?

    <p>E and HR, FR</p> Signup and view all the answers

    What is the consequence of a decrease in home return according to the UIP model?

    <p>A depreciation of domestic currency.</p> Signup and view all the answers

    If the Home Return curve shifts to the right, what does this indicate?

    <p>Exchange rate decreases indicating an appreciation of domestic currency.</p> Signup and view all the answers

    When there is a deviation from the covered interest parity condition, what can be expected?

    <p>Arbitrage profits can be made without uncertainty.</p> Signup and view all the answers

    How do simultaneous changes in expected exchange rate and domestic interest rate impact equilibrium in the UIP model?

    <p>Lead to appreciation of domestic currency.</p> Signup and view all the answers

    What is the null hypothesis regarding the beta coefficient for interest rate differences?

    <p>Beta equals 1.</p> Signup and view all the answers

    How does an increase in the expected exchange rate affect domestic currency?

    <p>Leads to depreciation of domestic currency.</p> Signup and view all the answers

    Which variable is not critical when examining the UIP?

    <p>Domestic price level at time t.</p> Signup and view all the answers

    What is the outcome if you perform a two-sided test on a coefficient estimated to be 4 with a standard error of 0.5 against a null of 2?

    <p>You reject the null hypothesis.</p> Signup and view all the answers

    Study Notes

    Summary of Macroeconomics Questions and Answers

    • GDP/GNP Ratio (Ireland): Ireland's GDP/GNP ratio is greater than 1.

    Exchange Rates and Real Exchange Rates

    • Thai Baht/USD Exchange Rate: The current exchange rate of 30 Thai Baht/1 USD does not determine the real exchange rate. Factors like the price of goods in both countries are crucial.

    • Real Exchange Rate Calculation: A real exchange rate greater than one signifies a price advantage for the Thai basket of goods.

    • Importance of Relative Prices: The real exchange rate is a key determinant of net exports.

    Balance of Payments

    • Balance of Payments: The balance of payments always balances.

    Currency Conversions

    • EUR/DNK Exchange Rate: To buy 10 EUR, you need to sell 75 DNK.

    Exchange Rate Definitions

    • Real Exchange Rate: The real exchange rate measures how goods and services trade between countries, and is a critical factor affecting net exports.

    GDP and GNP Relationships

    • GDP vs GNP (Country): If GDP is larger than GNP, the country produces more goods than are earned by its domestic citizens.

    Exchange Rate Appreciation/Depreciation

    • Euro/USD Exchange Rate (2020): The Euro appreciated against the US dollar from the beginning of 2020 to September 2020; the USD depreciated.

    • GBP/EUR Exchange Rate: The exchange rate change of the British pound to the Euro demonstrates an appreciation of the Euro.

    • EUR/YEN Exchange Rate: 1 EUR is worth 125 Yen.

    Interest Rate Differentials and Forward Rates

    • Foreign Interest Rate > Domestic Interest Rate: A higher foreign interest rate results in a negative forward rate premium/discount.

    • Expected Currency Depreciation: A predicted depreciation of a currency (like the Turkish Lira) against another currency (like the USD) implies a higher interest rate in the depreciating currency.

    UIP Model

    • Home Return and Foreign Return (UIP): HR represents the home return, and FR represents the foreign return.

    • UIP Model Axes: The diagram in the UIP model displays the exchange rate (E) against the domestic and foreign returns.

    • Home Return Effects: A decreased home return results in a depreciation of the domestic currency.

    • Home Return Increase Effect: An increased home return causes the home return curve to shift right, driving down the exchange rate and appreciating the domestic currency.

    Covered Interest Parity

    • Covered Interest Parity Violation: Deviations from covered interest parity allow for arbitrage opportunities with certainties on profits..

    UIP Model and Exchange Rate Changes

    • Expected Exchange Rate Decrease + Domestic Interest Increase: A decrease in the expected exchange rate and increase in the domestic interest rate will result in an appreciation of the domestic currency.

    • Expected Exchange Rate Increase: An increase in the expected exchange rate will cause a depreciation of the domestic currency.

    UIP Testing

    • UIP Coefficient Hypothesis: The null hypothesis for testing UIP is that the coefficient (beta) equals 1, and the alternative hypothesis is that it does not equal 1.

    • UIP Variables: Variables like domestic price level are not part of the UIP testing procedure.

    • UIP Regression Confidence Intervals and Coefficient Testing: If a regression coefficient deviates from 2 the null hypothesis has to be rejected.

    Comparative Advantage and Trade

    • Mercantilism Paradox: The mercantilist approach has a paradox; not all countries can simultaneously run trade surpluses.

    • Ricardo Model Differences: The Ricardo model incorrectly states that a country with an absolute advantage in one industry also has a comparative advantage in that industry.

    • Heckscher-Ohlin Theory: A country will export a product that intensively uses its abundant factor of production.

    • Factor Price Equalization and Comparative Advantage: Trade will lead to an increase in the return/price of factors which are abundant in a country, and lower returns in factors that are scarce in the country.

    Krugman Model

    • Krugman Model Firm Behavior: Firms in the Krugman model have market power and consider competitors' decisions.

    • Firm Optimality: Firm decisions maximize marginal revenue and marginal costs.

    • Industry Equilibrium: Industry equilibrium is reached when price equals average cost resulting in zero economic profit.

    • Perfect Competition vs Monopolistic Competition: Perfect competition results in zero economic profits in the long run, while firms in monopolistic competition can influence prices resulting in zero profits long run.

    • Trade and Firm Numbers in Krugman Model: Free trade increases the number of firms in each country but decreases availability of goods compared to more isolation.

    • Krugman Model Trade Reason: Trade in the Krugman model is driven by internal economies of scale.

    Tariffs

    • Tariff Incidence (Small Country): In a small country, tariffs are paid primarily by consumers.

    • Tariff Effects (Small Country): Tariffs increase producer surplus, decrease consumer surplus, and lead to a decrease in overall welfare.

    • Tariff Effects (Large Country): Government revenue increases, but overall welfare might increase or decrease, depending on the magnitude of the effects.

    • Tariff Impact on Trade Partners: In the case of a large country imposing a tariff, producer surplus will decrease for the other country, but consumer surplus might increase or decrease, depending on the economic size.

    Open Economy Macroeconomics

    • Exchange Rate and Monetary Policy: Expansionary monetary policy leads to inflation and currency depreciation.

    • Fiscal Policy: Increase in government spending generally cause an appreciation of the currency.

    • Output and Interest Rates: The relationship between output and interest rates varies based on whether or not the economy is capacity constrained. With floating exchange rates, the money supply is an endogenous variable

    • Currency Adjustment and Trust: A currency change can occur if the expectation of future exchange rate is different than the current rate; the same applies for interest rates.

    International Price Comparisons

    • Law of One Price: The Law of One Price does not always hold.
    • Absolute Purchasing Power Parity: Absolute PPP is the condition in which identical goods have the same price in different countries using the same currency.
    • Relative Purchasing Power Parity: Relative PPP is a more appropriate comparison. Relative PPP examines inflation differences across countries to understand how the exchange rate changes over time.
    • Exchange Rate Adjustment (Arbitrage): If absolute PPP is not held, arbitrage will occur, causing the exchange rate to adjust to make the prices for the identical good consistent.

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    Description

    This quiz covers key concepts in macroeconomics, focusing on GDP/GNP ratios, exchange rates, and the balance of payments. Explore the significance of real exchange rates and how they impact net exports. Test your understanding of these essential economic principles.

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