Macroeconomics 8th Canadian Edition Andrew Abel – Test Bank

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Macroeconomics, Cdn. 8e (Abel et al.)

Chapter 5   Saving and Investment in the Open Economy

 

5.1   Multiple-Choice Questions

 

1) Canada’s balance of payment accounts

  1. A) are a record of all Canadian international transactions.
  2. B) are part of the national income accounting.
  3. C) show a flow of funds into Canada as credit and the flow of funds out of Canada as debit.
  4. D) all of the above.

Answer:  D

Diff: 1      Type: MC      Page Ref: 132

 

2) The merchandise trade balance is a country’s

  1. A) exports of goods.
  2. B) net exports of goods.
  3. C) exports of goods and services.
  4. D) net exports of goods and services.

Answer:  B

Diff: 1      Type: MC      Page Ref: 133

 

3) If a country’s merchandise exports exceed its merchandise imports,

  1. A) it has a trade surplus.
  2. B) it has a trade deficit.
  3. C) it has a current account surplus.
  4. D) it has a current account deficit.

Answer:  A

Diff: 1      Type: MC      Page Ref: 133

 

4) If France has a trade deficit, then

  1. A) imports into France exceed exports from France.
  2. B) exports from France exceed imports into France.
  3. C) imports into Canada from France exceed exports from Canada into France.
  4. D) imports into France from Canada exceed exports from France into Canada.

Answer:  A

Diff: 1      Type: MC      Page Ref: 133

 

5) If all international factor payment flows are investment income, then net investment income from abroad equals

  1. A) net exports.
  2. B) the current account balance.
  3. C) the trade balance.
  4. D) net factor payments from abroad.

Answer:  D

Diff: 1      Type: MC      Page Ref: 133

 

6) If Canada donates footballs to Japan, how is the transaction recorded on the Canadian balance of payments accounts?

  1. A) debit: merchandise trade; credit: capital account
  2. B) debit: capital account; credit: merchandise trade
  3. C) debit: net unilateral transfers; credit: merchandise trade
  4. D) debit: merchandise trade; credit: net unilateral transfers

Answer:  C

Diff: 2      Type: MC      Page Ref: 133

 

7) The current account balance consists of

  1. A) the trade balance plus the services balance.
  2. B) net exports of goods and services, minus net unilateral transfers.
  3. C) net exports of goods and services, plus investment income from abroad, plus net unilateral transfers.
  4. D) net exports of goods and services, plus investment income from abroad, plus net unilateral transfers, minus the capital account balance.

Answer:  C

Diff: 1      Type: MC      Page Ref: 134

 

8) If a Canadian firm buys stereos from a Japanese firm and the Japanese firm uses the dollars it gets to buy Canadian Treasury bonds, what items are recorded in the Canadian balance of payments accounts?

  1. A) credit the trade account; credit the capital account
  2. B) credit the trade account; debit the capital account
  3. C) debit the trade account; debit the capital account
  4. D) debit the trade account; credit the capital account

Answer:  D

Diff: 2      Type: MC      Page Ref: 135

 

9) Suppose a wealthy Saudi Arabian prince donates 2000 camels to the San Diego Zoo. The Canadian trade balance ________ and the current account balance ________.

  1. A) falls; rises
  2. B) rises; rises
  3. C) is unchanged; is unchanged
  4. D) falls; is unchanged

Answer:  C

Diff: 2      Type: MC      Page Ref: 134

 

10) If a Canadian company imports 10 Toyotas from Japan at $15,000 each, and the Japanese company buys airline tickets on a Canadian airline with the money, how does this affect the Canadian balance of payments accounts?

  1. A) debit: merchandise trade; credit: capital account
  2. B) debit: capital account; credit: merchandise trade
  3. C) debit: merchandise trade; credit: services
  4. D) debit: services; credit: merchandise trade

Answer:  C

Diff: 2      Type: MC      Page Ref: 135

 

11) If a French company sells 1000 gallons of Perrier to a Canadian company at 25 francs per gallon and uses the money to buy stock in a Spanish cork company, how does this affect the French balance of payments accounts?

  1. A) debit: capital account; credit: merchandise trade
  2. B) debit: merchandise trade; credit: capital account
  3. C) debit: net investment income from abroad; credit: capital account
  4. D) debit: merchandise trade; credit: net investment income from abroad

Answer:  A

Diff: 2      Type: MC      Page Ref: 136

 

12) Which of the following would be part of the nation’s current account?

  1. A) an old house purchased by a Canadian in Croatia
  2. B) the purchase of a Canadian Treasury bond by a foreigner
  3. C) the interest a Canadian earns on a British bond
  4. D) a factory built by the Japanese in Canada

Answer:  C

Diff: 2      Type: MC      Page Ref: 136

 

13) Which of the following would be part of the nation’s capital account?

  1. A) a nightclub show seen by a Canadian in Mexico City
  2. B) a dividend from a British equity owned by a Canadian
  3. C) a payment to the Philippine government for the use of military bases in their country
  4. D) one hundred shares of British Petroleum stock purchased by a Canadian

Answer:  D

Diff: 2      Type: MC      Page Ref: 136

 

14) The difference between the current account balance and net exports is

  1. A) the capital account.
  2. B) net unilateral transfers plus net factor payments from abroad.
  3. C) adjustments in net foreign assets.
  4. D) income receipts from foreign assets.

Answer:  B

Diff: 1      Type: MC      Page Ref: 136

 

15) Which of the following statements is true?

  1. A) The world as a whole has a current account surplus.
  2. B) The world as a whole has a current account balance.
  3. C) The world as a whole has a balance of payment surplus.
  4. D) The world as a whole has a current account deficit.

Answer:  D

Diff: 2      Type: MC      Page Ref: 136

 

 

16) The world as a whole has a current account deficit because

  1. A) some countries export less than they import.
  2. B) there are statistical discrepancies.
  3. C) the United States and China have current account deficit.
  4. D) income from assets held abroad is misreported.

Answer:  D

Diff: 2      Type: MC      Page Ref: 136

17) The official settlements balance equals

  1. A) the sum of the current account and the capital account.
  2. B) the current account minus net unilateral transfers.
  3. C) net investment income from abroad.
  4. D) the net increase in a country’s official reserve assets.

Answer:  D

Diff: 1      Type: MC      Page Ref: 136

 

18) If the Bank of Canada buys $3 billion worth of Japanese yen, $4 billion of German marks, and $2 billion of French francs, and sells $5 billion of British pounds, how does this affect the official settlements balance?

  1. A) falls by $4 billion
  2. B) rises by $4 billion
  3. C) rises by $9 billion
  4. D) falls by $5 billion

Answer:  B

Diff: 1      Type: MC      Page Ref: 136

 

19) Suppose the current account shows debits of $4.7 billion and credits of $5.3 billion. The current account balance is ________, and the capital account balance is ________.

  1. A) +$0.6 billion; -$0.6 billion
  2. B) +$0.6 billion; +$0.6 billion
  3. C) -$0.6 billion; -$0.6 billion
  4. D) -$0.6 billion; +$0.6 billion

Answer:  A

Diff: 2      Type: MC      Page Ref: 136

 

20) A capital account surplus necessarily implies

  1. A) a balance of payments surplus.
  2. B) a current account surplus.
  3. C) a current account deficit.
  4. D) an increase in the nation’s official reserve assets.

Answer:  C

Diff: 1      Type: MC      Page Ref: 136

 

 

21) If Canada acquired net foreign assets of $50 billion in one year, this would be the equivalent of

  1. A) net imports of $50 billion.
  2. B) net foreign borrowing of $50 billion.
  3. C) a capital account deficit of $50 billion.
  4. D) a current account deficit of $50 billion.

Answer:  C

Diff: 1      Type: MC      Page Ref: 138

 

22) You just read that forecasters predict Canada will run a current account deficit in 2004. From this you would infer that Canada will also

  1. A) run a capital account deficit in 2004.
  2. B) decrease its official reserve assets.
  3. C) run a balance of payments surplus.
  4. D) decrease its holding of net foreign assets.

Answer:  D

Diff: 2      Type: MC      Page Ref: 138

23) Which of the following statement is true?

  1. A) In each period, except for measurement errors, the current account balance and the capital account balance must sum to zero.
  2. B) In each period, except for measurement errors, the sum of the current account balance and the capital account balance must be positive.
  3. C) In each period, except for measurement errors, the sum of the current account balance and the capital account balance must be negative.
  4. D) In each period, except for measurement errors, the sum of the current account balance and the capital account balance may be positive or negative.

Answer:  A

Diff: 2      Type: MC      Page Ref: 137

 

24) If there are no factor payments from abroad and no unilateral transfers, net exports of $10 billion is the same as

  1. A) a current account deficit of $10 billion.
  2. B) a capital account surplus of $10 billion.
  3. C) net acquisition of foreign assets of $10 billion.
  4. D) net foreign borrowing of $10 billion.

Answer:  C

Diff: 1      Type: MC      Page Ref: 138

 

 

25) A friend claims that Canada is a net international debtor. The best way of testing this claim is to

  1. A) see whether Canadian foreign liabilities exceeded Canadian foreign income.
  2. B) see whether Canadian receipts from foreign assets exceeded Canadian payments to foreign owners of Canadian assets.
  3. C) see whether Canadian official reserve assets were positive or negative.
  4. D) see whether Canada ran a balance of payments surplus or deficit last year.

Answer:  B

Diff: 2      Type: MC      Page Ref: 138

 

26) When a current account has a surplus of $5 billion, it means that

  1. A) the capital account must have a deficit of $5 billion.
  2. B) next exports must be negative.
  3. C) net foreign lending is negative.
  4. D) net acquisition of foreign assets is negative.

Answer:  A

Diff: 2      Type: MC      Page Ref: 136

 

27) In goods market equilibrium in an open economy,

  1. A) the desired amount of exports must equal the desired amount of imports.
  2. B) the desired amount of exports must equal the desired amount of imports less the amount lent abroad.
  3. C) the desired amount of national saving must equal the desired amount of domestic investment.
  4. D) the desired amount of national saving must equal the desired amount of domestic investment plus the amount lent abroad.

Answer:  D

Diff: 2      Type: MC      Page Ref: 139

28) In goods market equilibrium in an open economy,

  1. A) the desired amount of exports must equal the desired amount of imports.
  2. B) the desired amount of exports must equal the desired amount of imports less the amount lent abroad.
  3. C) the desired amount of national saving must equal the desired amount of domestic investment.
  4. D) the desired amount of national saving must equal the desired amount of domestic investment plus the current account balance.

Answer:  D

Diff: 2      Type: MC      Page Ref: 139

 

29) Absorption refers to

  1. A) the total amount of imports purchased by a country.
  2. B) the net amount of imports purchased by a country.
  3. C) total spending by domestic residents, businesses, and governments.
  4. D) GDP less desired consumption, desired investment, and government purchases.

Answer:  C

Diff: 1      Type: MC      Page Ref: 140

 

 

30) Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Net foreign lending would be equal to

  1. A) -$4 billion.
  2. B) -$2 billion.
  3. C) $2 billion.
  4. D) $4 billion.

Answer:  D

Diff: 2      Type: MC      Page Ref: 139

 

31) An economy in which output exceeds absorption

  1. A) will send goods abroad and have a current account surplus.
  2. B) is a net importer with a current account deficit.
  3. C) is a net borrower in the international market.
  4. D) will have a capital account deficit.

Answer:  A

Diff: 2      Type: MC      Page Ref: 140

 

32) Sweetland economy’s GDP is $2000 billion, desired consumption spending $1200 billion, desired investment spending $500 billion, and government purchases $400 billion. The Sweetland economy’s absorption is

  1. A) $2000 billion.
  2. B) $1200 billion.
  3. C) $2100 billion.
  4. D) -$100 billion.

Answer:  D

Diff: 2      Type: MC      Page Ref: 140

33) Which of the following statements about the Canadian balance of payment is true?

  1. A) Historically, Canada has for the most part had a current account surplus.
  2. B) Canada has always had a capital account deficit.
  3. C) Canadians’ ownership of foreign assets has always been greater than foreigners’ ownership of Canadian assets.
  4. D) Canada has always maintained a current account balance.

Answer:  A

Diff: 2      Type: MC      Page Ref: 141

 

34) Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Desired savings is equal to

  1. A) $2 billion.
  2. B) $10 billion.
  3. C) $14 billion.
  4. D) $16 billion.

Answer:  B

Diff: 2      Type: MC      Page Ref: 140

 

 

35) Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Absorption is equal to

  1. A) $25 billion.
  2. B) $31 billion.
  3. C) $35 billion.
  4. D) $39 billion.

Answer:  B

Diff: 2      Type: MC      Page Ref: 140

 

36) A small open economy is an economy that

  1. A) has a small government.
  2. B) has a very low net exports.
  3. C) is too small to affect the world real interest rate.
  4. D) has a negative balance of payments.

Answer:  C

Diff: 1      Type: MC      Page Ref: 140

 

37) For a small open economy, an increase in the world real interest rate would necessarily

  1. A) increase net foreign lending.
  2. B) decrease net exports.
  3. C) decrease the current account balance.
  4. D) worsen the balance of payments.

Answer:  A

Diff: 2      Type: MC      Page Ref: 141

 

38) A small open economy has a current account balance of zero. A rise in the world real interest rate causes

  1. A) a current account surplus.
  2. B) a capital account surplus.
  3. C) net borrowing from abroad.
  4. D) absorption to exceed income.

Answer:  A

Diff: 2      Type: MC      Page Ref: 141

39) A small open economy has a current account balance of zero. A rise in its investment demand causes

  1. A) a current account surplus.
  2. B) a capital account deficit.
  3. C) income to exceed absorption.
  4. D) net borrowing from abroad.

Answer:  D

Diff: 2      Type: MC      Page Ref: 143

 

 

40) A small open economy increases its investment demand. This causes the world real interest rate to ________ and the country’s current account balance to ________.

  1. A) rise; fall
  2. B) remain unchanged; rise
  3. C) rise; rise
  4. D) remain unchanged; fall

Answer:  D

Diff: 2      Type: MC      Page Ref: 143

 

41) A small open economy increases its desired saving. This causes the world real interest rate to ________ and the country’s current account balance to ________.

  1. A) fall; fall
  2. B) remain unchanged; rise
  3. C) fall; rise
  4. D) remain unchanged; fall

Answer:  B

Diff: 2      Type: MC      Page Ref: 143

 

42) When a temporary adverse supply shock hits a small open economy, it causes the current account to ________ and investment to ________.

  1. A) fall; fall
  2. B) rise; remain unchanged
  3. C) fall; remain unchanged
  4. D) rise; fall

Answer:  C

Diff: 2      Type: MC      Page Ref: 145

 

43) When future labour income falls in a small open economy, it causes the current account to ________ and investment to ________.

  1. A) fall; rise
  2. B) rise; remain unchanged
  3. C) fall; remain unchanged
  4. D) rise; rise

Answer:  B

Diff: 2      Type: MC      Page Ref: 146

44) If there is an increase in the future marginal product of capital in a small open economy, it causes the current account to ________ and saving to ________.

  1. A) fall; rise
  2. B) rise; remain unchanged
  3. C) fall; remain unchanged
  4. D) rise; rise

Answer:  C

Diff: 2      Type: MC      Page Ref: 146

 

 

45) If there is an increase in taxes on business firms in a small open economy, it causes the current account to ________ and saving ________.

  1. A) fall; fall
  2. B) rise; remain unchanged
  3. C) fall; remain unchanged
  4. D) rise; fall

Answer:  B

Diff: 2      Type: MC      Page Ref: 146

 

46) You have just read in the newspaper that a hurricane has destroyed Guatemala’s coffee crop for this year. Guatemala is a small open economy. Based on this information alone, you would expect that

  1. A) desired investment would fall in Guatemala.
  2. B) desired investment would increase in Guatemala.
  3. C) net foreign lending by Guatemala would increase.
  4. D) net foreign lending by Guatemala would decrease.

Answer:  D

Diff: 2      Type: MC      Page Ref: 146

 

47) The best weather in a decade has given Australia a bumper wheat crop. Australia is a small open economy. Based on this information alone, you would expect that

  1. A) desired investment would decrease.
  2. B) desired investment would increase.
  3. C) the current account would increase.
  4. D) the current account would decrease.

Answer:  C

Diff: 2      Type: MC      Page Ref: 146

 

48) An innovation will enable Haitian sugar cane farmers to harvest the sugar cane twice as efficiently in the future. Haiti is a small open economy. Based on this information alone, you would expect that

  1. A) desired saving would increase.
  2. B) net foreign borrowing would increase.
  3. C) net exports would increase.
  4. D) the current account balance would go further into surplus.

Answer:  B

Diff: 2      Type: MC      Page Ref: 146

49) When there are two large open economies, the world real interest rate will be such that

  1. A) desired international lending by one country equals desired international borrowing by the other country.
  2. B) desired international lending will be the same in both countries.
  3. C) desired international borrowing will be the same in both countries.
  4. D) desired international lending and borrowing will be zero in both countries.

Answer:  A

Diff: 1      Type: MC      Page Ref: 150

 

50) A large open economy is an economy

  1. A) that has a large government sector.
  2. B) that has a positive net exports.
  3. C) that is large enough to affect the world real interest rate.
  4. D) that has a positive balance of payments.

Answer:  C

Diff: 1      Type: MC      Page Ref: 149

 

51) The main difference between the small open economy and the large open economy is that

  1. A) the former faces a fixed international real interest rate, but the latter can influence it.
  2. B) the former can influence the international real interest rate, but the latter cannot.
  3. C) the former cannot maintain a large current account deficit, but the latter can.
  4. D) the former can maintain a large current account deficit, but the latter cannot.

Answer:  A

Diff: 2      Type: MC      Page Ref: 149

 

52) When there are two large open economies, if desired international lending by the domestic country exceeds desired international borrowing by the foreign country, then

  1. A) domestic saving must rise.
  2. B) domestic saving must fall.
  3. C) the world real interest rate must fall.
  4. D) the world real interest rate must rise.

Answer:  C

Diff: 2      Type: MC      Page Ref: 150

 

53) When there are two large open economies, if desired international borrowing by the domestic country exceeds desired international lending by the foreign country, then

  1. A) domestic investment must fall.
  2. B) domestic investment must rise.
  3. C) the world real interest rate must fall.
  4. D) the world real interest rate must rise.

Answer:  D

Diff: 2      Type: MC      Page Ref: 150

 

54) A large open economy increases its investment demand. This causes the world real interest rate to ________ and the country’s current account balance to ________.

  1. A) rise; fall
  2. B) remain unchanged; rise
  3. C) rise; rise
  4. D) remain unchanged; fall

Answer:  A

Diff: 2      Type: MC      Page Ref: 150

 

55) A large open economy increases its desired saving. This causes the world real interest rate to ________ and the country’s current account balance to ________.

  1. A) fall; fall
  2. B) remain unchanged; rise
  3. C) fall; rise
  4. D) remain unchanged; fall

Answer:  C

Diff: 2      Type: MC      Page Ref: 150

 

56) When a temporary adverse supply shock hits a large open economy, it causes the current account to ________ and investment to ________.

  1. A) fall; fall
  2. B) rise; remain unchanged
  3. C) fall; remain unchanged
  4. D) rise; fall

Answer:  A

Diff: 2      Type: MC      Page Ref: 150

 

57) When future labour income falls in a large open economy, it causes the current account to ________ and investment to ________.

  1. A) fall; rise
  2. B) rise; remain unchanged
  3. C) fall; remain unchanged
  4. D) rise; rise

Answer:  D

Diff: 2      Type: MC      Page Ref: 150

 

58) If there is an increase in the future marginal product of capital in a large open economy, it causes the current account to ________ and saving to ________.

  1. A) fall; rise
  2. B) rise; remain unchanged
  3. C) fall; remain unchanged
  4. D) rise; rise

Answer:  A

Diff: 2      Type: MC      Page Ref: 150

 

59) If business taxes rise in a large open economy, it causes the current account to ________ and saving to ________.

  1. A) fall; fall
  2. B) rise; remain unchanged
  3. C) fall; remain unchanged
  4. D) rise; fall

Answer:  D

Diff: 2      Type: MC      Page Ref: 150

 

60) Real domestic interest rates would increase in a large open economy if

  1. A) there were a temporary negative domestic supply shock.
  2. B) the government imposed capital controls and the capital account had been in deficit.
  3. C) foreigners were more willing to save.
  4. D) there were a temporary negative supply shock abroad in a small open economy.

Answer:  A

Diff: 2      Type: MC      Page Ref: 150

 

61) Assuming no change in the effective tax rate on capital, an increase in the government budget deficit will raise the current account deficit if and only if the increase in the budget deficit

  1. A) reduces desired national saving.
  2. B) increases desired national saving.
  3. C) reduces desired national investment.
  4. D) increases desired national investment.

Answer:  A

Diff: 1      Type: MC      Page Ref: 152

 

62) Assume that an increase in Costa Rica’s government budget deficit reduced desired national saving by 10 million colon. Assuming Costa Rica is a small open economy, you would expect the government’s action to

  1. A) increase the current account balance by exactly 10 million colon.
  2. B) increase the current account balance by less than 10 million colon.
  3. C) reduce the current account balance by exactly 10 million colon.
  4. D) reduce the current account balance by more than 10 million colon.

Answer:  C

Diff: 2      Type: MC      Page Ref: 152

 

63) Assume that Costa Rica, a small open economy, has increased the government budget deficit by 10 million colon, reducing the current account balance in the process. All else being equal, you would expect this action to cause

  1. A) an increase in desired saving in Costa Rica.
  2. B) an increase in the real world interest rate.
  3. C) an increase in exports by Costa Rica.
  4. D) an increase in Costa Rica’s absorption.

Answer:  D

Diff: 2      Type: MC      Page Ref: 152

 

64) In a large open economy like the United States, an increased government budget deficit that reduces national saving

  1. A) reduces investment and improves the current account balance.
  2. B) reduces investment and reduces the current account balance.
  3. C) has no effect on investment, but reduces the current account balance.
  4. D) has no effect on either investment or the current account balance.

Answer:  B

Diff: 2      Type: MC      Page Ref: 152

 

65) If Ricardian equivalence proposition is true, a budget deficit resulting from a tax cut will have

  1. A) no effect on government expenditures.
  2. B) no effect on current account because it does not affect national saving.
  3. C) no effect on current account because people expect to pay lower taxes in the future.
  4. D) no effect on current account because people expect to increase their consumption.

Answer:  B

Diff: 2      Type: MC      Page Ref: 153

 

66) The term “twin deficits” refers to a situation in which there exists

  1. A) a budget deficit as well as a current account deficit.
  2. B) a budget deficit as well as a capital account deficit.
  3. C) a budget deficit as well as a balance of payment deficit.
  4. D) a current account deficit as well as a capital account deficit.

Answer:  A

Diff: 2      Type: MC      Page Ref: 152

 

67) Justin spends his holidays in Mexico, where he spends $2500. This will

  1. A) reduce the Canadian current account by $2500.
  2. B) increase the Canadian current account by $2500.
  3. C) have no change in the Canadian current account.
  4. D) increase Canadian exports by $2500.

Answer:  A

Diff: 1      Type: MC      Page Ref: 136

 

68) A group of Japanese tourists visits Banff National Park in Alberta and spends $20,000 on goods and services in Canada. This will

  1. A) reduce the Canadian current account by $20,000.
  2. B) increase the Canadian current account by $20,000.
  3. C) have no change in the Canadian current account.
  4. D) increase Canadian imports.

Answer:  B

Diff: 1      Type: MC      Page Ref: 136

 

69) An increase in the number of international students in Canada

  1. A) has no effect on the Canadian current account.
  2. B) decreases the Canadian current account.
  3. C) decreases Canadian imports.
  4. D) increases the Canadian current account.

Answer:  D

Diff: 2      Type: MC      Page Ref: 136

 

 

70) Suppose desired consumption is $10 billion and desired investment is $3 billion. If GDP is $25 billion and government purchases are $2 billion, the desired national saving is

  1. A) $12 billion.
  2. B) $15 billion.
  3. C) $14 billion.
  4. D) $13 billion.

Answer:  D

Diff: 2      Type: MC      Page Ref: 145

71) Suppose desired consumption is $10 billion and desired investment is $3 billion. If GDP is $25 billion and government purchases are $2 billion, the desired foreign lending is

  1. A) $10 billion.
  2. B) $12 billion.
  3. C) $13 billion.
  4. D) $15 billion.

Answer:  A

Diff: 3      Type: MC      Page Ref: 145

 

72) Suppose GDP is $20 billion and the desired absorption is $16 billion. What are the net exports?

  1. A) $10 billion
  2. B) $4 billion
  3. C) $36 billion
  4. D) $1 billion

Answer:  B

Diff: 3      Type: MC      Page Ref: 143

 

73) Suppose GDP is $20 billion, desired consumption $11 billion, desired investment $1 billion, and government purchases of goods and services $4 billion. What is the desired absorption in this economy?

  1. A) $31 billion
  2. B) $36 billion
  3. C) $21 billion
  4. D) $16 billion

Answer:  D

Diff: 3      Type: MC      Page Ref: 143

 

74) Suppose desired consumption $11 billion, desired investment $1 billion, and government purchases of goods and services $4 billion. If the desired foreign lending in this economy is $4 billion, what is the GDP?

  1. A) $20 billion
  2. B) $16 billion
  3. C) $12 billion
  4. D) $10 billion

Answer:  A

Diff: 3      Type: MC      Page Ref: 143

 

75) Which of the following is true when the expected future marginal product of capital increases?

  1. A) The investment and the current account rise.
  2. B) The investment rises but the current account declines.
  3. C) The investment and the current account declines.
  4. D) The investment declines but the current account rises.

Answer:  B

Diff: 2      Type: MC      Page Ref: 146

76) Which of the following is the true description of the impacts of a temporary positive oil price shock on an oil-importing country like the U.S.?

  1. A) National saving and current account surplus increase.
  2. B) National saving decreases but current account surplus increases.
  3. C) National saving increases but current account surplus decreases.
  4. D) National saving and current account surplus decrease.

Answer:  D

Diff: 2      Type: MC      Page Ref: 145

 

77) Which of the following is true for the foreign direct investment (FDI) and Canadian direct investment abroad (CDIA)?

  1. A) Although FDI has been historically lower than CDIA in Canada, the trend has recently changed in favour of FDI.
  2. B) Canadians now own a smaller amount of foreign companies than foreigners own of Canadian companies.
  3. C) Although CDIA has been historically lower than CDIA, the trend has recently changed in favour of CDIA.
  4. D) FDI has always been greater than CDIA in Canada.

Answer:  A

Diff: 2      Type: MC      Page Ref: 148

 

78) If the Ricardian equivalence is true, a tax cut will

  1. A) increase the current account surplus.
  2. B) decrease the current account surplus.
  3. C) have no effect on the current account.
  4. D) increase national saving.

Answer:  C

Diff: 2      Type: MC      Page Ref: 153

 

79) If Ricardian equivalence does NOT hold, a budget deficit arising from a tax cut will

  1. A) have no effect on national saving.
  2. B) have no effect on the current account.
  3. C) increase national saving.
  4. D) increase consumption.

Answer:  D

Diff: 2      Type: MC      Page Ref: 152

 

5.2   Essay Questions

 

1) Suppose a country has the following balance of payments data:

 

Merchandise exports                                        100

Merchandise imports                                        130

Service exports                                                   60

Service Imports                                                  50

Investment income receipts                                75

Investment income payments                           100

Transfers to other countries                               15

Increase in home country assets abroad           130

Increase in foreign assets in home country      190

 

  1. Calculate the current account balance.
  2. Calculate the capital account balance.
  3. Calculate the trade balance.
  4. Calculate net factor payments.

Answer:

  1. -60
  2. 60
  3. -30
  4. -25

Diff: 2      Type: ES      Page Ref: Sec. 5.1

 

 

2) Show where each of the following transactions belongs on the Canadian balance of payments table, using an exchange rate of 100 Japanese yen per Canadian dollar.

 

  1. A Japanese firm spends 5 billion yen to buy personal computers from IBM (a Canadian firm).
  2. A wealthy Japanese businessman gives $100 thousand to the San Diego Zoo.
  3. A Canadian firm buys 1 million Sony Walkmans at 6000 yen each (Sony is a Japanese firm).
  4. A Japanese investment banking firm buys 500 million dollars’ worth of newly issued Canadian government Treasury bills.
  5. Canadian steel firms send 2000 executives to Japan to take courses in the Japanese method of steel production and Japanese management techniques, paying 2 million yen per executive.
  6. Repeat parts a. – e. for the balance of payments table of Japan.

Answer:

  1. Credit: $50 million exports of merchandise
  2. Credit: $100 thousand net unilateral transfers
  3. Debit: $60 million imports of merchandise
  4. Credit: $500 million increase in foreign-owned assets in Canada
  5. Debit: $40 million imports of services
  6. Debit: 5 billion yen imports of merchandise

Debit: 10 million yen net unilateral transfers

Credit: 6 billion yen exports of merchandise

Debit: 50 billion yen increase in Japanese-owned assets abroad

Credit: 4 billion yen exports of services

Diff: 2      Type: ES      Page Ref: Sec. 5.1

3) In a small open economy

 

Sd = $20 billion + ($100 billion) r%

Id = $30 billion – ($100 billion) r%

Y = $70 billion

G = $20 billion

rw = .04.

 

  1. Calculate the current account balance.
  2. Calculate net exports.
  3. Calculate desired consumption.
  4. Calculate absorption.

Answer:

  1. -$2 billion
  2. -$2 billion
  3. $26 billion
  4. $72 billion

Diff: 2      Type: ES      Page Ref: Sec. 5.2

 

 

4) Consider a small open economy with desired national saving of Sd = 20 + 200 rw and desired investment of Id = 30 – 200 rw. Calculate national saving, investment, and the current account balance in equilibrium when the real world interest rate is

 

  1. rw= 0.025
  2. rw= 0.05
  3. rw= 0.0
  4. Now suppose something causes desired national saving to increase by 10, so that it is now . Repeat parts a, b, and c.
  5. Suppose, with desired national saving at its original level of Sd= 20 + 200 rw, something causes desired investment to rise by 10, Id = 40 – 200 rw. Repeat parts a, b, and c.

Answer:

  1. S = 25, I = 25, CA = 0
  2. S = 30, I = 20, CA = 10
  3. S = 20, I = 30, CA = -10
  4. rw= 0.025: S = 35, I = 25, CA = 10

rw = 0.050: S = 40, I = 20, CA = 20

rw = 0.000: S = 30, I = 30, CA = 0

  1. rw= 0.025: S = 25, I = 35, CA = -10

rw = 0.050: S = 30, I = 30, CA = 0

rw = 0.000: S = 20, I = 40, CA = 20

S = 20, I = 40, CA = -20

Diff: 2      Type: ES      Page Ref: Sec. 5.3

5) Consider a small open economy in equilibrium with a zero current account balance. What happens to national saving, investment, and the current account balance in equilibrium if

 

  1. future income rises?
  2. business taxes rise?
  3. government expenditures decline temporarily?
  4. the future marginal product of capital rises?

Answer:

  1. Saving curve shifts left, so S falls, I is unchanged, CA falls.
  2. Investment curve shifts left, so S is unchanged, I fails, CA rises.
  3. Saving curve shifts right, so S rises, I is unchanged, CA rises.
  4. Investment curve shifts right, so S is unchanged, I rises, CA falls.

Diff: 2      Type: ES      Page Ref: Sec. 5.3

 

 

6) A large open economy has desired national saving of Sd = 20 + 200 rw and desired national investment of Id = 30 – 200 rw. The foreign economy has desired national saving of Sd = 40 + 100 rw and desired national investment of IdFor = 75 – 400 rw.

 

  1. Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor,and IFor.
  2. Suppose Sdrises by 45, so that now Sd = 65 + 200 rw. Calculate the equilibrium values of rw CA, CAFor, S, I, SFor, and IFor.
  3. Suppose with Sdback to Sd = 20 + 200 rw as in part a, that Id rises by 45, to Id = 75 – 200 rw. Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor and IFor.

Answer:

  1. In equilibrium, Sd + SdFor= Id + IdFor, so that 60 + 300 rw = 105 – 600 rw, or 900 rw = 45, so rw = 0.05. Using this in the formulas, we get S = 30, I = 20, CA = 10, SFor = 45,

IFor = 55, and CAFor = -10.

  1. Now 900 rw= 0, so rw = 0.0. Using this in the formulas, we get S = 65, I = 30, CA = 35, SFor = 40, IFor = 75, and CAFor = 35.
  2. Now 900 rw= 90, so rw = 0.10. Using this in the formulas, we get S = 40, I = 55, CA = -15, SFor = 50, IFor = 35, and CAFor = 15. Notice that the current account may swing from positive to negative, depending on the value of the real interest rate.

Diff: 2      Type: ES      Page Ref: Sec. 5.4

 

7) Consider a large open economy that has a zero current account balance. What are the effects on the world real interest rate, national saving, investment, and the current account balance in equilibrium if

 

  1. future income rises?
  2. business taxes decline?
  3. government purchases decline?
  4. the future marginal product of capital declines?

Answer:

  1. rwrises, S falls, I falls, CA falls
  2. rwrises, S rises, I rises. CA falls
  3. rwfalls, S rises, I rises, CA rises
  4. rwfalls, S falls, I falls, CA rises

Diff: 2      Type: ES      Page Ref: Sec. 5.4

8) Due to a change in the regulatory structure of a small open economy, the desired capital stock becomes higher for both private investment and government investment. Increased government investment spending is financed by borrowing, not by higher taxes. If both desired investment and government spending rise at the same time, will there be “twin deficits”?

Answer:  Desired saving shifts left, desired investment shifts right, so the current account balance declines; there are twin deficits.

Diff: 1      Type: ES      Page Ref: Sec. 5.5

 

 

9) Suppose the government of a large open economy announces a major expansion of government spending to dig a tunnel to the earth’s core, to be financed entirely by borrowing. What effect does this have on the world real interest rate, national saving, investment, and the current account balance in equilibrium?

Answer:  Desired national saving shifts left, causing the equilibrium world real interest rate to rise, investment to fall, desired national saving to fall, and the current account balance to fall.

Diff: 2      Type: ES      Page Ref: Sec. 5.5

 

10) The government of a small open economy announces a tax cut of $100 this year, combined with a tax increase of $110 next year, when the interest rate is 10%. What are the effects of this change on the world real interest rate, national saving, investment, and the current account balance in equilibrium when

 

  1. Ricardian equivalence holds?
  2. Ricardian equivalence does NOT hold?

Answer:

  1. No effect on any of the variables.
  2. Real world interest rate unchanged, national saving declines (private saving rises, but not as much as government saving declines), investment is unchanged, and the current account balance declines.

Diff: 2      Type: ES      Page Ref: Sec. 5.5

 

11) Briefly discuss the idea of “twin deficit.” In your answer, include historical evidence, if any, and explain why some economists do not agree with the idea. Is Ricardian equivalence proposition consistent with the idea of twin deficit? Why?

Answer:  The twin deficit idea is that the budget deficit is the primary cause of current deficit. Therefore, if government runs a budget deficit, we should expect to see the current deficit as well. The evidence on twin deficit is mixed. Although twin deficit can be observed in some periods of the Canadian and the U.S. budget deficit and current account data, it is not evident in some other periods. In addition, the opposite has occurred in Japan. Therefore, some economists doubt that there is a correlation between the two deficits. The Ricardian equivalence hypothesis is not consistent with the twin deficit. According to the Ricardian equivalence hypothesis, a deficit caused by a tax cut will lead to higher saving and, therefore, will not lead to any deficit in the current account.

Diff: 2      Type: ES      Page Ref: Sec. 5.5

12) Consider an economy with GDP of $100 billion, desired investment of $20 billion, desired consumption of $50 billion, and government purchases of $2 billion. Calculate the following:

  1. Desired absorption
  2. Desired national saving
  3. Desired foreign lending

Answer:

  1. $72 billion
  2. $48 billion
  3. $28 billion

Diff: 2      Type: ES      Page Ref: Sec. 5.3

 

13) Discuss the main differences between the small and large open economies in the impacts of a decrease in domestic saving on the interest rate and the domestic investment.

Answer:  Unlike the situation in a small open economy, for large open economies the world real interest rate is not fixed but will change when desired national saving or desired investment changes in either country. Generally, any factor that increases desired international lending relative to desired international borrowing at the initial world real interest rate causes the world real interest rate to fall. Similarly, a change that reduces desired international lending relative to desired international borrowing at the initial world real interest rate will cause the world real interest rate to rise.

Diff: 2      Type: ES      Page Ref: 147

 

14) Explain how a temporary increase in oil price affects the national saving, investment, and current account of an oil-importing country.

Answer:  Higher oil prices decreases aggregate output and income and, therefore, saving. Since interest rate rises, investment declines. Current account decreases as exports decline.

Diff: 2      Type: ES      Page Ref: 144

 

15) Explain why the current account balance and the capital account balance of an economy must sum to zero.

Answer:  The reason is that every international transaction involves a swap of goods, services, or assets between countries. The two sides of the swap always have offsetting effects on the sum of the current and capital account balances, CA + KA. Thus, the sum of the current and capital account balances must equal zero.

Diff: 2      Type: ES      Page Ref: 135

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