Download Current Account

Chapter 18
The Global Economy: Finance
True/False Questions
1. The current account contains imports, exports, and net unilateral transfers.
ANSWER: T
2. When the U.S. imports goods from Brazil, this is entered as a debit in the current account.
ANSWER: T
3. A current account deficit is usually the result of exports being greater than imports.
ANSWER: F
4. If U.S. citizens purchase foreign stock, this is a debit in the current account.
ANSWER: F
5. When U.S. companies establish foreign subsidiaries, this is included in the capital account.
ANSWER: T
6. The U.S. tends to have relatively more capital flowing into the country than out of the country.
ANSWER: T
7. Most of the current account deficit is financed by the intervention of the Federal Reserve in
international transactions.
ANSWER: F
8. The increase in foreign ownership in the U.S. means that foreigners will receive more income
and interest from the U.S. and U.S. citizens will receive less.
ANSWER: T
9. The largest debtor nations are less-developed countries.
ANSWER: F
10. The greater a country’s ratio of international indebtedness to GDP, the greater the likelihood that
the country will have problems repaying this debt.
ANSWER: T
11. The United States has the highest ratio of indebtedness to GDP in the world.
ANSWER: F
12. If an exchange rate is above the equilibrium rate (and exchange rates are flexible) the exchange
rate will tend to fall.
ANSWER: T
13. If the yen depreciates, it now takes fewer yen to purchase a dollar.
ANSWER: F
14. If GDP in the U.S. rises, the U.S. will buy more from abroad.
ANSWER: T
506
Test Bank  507
15. In a fixed exchange rate system, supply and demand determine exchange rates, much like in a
flexible exchange rate system.
ANSWER: F
16. In recent years, the United States has run a deficit in its current account.
ANSWER: T
17. The balance of payments is only occasionally out of balance.
ANSWER: F
18. Under a flexible exchange rate regime, exchange rates are determined by the forces of demand
and supply.
ANSWER: T
19. Suppose the current exchange rate is 3 German Marks for 1 U.S. dollar. If the exchange rate
falls, the dollar will have appreciated.
ANSWER: F
20. Under a fixed exchange rate system, if a exchange rates are allowed to fall, we say the currency
has been devalued.
ANSWER: T
Multiple-Choice Questions
1. A summary of all economic transactions between the residents of one country and those of all
other countries during a given time period is called:
a. the balance of payments
b. the current account
c. a net unilateral transfer
d. the capital account
ANSWER: a
2. Which of the following would not be included in the current account?
a. net unilateral transfers
b. purchases of foreign currencies
c. exports
d. imports
ANSWER: b
3. Which of the following would not be included in the capital account?
a. purchases of U.S. securities by foreigners
b. establishment of foreign subsidiaries by U.S. companies
c. purchases of foreign securities
d. net unilateral transfers
ANSWER: d
508  Chapter 18/The Global Economy: Finance
4. In recent years, the U.S. has run a deficit in which of the following?
a. balance of payments
b. capital account
c. current account
d. b and c only
ANSWER: c
5. Which nation owes more to foreign creditors than any other nation in the world?
a. The United States
b. Mexico
c. Russia
d. Australia
ANSWER: a
6. The number of units of one currency exchangeable for one unit of another currency is called:
a. currency revaluation.
b. a quota.
c. an exchange rate.
d. a balance of payment.
ANSWER: c
7. The _____ the ratio of international debt to GDP, the ______ the likelihood that the country will
have trouble repaying the debt.
a. greater; greater
b. smaller; greater
c. greater; smaller
d. None of the above are true.
ANSWER: a
8. If a country that maintains fixed exchange rates decides to let their exchange rate fall, the
currency has:
a. devalued
b. revalued
c. appreciated
d. depreciated
ANSWER: a
9. Which of the following is not a reason why the U.S. continues to be a large debtor nation?
a. The U.S. is the largest market in the world in which to invest.
b. The U.S. is a safe place to invest.
c. Creditors believe the U.S. is capable of servicing this debt.
d. The U.S. has the highest ratio of indebtedness to GDP in the world.
ANSWER: d
10. Under a flexible exchange rate system, if a country’s exchange rate increases, then the currency
has:
a. devalued.
b. revalued.
c. depreciated.
d. appreciated.
ANSWER: d
Test Bank  509
11. Which of the following might affect flexible exchange rates between two countries?
a. Inflation in one country relative to the other.
b. Interest rates in one country relative to the other.
c. GDP growth in one country relative to the other.
d. All of the above.
ANSWER: d
12. Why did the Mexican peso depreciate in 1994?
a. The peso depreciated because Mexican authorities insisted on using their international
reserves to buy pesos in the foreign exchange market.
b. Concern abroad after the assassination of a presidential candidate made Mexican holdings
less attractive.
c. The peso depreciated because Americans wanted to buy more of Mexico’s exports.
d. All of the above were factors.
ANSWER: b
13. The depreciation of the Mexican peso had which of the following effects?
a. Mexican goods became cheaper to Americans.
b. American goods became more expensive to Mexicans.
c. The U.S. went from having a trade surplus with Mexico to having a trade deficit.
d. All of the above.
ANSWER: d
14. The balance of payments refers to:
a. the value of country's exports less the value of its imports during a given time period.
b. a summary of all economic transactions between one country and all other countries during a
given time period.
c. the capital inflows into a country less the capital outflows during a given time period.
d. a country's gross domestic product less the value of its imports during a given time period.
ANSWER: b
15. When is the balance of payments out of balance?
a. Whenever imports exceed exports.
b. Whenever exports exceed imports.
c. If the balance in the capital account exceeds the balance in the current account.
d. Never.
ANSWER: d
16. In the United States, much of the deficit balance in the current account has been financed by:
a. selling U.S. Treasury securities.
b. foreign investment in the United States.
c. selling U.S. savings bonds.
d. increasing the size of the federal deficit.
ANSWER: b
17. Financing a deficit balance in the current account by increasing foreign investment:
a. increases the income of domestic citizens.
b. increases the interest payments domestic citizens receive from foreign investors.
c. causes more domestic assets to be owned by foreigners.
d. decreases the size of the current account deficit.
ANSWER: c
510  Chapter 18/The Global Economy: Finance
18. An exchange rate is:
a. the price consumers pay for goods in the market place.
b. the rate at which consumers are willing to exchange one good for another.
c. the rate at which producers can transform inputs into outputs.
d. the rate at which the units of one currency can be exchanged for units of another.
ANSWER: d
19. Under a system of flexible exchange rates, rates are determined by:
a. the forces of demand and supply.
b. the central bank in the economy.
c. an international monetary board.
d. the federal government.
ANSWER: a
20. Which of the following is not an argument in favor of flexible exchange rates?
a. Flexible exchange rates result in greater economic stability.
b. Flexible exchange rates provide a discipline for central banks in their practice of monetary
policy.
c. Flexible rates allow central banks the freedom to pursue the whatever policies are necessary
for full employment.
d. Destabilizing speculation is less likely to occur when exchange rates adjust continuously.
ANSWER: b
21. Which events triggered the Asian financial crisis?
a. The IMF intervened in the Malaysian economy.
b. Thailand’s largest finance company failed.
c. Capital flowed out of the Asian countries and currencies depreciated.
d. Both b and c.
ANSWER: d
22. To prevent a _______ of its currency, a country may impose controls to prevent capital ______.
a. devaluation; inflow
b. appreciation; outflow
c. depreciation; outflow
d. none of the above
ANSWER: c
23. The traditional view of capital flows says that:
a. capital should be free to flow from countries offering low prospective returns to those
offering high prospective returns.
b. capital flows should be restricted in order to reduce short-term volatility.
c. capital should be free to flow only from greater developed countries to lesser developed
countries.
d. capital controls allow time for countries to initiate new policies and undertake fundamental
reforms in their banking systems and financial markets.
ANSWER: a
Test Bank  511
Critical Thinking Multiple-Choice Questions
24. Suppose that in 1995 Narnia exported $350 thousand worth of goods and services, imported
$275 thousand worth of goods and services, had net unilateral transfers of -$15 thousand, and
had a net capital outflow of $30 thousand. The balance on its current account would be:
a. $75 thousand.
b. $60 thousand.
c. -$60 thousand.
d. -$75 thousand.
ANSWER: b
25. Suppose a country has $500 million in exports, $600 million in imports, and $50 million in net
unilateral transfers. The balance in its capital account must be:
a. -$100 million.
b. +$100 million.
c. -$50 million.
d. +$50 million.
ANSWER: c
26. Suppose a country has a balance of -$25 billion in its current account. It must have what balance
in its capital account?
a. -$25 billion.
b. $25 billion.
c. $10 billion.
d. $0.
ANSWER: b
27. If a country has a positive balance in its current account we know that:
a. the balance in its capital account must be negative.
b. the balance in its capital account must be positive.
c. the balance in its capital account must be zero.
d. the balance in its capital account cannot be determined without further information.
ANSWER: a
512  Chapter 18/The Global Economy: Finance
Use the following diagram to answer questions 28 – 32 .
Exchange Rate
S
E
E
E
3
2
1
D
0
Dollars
28. Given the demand for and supply of dollars, the equilibrium exchange rate is:
a. E1.
b. E2.
c. E3.
d. between E1 and E2.
ANSWER: b
29. Suppose the exchange rate is currently E3. In this case, there is:
a. an excess demand for dollars and the exchange rate will fall.
b. an excess demand for dollars and the exchange rate will increase.
c. an excess supply of dollars and the exchange rate will fall.
d. an excess supply of dollars and the exchange rate will increase.
ANSWER: c
30. Suppose the exchange rate is currently E1. In this case, there is:
a. an excess demand for dollars and the exchange rate will fall.
b. an excess demand for dollars and the exchange rate will increase.
c. an excess supply of dollars and the exchange rate will fall.
d. an excess supply of dollars and the exchange rate will increase.
ANSWER: b
31. If the exchange rate is currently E1, the dollar will:
a. appreciate as the market moves towards equilibrium.
b. depreciate as the market moves towards equilibrium.
c. be less valuable as the market moves towards equilibrium.
d. will remain unchanged in value as the market moves towards equilibrium.
ANSWER: a
Test Bank  513
32. If the exchange rate is currently E3, the dollar will:
a. appreciate as the market moves towards equilibrium.
b. depreciate as the market moves towards equilibrium.
c. be more valuable as the market moves towards equilibrium.
d. will remain unchanged in value as the market moves towards equilibrium.
ANSWER: b
33. Suppose the current exchange rate of pounds per dollars is 1.5 while the equilibrium exchange
rate of pounds per dollars is 2. This implies that:
a. the quantity of dollars demanded by Great Britain exceeds the quantity of dollars supplied.
b. the quantity of dollars supplied exceeds the quantity of dollars demanded by Great Britain.
c. the exchange rate will tend to decrease.
d. the exchange rate is in equilibrium.
ANSWER: a
34. Suppose the current exchange rate of euro per dollars is 0.75 while the equilibrium exchange rate
is 0.70. This implies that:
a. the quantity of dollars demanded by Italy exceeds the quantity of dollars supplied.
b. the quantity of dollars supplied exceeds the quantity of dollars demanded by Italy.
c. the exchange rate will tend to increase.
d. the exchange rate is in equilibrium.
ANSWER: b
35. Suppose the current exchange rate between the United States and Japan is 3.9 yen per dollar
while the equilibrium exchange rate is 3.3 yen per dollar. It is likely that:
a. the quantity of imports into the United States will decrease because of an appreciation of the
dollar.
b. the quantity of imports into the United States will increase because of a depreciation of the
dollar.
c. the quantity of imports into the United States will increase because of an appreciation of the
dollar.
d. the quantity of imports into the United States will decrease because of a depreciation of the
dollar.
ANSWER: d
36. Suppose the current exchange rate between the United States and Germany is 3.7 euro per dollar
while the equilibrium exchange rate is 4 euro per dollar. It is likely that:
a. the quantity of imports into the United States will decrease because of an appreciation of the
dollar.
b. the quantity of imports into the United States will increase because of a depreciation of the
dollar.
c. the quantity of imports into the United States will increase because of an appreciation of the
dollar.
d. the quantity of imports into the United States will decrease because of a depreciation of the
dollar.
ANSWER: c
514  Chapter 18/The Global Economy: Finance
Use the following diagram to answer questions 37 – 38.
Exchange Rate
S
E3
E2
E1
D
Dollars
37. Suppose the exchange rate of euros per dollar is E3. There will be a tendency for:
a. the price of imports to fall.
b. the price of exports to rise.
c. the price of imports to rise.
d. the relative price of imports and exports to be unchanged.
ANSWER: c
38. Suppose the exchange rate euros per dollar is currently E1. There will be a tendency for:
a. the price of imports to rise.
b. the price of exports to rise.
c. the price of exports to fall.
d. the relative price of imports and exports to be unchanged.
ANSWER: b
39. Suppose that Toon Land enters an expansionary period and GDP rises by 4.8 percent. If we were
examining Toon dollars per U.S. dollar, the increase in GDP would result in:
a. an appreciation of the U.S. dollar.
b. a depreciation of the U.S. dollar.
c. no change in exchange rates.
d. a decrease in Toon Land's imports from the United States.
ANSWER: a
Test Bank  515
Use the following diagram to answer questions 40 – 42.
Yen per Dollar
Supply of Dollars
100
90
80
Demand
for Dollars
150
170
185
Billions of Dollars
40. Assume that exchange rates have been fixed at 90 yen per dollar, what should the United States
do if it is determined that the current exchange rate is already 90 yen per dollar?
a. The Federal Reserve should sell dollars as a preventative action.
b. The Federal Reserve should buy dollars as a preventative action.
c. No intervention is necessary to maintain the exchange rate.
d. The Federal Reserve should buy yen as a preventative measure.
ANSWER: c
41 If the United States fixes the exchange rate at 100, there will be a(n):
a. U.S. balance of payments deficit.
b. U.S. balance of payments surplus.
c. excess demand for dollars.
d. Mismatch in trade between the U.S. and Japan.
ANSWER: a
42. If the United States fixes the exchange rate at 100, what action will be necessary to maintain this
rate?
a. The Federal Reserve may use any foreign currency holdings to purchase dollars.
b. The Federal Reserve may purchase any foreign currency using its holdings of dollars.
c. The Federal Reserve must use yen to buy dollars.
d. The Federal Reserve must use dollars to buy yen.
ANSWER: c
43. If the U.S. Federal Reserve were to purchase yen using dollars, what would be the result?
a. The dollar would not change in value against the yen.
b. The dollar would appreciate against the yen.
c. The supply of dollars to Japan would decrease.
d. The supply of dollars to Japan would increase.
ANSWER: d
516  Chapter 18/The Global Economy: Finance
44. A decrease in the interest rate in the United States relative to the rest of the world would:
a. increase foreign investment in the United States.
b. decrease foreign investment in the United States.
c. decrease U.S. investment in other countries.
d. increase the demand for U.S. dollars.
ANSWER: b
45. Suppose the exchange rate is $1 per ¥ 100. An IBM computer selling for $1500 in New York
would be sell for ______ in Tokyo.
a. ¥100,000.
b. ¥150.
c. ¥150,000.
d. ¥1,500.
ANSWER: c
46. Suppose the exchange rate is $0.01 per ¥ 1. An IBM computer selling for $1500 in New York
would be sell for ______ in Tokyo.
a. ¥100,000.
b. ¥150,000.
c. ¥150.
d. ¥1,500.
ANSWER: b
47. Suppose the exchange rate is $1 per ¥ 100. A SONY television selling for ¥ 3000 in Tokyo
would be sell for ______ in New York.
a. $100.
b. $300.
c. $350.
d. $400.
ANSWER: b
48. Suppose the exchange rate is $0.01 per ¥ 1. A SONY television selling for ¥ 3000 in Tokyo
would be sell for ______ in New York.
a. $100.
b. $300.
c. $350.
d. $400.
ANSWER: b
Test Bank  517
Use the following diagram to answer questions 49 – 50.
Exchange Rate
S
1
E4
E
E
E
S
2
3
2
D
2
1
D
0
1
Dollars
49. Suppose that the demand for and supply of dollars is initially D2 and S2, respectively. If real
GDP in the U.S. were to decrease, the effect would be to:
a. decrease the supply of dollars to S1 and increase the exchange rate to E4.
b. decrease the demand for dollars to D1 and decrease the exchange rate to E1.
c. decrease the supply of dollars to S1 and increase the exchange rate to E3.
d. decrease the supply of dollars to S1, decrease the demand for dollars to D1, and increase the
exchange rate to E3.
ANSWER: a
50. Suppose that the demand for dollars is initially represented by D1 and the supply of dollars is
represented by S2. If the inflation rate were to decrease, the effect would:
a. decrease the supply of dollars to S1, thereby increasing the exchange rate to E3.
b. decrease the supply of dollars to S1 and increase the demand for dollars to D2, thereby
increasing the exchange rate to E4.
c. increase the demand for dollars to D2, thereby increasing the exchange rate to E2.
d. increase the supply of dollars and decrease the demand for dollars, thereby raising the
exchange rate.
ANSWER: b
Essay and Discussion Questions
1. "Changes in exchange rates alter the international price of goods and service." Explain
this statement.
Exchange rates determine how many units of one currency can be exchanged for one unit of
another currency. The exchange rate, say between dollars and yen, is determined by the demand
for and supply of dollars. In turn, the demand for dollars is determined by how many U.S. goods
the Japanese wish to purchase. (In order to purchase these goods, yen must be converted to
dollars.) The supply of dollars is determined by how many Japanese goods U.S. citizens wish to
purchase. (In order to purchase these goods, dollars must be converted to yen.)
Suppose the exchange rate of yen per dollars increases. In this case, it takes more yen to
purchase a dollar. This means that the Japanese will be able to purchase fewer U.S. goods with
518  Chapter 18/The Global Economy: Finance
the yen. The relative price of U.S. goods to the Japanese has increased. On the other hand, a
dollar will purchase more yen. This means that Americans will be able to purchase more
Japanese goods with the dollar. The relative price of Japanese good to Americans has decreased.
Thus, changes in exchange rates work to alter the relative prices of imports and exports.
2. Suppose GDP in the United States increases as the economy enters an expansion. How will
this change in GDP affect trade between the United States and other countries?
An increase in GDP in the U.S. will cause the U.S. to want to import more from other countries.
As a result, the supply of dollars would increase. The change in supply will cause the exchange
rate to fall and the dollar will depreciate. Ultimately, the decrease in the exchange rate will cause
U.S. exports to become cheaper and imports into the U.S. to become more expensive.
3. Evaluate the following statement, “Economists agree that a system of flexible exchange
rates is the most appropriate for all countries.”
This statement is, of course, incorrect. There are various points of view on this, and the student
should understand the arguments in favor of flexible rates and the arguments in favor of fixed
rates.
4. Evaluate the following statement, “Only countries with fixed exchange rates will be
interested in restricting capital flows.”
This statement is incorrect. A country with flexible rates might still become alarmed if there
was, for example, a sudden flow of capital out of the country. This could lead to a substantial
depreciation of the currency. If viewed as unfavorable, the country might want to establish
controls to prevent such an outflow.
Problems
1. If 1 dollar can be traded for 5 francs, how many dollars will 1 franc buy?
One franc is worth 20 cents, or 0.20 of a dollar.
2. Suppose the U.S. balance of payments in 2000 was equal to the following.
Current Account
Exports of goods and services
1,500
Imports of goods and services
2,000
Net Unilateral transfers
-50
a. What is the balance on the current account?
b. What is the balance on the capital account?
c. What is the balance of payments?
a. Exports enter the current account positively, and imports enter negatively. Therefore, net
exports (exports minus imports) equals -500. The balance equals: -500 - 50 = -550
b. If the balance on the current account is -550, then the balance on the capital account must be
+550.
c. By definition, the balance of payments must be zero.
3. Your trip to Mexico cost you 9,000 pesos. The exchange rate is 3 pesos per dollar. How
much did the trip cost you in American dollars? How much would you pay in American
dollars if the exchange rate was 5 pesos per dollar?
If the exchange rate is 3 pesos per dollar, the trip would cost 9,000/3 or 3,000 dollars. If the
exchange rate is 5 pesos per dollar, the trip would cost 9,000/5 or 1,800 dollars.