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Economics 3422
Sample Quiz #4
Multiple choice. Choose the best alternative that completes the answer.
1.
Demand is said to be __________ when the elasticity of demand is __________.
a.
c.
e.
2.
elastic; one
elastic; less than one
none of the above
c.
d.
increases demand for domestic money
increases demand for domestic bond
increases demand for foreign currency
all of the above
only (a) and (b) above
According to the Portfolio Approach to exchange rate determination, when the domestic central bank purchases
domestic Treasury bond,
a.
b.
c.
d.
e.
6.
the demand curve must be downward sloping and the supply curve must be upward sloping
the supply and demand curves can both be downward sloping provided the demand curve is
steeper than the supply curve
excess demand leads to a fall in price and an excess supply leads to a rise in price
excess demand leads to a rise in price and an excess supply leads to a fall in price
In the Portfolio Approach to exchange rate determination, an increase in domestic real income
a.
b.
c.
d.
e.
5.
the goods market is stable
b.
the foreign exchange market is stable
both the goods and foreign exchange markets are stable
both the goods and foreign exchange markets are unstable
A stable market is one where
a.
b.
4.
elastic; greater than one
inelastic; greater than one
When the Marshall-Lerner condition is satisfied, we know that
a.
c.
d.
3.
b.
d.
domestic interest rate rises, and domestic currency depreciates
domestic interest rate falls, and domestic currency appreciates
domestic interest rate rises, and domestic currency appreciates
domestic interest rate falls, and domestic currency depreciates
the effects are indeterminate
When the U.S. demand for U.K. goods and services is elastic, in the foreign exchange market
a.
b.
c.
d.
e.
the supply curve of Pound Sterling is upward (forward) sloping
the demand curve for Pound Sterling is upward (forward) sloping
the supply curve of U.S. $ is upward (forward) sloping
the demand curve for U.S. $ is upward (forward) sloping
the supply curve of U.S. $ is downward (backward) sloping
7.
The arc elasticity of demand is calculated approximately as the ratio of:
a.
b.
c.
d.
e.
8.
the percentage change in real income to the percentage change in demand
the percentage change in demand to the percentage change in real income
the percentage change in quantity demanded to the percentage change in price
the percentage change in price to the percentage change in quantity demanded
none of the above
In the portfolio approach, when there is an increase in the real wealth of the domestic residents, this will
ultimately result in
a.
c.
d.
domestic currency depreciates
b.
foreign currency appreciates
indeterminate result without further information
none of the above
Part B.
In the Dornbusch overshooting model, how is it possible for a country’s currency to appreciate at the same time that
its price level is increasing relative to the price level of other countries? Does this mean that relative PPP does not
hold even in the long run?
Solution: 1. b; 2. c; 3. d; 4. a; 5. d; 6. c; 7.c; 8.c;
Part B.
The key features in the overshooting model is that the exchange rate will adjust to maintain interest parity only in
the short run but will adjust to maintain both interest parity and PPP in the long run. In the short run, say after an
expansion in the domestic money supply, domestic currency depreciates to maintain interest rate parity and
overshoots its eventual long-run equilibrium. In the long run, domestic price level rises relative to price levels in
other countries, at the same time domestic currency appreciates to its long-run equilibrium level having overshot its
long-run level in the short run.
No, this does not violate relative PPP since in the long run, domestic currency would have depreciated by the same
percentage as the domestic inflation rate, even-though it appreciated from its short-run equilibrium level to reach its
long-run equilibrium.