Open Economy: Basic Concepts

1. In an open economy, national saving equals domestic investment

2. If the value of a nation’s imports exceeds the value of its exports, which of the following is Not
true?
a. Net exports are negative.
b. GDP is less than the sum of consumption, investment, and government purchases.
c. Domestic investment is greater than national saving.
d. The nation is experiencing a net outflow of capital.

3. If a nation’s currency doubles in value on foreign exchange markets, the currency is said to
_________, reflecting a change in the _________ exchange rate.
a. appreciate; nominal
b. appreciate; real
c. depreciate; nominal
d. depreciate; real

4. 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 copy of this textbook.
e. A Canadian citizen shops at a store in northern Vermont to avoid Canadian sales taxes.

5. If the VND appreciates and prices remain the same at home and abroad, foreign goods become
_________ expensive relative to Vietnamese goods, pushing the Vietnam trade balance toward
_________.
a. more; surplus
b. more; deficit
c. less; surplus
d. less; deficit

6. The dollar–yen exchange rate falls from 100 to 80 yen per dollar. At the same time, the price
level in the United States rises from 180 to 200, and the price level in Japan remains the same. As
a result,
a. American goods have become more expensive relative to Japanese goods.
b. American goods have become less expensive relative to Japanese goods.
c. the relative price of American and Japanese goods has not changed.
d. both American and Japanese goods have become relatively less expensive.

7. If a cup of coffee costs 2 euros in Paris and $6 in New York and purchasing-power parity holds,
what is the exchange rate?
a. 1/4 euro per dollar
b. 1/3 euro per dollar
c. 3 euros per dollar
d. 4 euros per dollar

8. The theory of purchasing-power parity says that higher inflation in a nation causes the nation’s
currency to _________, leaving the _________ exchange rate unchanged.
a. appreciate; nominal
b. appreciate; real
c. depreciate; nominal
d. depreciate; real

9. Would each of the following transactions be included in U.S. net exports or in U.S. net capital
outflow? Indicate 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.

10. 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?
11. Explain how the following transactions would affect U.S. net capital outflow. For each
transaction, state whether it represents 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 Motors pension fund.
c. Honda expands its factory in Marysville, Ohio.
d. An American mutual fund sells its Volkswagen stock to a French investor.

12. Would each of the following groups be happy or unhappy if the U.S. dollar appreciated?
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

13. 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

14. Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only
commodity is Spam.
a. In 2020, a can of Spam costs 4 dollars in Ectenia and 24 pesos in Wiknam. What is the
exchange rate between Ectenian dollars and Wiknamian pesos?
b. Over the next 20 years, inflation is expected to be 3.5 percent per year in Ectenia and 7
percent per year in Wiknam. If this inflation comes to pass, what will the price of Spam and the
exchange rate be in 2040?
c. Which of these two nations will likely have a higher nominal interest rate? Why?
d. A friend of yours suggests a get-rich-quick scheme: Borrow from the nation with the lower
nominal interest rate, invest in the nation with the higher nominal interest rate, and profit from
the interest-rate differential. Do you see any potential problems with this idea? Explain.