Tutorial 10

Open-Economy Macroeconomics: Basic Concepts

I. Terms

1. closed economy
2. open economy
3. net exports
4. trade balance
5. trade surplus
6. trade deficit
7. balanced trade
8. net capital outflow
9. nominal exchange rate
10. appreciation
11. depreciation
12. real exchange rate
13. purchasing-power parity

II. Short-Answer Questions

1. Define net exports and net capital outflow. Explain how and why they are
related.
2. Explain the relationship among saving, investment, and net capital outflow.
3. If a Japanese car costs 500,000 yen, a similar American car costs $10,000, and
a dollar can buy 100 yen, what are the nominal and real exchange rates?
4. Describe the economic logic behind the theory of purchasing-power parity.
5. If the Fed started printing large quantities of U.S. dollars, what would happen
to the number of Japanese yen a dollar could buy? Why?
6. Why might purchasing power parity fail to be completely accurate?

III. Practice problems

1. How would the following transactions affect U.S. exports, imports, and net
exports?
a. An American art professor spends the summer touring museums in
Europe.
b. Students in Paris flock to see the latest movie from Hollywood.
c. Your uncle buys a new Volvo.
d. The student bookstore at Oxford University in England sells a pair of
Levi’s 501 jeans.
e. A Canadian citizen shops at a store in northern Vermont to avoid
Canadian sales taxes.
2. Would each of the following transactions be included in net exports or net
capital outflow?
Be sure to say whether it would represent an increase or a decrease in that
variable.
a. An American buys a Sony TV.
b. An American buys a share of Sony stock.
c. The Sony pension fund buys a bond from the U.S. Treasury.
 d. A worker at a Sony plant in Japan buys some Georgia peaches from an
American farmer.
3. Describe the difference between foreign direct investment and foreign
portfolio investment.
Who is more likely to engage in foreign direct investment—a corporation or
an individual investor? Who is more likely to engage in foreign portfolio
investment?
4. How would the following transactions affect U.S. net capital outflow? Also,
state whether each involves direct investment or portfolio investment.
a. An American cellular phone company establishes an office in the
Czech Republic.
b. Harrods of London sells stock to the General Electric pension fund.
c. Honda expands its factory in Marysville, Ohio.
d. A Fidelity mutual fund sells its Volkswagen stock to a French investor.
5. Would each of the following groups be happy or unhappy if the U.S. dollar
appreciated?
Explain.
a. Dutch pension funds holding U.S. government bonds
b. U.S. manufacturing industries
c. Australian tourists planning a trip to the United States
d. An American firm trying to purchase property overseas
6. What is happening to the U.S. real exchange rate in each of the following
situations? Explain.
a. The U.S. nominal exchange rate is unchanged, but prices rise faster in
the United States than abroad.
b. The U.S. nominal exchange rate is unchanged, but prices rise faster
abroad than in the United States.
c. The U.S. nominal exchange rate declines and prices are unchanged in
the United States and abroad.
d. The U.S. nominal exchange rate declines, and prices rise faster abroad
than in the United States.
7. Assume that American rice sells for $100 per bushel, Japanese rice sells for
16,000 yen per bushel, and the nominal exchange rate is 80 yen per dollar.
a. Explain how you could make a profit from this situation. What would
be your profit per bushel of rice? If other people exploit the same
opportunity, what would happen to the price of rice in Japan and the
price of rice in the United States?
b. Suppose that rice is the only commodity in the world. What would
happen to the real exchange rate between the United States and Japan?

IV. Multiple- Choice Questions

1. An economy that interacts with other economies is known as

a. A balanced trade economy.
b. An export economy.
c. An import economy.
d. A closed economy.
e. An open economy.
2. Each of the following is a reason why the U.S. economy continues to engage in
greater amounts of international trade except which one?
a. There are larger cargo ships and airplanes.
b. High-technology goods are more valuable per pound and, thus, more likely to
be traded.
c. NAFTA imposes requirements for increased trade between countries in North
America.
d. There have been improvements in technology that have improved
telecommunications between countries.
e. All of the above are reasons for increased trade by the United States.

3. Which of the following statements is true about a country with a trade deficit?
a. Net capital outflow must be positive.
b. Net exports are negative.
c. Net exports are positive.
d. Exports exceed imports.
e. None of the above is true.

4. Which of the following would directly increase U.S. net capital outflow?
a. General Electric sells an aircraft engine to Airbus in Great Britain.
b. Microsoft builds a new distribution facility in Sweden.
c. Honda builds a new plant in Ohio.
d. Toyota buys stock in AT&T.

5. Which of the following is an example of foreign direct investment?

a. McDonald’s builds a restaurant in Moscow.
b. Columbia Pictures sells the rights to a movie to a Russian movie studio.
c. General Motors buys stock in Volvo.
d. General Motors buys steel from Japan.

6. If Japan exports more than it imports,

a. Japan’s net exports are negative.
b. Japan’s net capital outflow must be negative.
c. Japan’s net capital outflow must be positive.
d. Japan is running a trade deficit.

7. If the United States saves $1,000 billion and U.S. net capital outflow is -$200
billion, U.S. domestic investment is
a. -$200 billion.
b. $200 billion.
c. $800 billion.
d. $1,000 billion.
e. $1,200 billion.

8. If the exchange rate changes from 3 Brazilian real per dollar to 4 reals per dollar,
a. The dollar has depreciated.
b. The dollar has appreciated.
c. The dollar could have appreciated or depreciated depending on what happened
to relative prices in Brazil and the United States.
d. None of the above is true.
9. Suppose the real exchange rate between Russia and the United States is defined in
terms of bottles of Russian vodka per bottle of U.S. vodka. Which of the
following will increase the real exchange rate (that is, increase the number of
bottles of Russian vodka per bottle of U.S. vodka)?
a. a decrease in the ruble price of Russian vodka
b. an increase in the dollar price of U.S. vodka
c. an increase in the number of rubles for which the dollar can be exchanged
d. All of the above will increase the real exchange rate
e. None of the above will increase the real exchange rate.

10. If the nominal exchange rate between British pounds and dollars is 0.5 pound per
dollar, how many dollars can you get for a British pound?
a. 2 dollars
b. 1.5 dollars
c. 1 dollar
d. 0.5 of a dollar
e. None of the above is correct

11. Suppose the nominal exchange rate between the Japanese yen and the U.S. dollar
is 100 yen per dollar. Further, suppose that a pound of hamburger costs $2 in the
United States and 250 yen in Japan. What is the real exchange rate between Japan
and the United States?
a. 0.5 pound of Japanese hamburger/pound of American hamburger
b. 0.8 pound of Japanese hamburger/pound of American hamburger
c. 1.25 pounds of Japanese hamburger/pound of American hamburger
d. 2.5 pounds of Japanese hamburger/pound of American hamburger
e. none of the above

12. Which of the following people or firms would be pleased by a depreciation of the
dollar?
a. a U.S. tourist traveling in Europe
b. a U.S. importer of Russian vodka
c. a French exporter of wine to the United States
d. an Italian importer of U.S. steel
e. a Saudi Arabian prince exporting oil to the United States

13. Suppose a cup of coffee is 1.5 Euros in Germany and $0.50 in the United States. If
purchasing-power parity holds, what is the nominal exchange rate between Euros
and dollars?
a. 1/3 euro per dollar
b. 3 Euros per dollar
c. 1.5 Euros per dollar
d. 0.75 euro per dollar

14. Which of the following products would likely be the least accurate if used to
calculate purchasing-power parity?
a. gold
b. automobiles
c. diamonds
 d. dental services

15. Suppose the money supply in Mexico grows more quickly than the money supply
in the United States. We would expect that
a. The peso should depreciate relative to the dollar.
b. The peso should appreciate relative to the dollar.
c. The peso should maintain a constant exchange rate with the dollar because of
purchasing-power parity.
d. None of the above is true.

16. When people take advantage of differences in prices for the same good by buying
it where it is cheap and selling it where it is expensive, it is known as
a. Purchasing-power parity.
b. Net capital outflow.
c. Arbitrage.
d. Net exports.
e. Currency appreciation.

17. Suppose a U.S. resident buys a Jaguar automobile from Great Britain and the
British exporter uses the receipts to buy stock in General Electric. Which of the
following statements is true from the perspective of the United States?
a. Net exports fall, and net capital outflow falls.
b. Net exports rise, and net capital outflow rises.
c. Net exports fall, and net capital outflow rises.
d. Net exports rise, and net capital outflow falls.
e. None of the above is true.

18. Which of the following statements is not true about the relationship between
national saving, investment, and net capital outflow?
a. Saving is the sum of investment and net capital outflow.
b. For a given amount of saving, an increase in net capital outflow must decrease
domestic investment.
c. For a given amount of saving, a decrease in net capital outflow must decrease
domestic investment.
d. An increase in saving associated with an equal increase in net capital outflow
leaves domestic investment unchanged.

19. Suppose the inflation rate over the last 20 years has been 10 percent in Great
Britain, 7 percent in Japan, and 3 percent in the United States. If purchasing-
power parity holds, which of the following statements is true? Over this period,
a. The value of the dollar should have fallen compared to the value of the pound
and the yen.
b. The yen should have risen in value compared to the pound and fallen
compared to the dollar.
c. The yen should have fallen in value compared to the pound and raised
compared to the dollar.
d. The value of the pound should have risen compared to the value of the yen and
the dollar.
e. None of the above is true.