2. In the short-run international macroeconomic theory developed in the textbook, the AA curve shows

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1 HOMEWORK 9 (CHAPTER 17 OUTPUT AND THE EXCHANGE RATE IN THE SHORT RUN) ECO41 FALL 2015 UDAYAN ROY Each correct answer is worth 1 point. The maximum score is 20 points. This homework is due in class on Monday, December 7. Please show your answers on the answer sheet (on the last page). 1. In the short-run international macroeconomic theory developed in class, the DD curve shows all combinations of at which the market is in equilibrium? a. imports and exports; goods and services b. exports and the exchange rate; foreign exchange market c. foreign prices and the exchange rate; foreign exchange market d. output and the exchange rate; goods and services e. output and exports; goods and services 2. In the short-run international macroeconomic theory developed in the textbook, the AA curve shows a. interest rate and output combinations at which there is equilibrium in the domestic money market and the foreign exchange market. b. exchange rate and output combinations at which there is equilibrium in the foreign money market and the domestic exchange market. c. exchange rate and output combinations at which there is equilibrium in the domestic money market and the foreign exchange market. d. exchange rate and output combinations at which there is equilibrium in the domestic bond market and the foreign asset market. e. exchange rate and output combinations that are greater than equilibrium in the foreign money market and the domestic exchange market. 3. Expansionary fiscal policy refers to: a. An increase in government spending and/or an increase in taxes b. An increase in government spending and/or a decrease in taxes c. A decrease in government spending and/or an increase in taxes d. An increase in money supply e. A decrease in money supply 4. In a country that has flexible exchange rates, contractionary monetary policy refers to: a. An increase in government spending and/or an increase in taxes b. An increase in government spending and/or a decrease in taxes c. A decrease in government spending and/or an increase in taxes d. An increase in money supply e. A decrease in money supply 5. The short-run effect of a tax cut in an economy that has a flexible exchange rate system can be shown in the adjoining figure as a movement from:

2 a. Point 1 to Point 2. Therefore, output will decrease (Y ) and the domestic currency will depreciate (E ). b. Point 1 to Point 4. Therefore, output will decrease and the domestic currency will appreciate. c. Point 3 to Point 2. Therefore, output will increase and the domestic currency will depreciate. d. Point 3 to Point 4. Therefore, output will increase and the domestic currency will appreciate. 6. The short-run effect of a decrease in government spending in an economy that has a flexible exchange rate system can be shown in the adjoining figure as a movement from a. Point 1 to Point 2. Therefore, output will decrease and the domestic currency will depreciate. b. Point 1 to Point 4. Therefore, output will decrease and the domestic currency will appreciate. c. Point 3 to Point 2. Therefore, output will increase and the domestic currency will depreciate. d. Point 3 to Point 4. Therefore, output will increase and the domestic currency will appreciate. 7. The economy is in recession, GNP is falling and unemployment is soaring. You are the president s economic adviser. The president faces a tough re-election campaign and wants a quick increase in GNP. Based on the AA-DD analysis that was discussed in class, what policies would you recommend to her? a. Cut taxes b. Increase government spending c. Increase the money supply d. Raise tariffs on imported goods e. Any or all of the above 8. You are the president s economic adviser. The president faces a tough re-election campaign and wants a quick increase in the nation s current account balance (CA). Based on the AA-DD analysis that was discussed in class, what policies would you recommend to her? a. Expansionary fiscal policy b. Contractionary fiscal policy (also called, fiscal austerity ) c. Expansionary monetary policy d. Contractionary monetary policy e. Both (b) and (c) would be good advice 9. How does an increase in the real exchange rate affect exports and imports? (Hint: Read the section in Ch. 17 of the textbook with the title How Real Exchange rate Changes Affect the Current Account.) a. Exports increase; imports decrease. b. Exports decrease; imports increase. c. Exports increase; imports change ambiguously. d. Exports change ambiguously; imports decrease. 2

3 e. Exports increase; imports are constant. 10. How does a rise in real income affect aggregate demand? a. Y Y d Im CA AD, but Y Y d C AD by more b. Y Y d Im CA AD, but Y Y d C AD by more c. Y Y d Im CA AD, and Y Y d C AD d. Y Y d Im CA AD, but Y Y d C AD by less e. Y Y d Im CA AD, but Y Y d C AD by less 11. Which of the following are true statements about the current account balance (CA)? a. Monetary expansion increases the current account balance. b. Monetary expansion decreases the current account balance. c. Fiscal expansion increases the current account balance. d. Fiscal expansion decreases the current account balance. e. Both (a) and (d) 12. In the short run, what would be the effect of an increase in government spending? a. It will increase domestic output and appreciate the domestic currency. b. It will increase domestic output and depreciate the domestic currency. c. It will decrease domestic output and appreciate the domestic currency. d. It will decrease domestic output and depreciate the domestic currency. e. None of the above. 13. Which one of the following statements is the most accurate? a. An increase in disposable income (Y d = Y T) improves the current account. b. An increase in disposable income does not affect the current account. c. An increase in disposable income worsens the current account. d. An increase in income worsens the current account. e. An increase in income improves the current account. 14. In the short-run, a temporary increase in the money supply a. Shifts the AA curve to the right, increases output and depreciates the domestic currency b. Shifts the AA curve to the left, increases output and depreciates the domestic currency c. Shifts the AA curve to the left, decreases output and depreciates the domestic currency d. Shifts the AA curve to the left, increases output and appreciates the domestic currency e. Shifts the AA curve to the right, increases output and appreciates the domestic currency 15. In the short-run, a temporary increase in fiscal policy causes a. A shift of the DD curve to the left, output increases and the domestic currency appreciates b. A shift of the DD curve to the right, output decreases and the domestic currency appreciates c. A shift of the DD curve to the right, output increases and the domestic currency depreciates d. A shift of the DD curve to the left, output decreases and the domestic currency depreciates 3

4 e. A shift of the DD curve to the right, output increases and the domestic currency appreciates 16. A permanent increase in the domestic money supply a. Must ultimately lead to a proportional decrease in E, and, therefore, the expected future exchange rate must rise proportionally. b. Must ultimately lead to a proportional decrease in E, and, therefore, the expected future exchange rate must decrease proportionally. c. Must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise proportionally. d. Must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise more than proportionally. e. Must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise less than proportionally. 17. In the short run, a permanent increase in the domestic money supply causes a. an upward shift in the DD curve that is greater than that caused by an equal but temporary increase b. a downward shift in the AA curve that is greater than that caused by an equal but temporary increase c. an upward shift in the AA curve which is smaller than that caused by an equal but temporary increase d. a downward shift in the AA curve which is smaller than that caused by an equal but temporary increase e. an upward shift in the AA curve which is greater than that caused by an equal but temporary increase 18. In the short run, a permanent increase in the domestic money supply a. Has stronger effects on the exchange rate and output than an equal temporary increase b. Has stronger effects only on the exchange rate but not on output than an equal temporary increase c. Has weaker effects on the exchange rate and output than an equal temporary increase d. Has stronger effects on output, but lower effect the exchange rate than an equal temporary increase e. None of the above. 19. The DD schedule shows all combinations of which two variables so that the output market is in equilibrium? a. Imports and exports. b. Exports and the exchange rate. c. Foreign prices and the exchange rate. d. Output and the exchange rate. e. Output and exports. 20. How is the AA schedule derived? a. It is derived by the schedule of interest rate and output combinations that are consistent with equilibrium in the domestic money market and the foreign exchange market. b. It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the foreign money market and the domestic exchange market. c. It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the domestic money market and the foreign exchange market. 4

5 d. It is derived by the schedule of exchange rate and output combinations that are consistent with equilibrium in the domestic bond market and the foreign asset market. e. None of the above. 21. According to the AA-DD model of international macroeconomics discussed in class, expansionary monetary policy and expansionary fiscal policy the nominal interest rate (R). a. Increases; increases b. Increases; decreases c. Decreases; increases d. Decreases; decreases 22. According to the AA-DD model of international macroeconomics discussed in class, a temporary increase in foreign GNP will affect the domestic economy as follows: a. The DD curve will shift right. Domestic GNP will increase (Y ) and the exchange rate of the foreign currency will decrease (E ). The domestic interest rate will increase (R ), and the domestic economy s net exports will decrease (CA ). b. The DD curve will shift right. Y, E, R, and CA. c. The DD curve will shift left. Y, E, R, and CA. d. The AA curve will shift right. Y, E, R, and CA. 5

6 ANSWER SHEET HOMEWORK 9 (Ch. 17) ECO41 FALL 2015 UDAYAN ROY NAME: DATE: