NAME ECONOMICS 248A, FALL 2000 INTERNATIONAL TRADE AND THE WORLD FINANCIAL SYSTEM

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1 NAME ECONOMICS 248A, FALL 2000 INTERNATIONAL TRADE AND THE WORLD FINANCIAL SYSTEM Final Examination Part One 1 pt each. 1. Which of the following transactions would not be a component of United States the balance of trade? (a) An American automobile importer buys cars from Subaru in Japan. (b) An American multinational oil company buys a string of gas stations in Cyprus. (c) IBM receives a ship ment of hard drives from its subsidiary in T aiwan.. (d) Archer D aniels Midland (a US agribusiness company) sells soybeans grown in K ansas to M exico.. 2. Under a system of fixed exchange rates, the exchange rate is maintained through (a) maintaining a constant level of official reserves. (b) balance of payments disequilibrium. (c) changes in the level of official reserves. (d) changes in the volume of international trade. 3. Countries with a current acc ount deficit (a) are capital-importing. (b) are capital-exporting. (c) must devalue their currencies. (d) must apply to the IMF for a credit facility. 4. A decrea se in foreign asse ts in the US is (a) a capital outflow and a "minus" entry on the balance of payments. (b) a capital outflow and a "plus" entry on the balance of paym ents. (c) a capital inflow and a "minus" entry on the balance of payments. (d) a capital inflow and a "plus" entry on the balance of payments. 5. In the balance of payments accounts (a) both direct foreign investment (DFI) and income from it appear in the capital account. (b) DFI appears in the current account and incom e from it appears in the cap ital account. (c) DFI appears in the ca pital account and incom e from it appears in the curre nt account. (d) both DF I and theinco me from it appear in the current account. 6. In the balance of payments accounts all of the following are autonom ous items except (a) imports. (b) exports. (c) foreign investm ent. (d) changes in official reserves.

2 7. The purchasing po wer parity principle (a) is not applicable in the long run. (b) would assert that a comm odity costing $ 10 in the US should cost 10 DM in Ge rmany. (c) would assert that, if the same commodity costs $5 in the US and 10 DM in Germany, then the exchange rate should be $1 = 2DM. (d) would assert that, if the same commodity costs $5 in the US and 10 DM in Germany, then the exchange rate should be $2 = 1DM. 8.. If 1 = 3 DM and 1 D M = 2 FF, then orderly cross rates require (a) 1 = 1.50 FF. (b) 2 = 3 FF. (c) 1 = 6 FF. (d) 6 = 1 FF. 9. Exchange rate differentials between different financial centers are removed through (a) the central bank's purchase and sale of international resources. (b) changes in the volume of exp orts and imports. (c) arbitrage. (d) all of the above. 10. Which of the following is true? (a) Speculation involves the assumption o f risk. Arbitrage d oes not. (b) Both speculation and arbitrage involve the assumption of risk. (c) Neither speculation nor arbitrage involve the assumption of risk. (d) Arbitrage involves the assumption of risk. Speculation does not. 11. Under fixed exchange rates, if the domestic currency is about to cross its upper parity bound, then the central bank must: (a) do nothing since it must allow the market to determine the rate. (b) restore the exchange rate by increasing its official reserves. (c) restore the exchange rate by decreasing its official reserves. (d) revalue its currency. 12. Under a "dirty" float (a) the central bank does not need to accumulate official reserves. (b) balance of payments equilibrium will always be maintained. (c) balance of trade equilibrium will always be maintained. (d) exchange rate fluctuations are moderated through central bank intervention. 13. A country m ay use SDRs to (a) obtain foreign currencies. (b) redeem a balance of its own currency held by another memb er country. (c) repurchase its own currency from the IM F general ac count. (d) all of the above. 14. A lowering of the value of the domestic currency under a fixed exchange rate is called (a) devaluation. (b) revaluation. (c) depreciation. (d) appreciation.

3 15. Which of the following combinations of economic conditions could be remedied through expenditure changing policies? (a) Domestic unemployment and a BP surplus. (b) Domestic unemplo yment and a BP deficit. (c) Domestic inflation and a B P surplus. (d) None of the above. 16. If MPS is.9 and MPM is.1, a $ 250 fall in exports will cause imports to (a) rise by $ 125. (b) fall by $ 125. (c) fall by $ 25. (d) fall by $ One implication of the "portfolio approach" is that (a) interest rate differentials will create consistently large flows of funds until the differentials are eliminated. (b) foreign and domestic assets are considered perfect substitutes. (c) to attract continuously large capital inflows, a government must repeatedly raise interest rates. (d) portfolio managers ignore risk considerations in making investment decisions. 18. A commodity with a price elasticity of demand greater than one is referred to as: (a) relatively inelastic (b) infinitely elastic (c) unitary elastic (d) relatively elastic 19. The Marshall-Lerner conditions indicate that devaluation will improve the trade balance if the sum of the price elasticities o f demand for domestic exports and imports is (a) less than one. (b) equal to zero. (c) greater than one. (d) less than zero. (e) equal to one. 20. A country that faces the problems of unemployment and a trad e deficit should use the following policy: (a) devaluation and expansionary fiscal policy. (b) devaluation and contractionary fiscal p olicy. (c) revaluation and expansionary fiscal po licy. (d) revaluation o nly. 21. Depreciation will provide a consistent solution for an economy with: (a) Low unemployment and a balance of payments surplus. (b) High unemploym ent and a balance of payments surplus. (c) Low unem ployment and a balance of payments deficit. (d) High unem ployment and a balance of payments deficit. 22. Which of the following factors might not be a reason for a delay in the response of the trade deficit: (a) The J-curve effect (b) A high price elasticity for expo rts (c) Incomplete

4 23. If nominal G NP = $100,00 0 and velo city = 2, then the d emand for money is (a) $200,000. (b) $50,000. (c) $20,000. (d) $2, Under the monetary approach with fixed exchange rates, an increase in the domestic money sup ply will create (a) an increased demand for money. (b) a balance of payments deficit in the long run. (c) a balance of payments surplus in the long run. (d) an increase in outpayments in the short run. 25. Proponents of freely fluctuating exchange rates maintain such a system results in all of the follow ing except: (a) balance of payments equilibrium would be maintained. (b) speculation in free currency markets would be destabilizing. (c) discretionary intervention by authorities would be obviated. (d) reserves would not be needed. 26 Under a floating exchange rate regime (a) fiscal policy is highly efficient and monetary policy is inefficient. (b) fiscal policy is inefficient and monetary policy is highly efficient. (c) both are highly efficient. (d) both are inefficient. 27. A country with a very large marginal propensity to import: (a) requires relatively large changes in GNP to balance its external accounts through domestic policy. (b) requires relatively small changes in GNP to balance its external accounts through domestic policy. (c) cannot be able to balance its external accounts through domestic policy. (d) is always in external equilibrium. 28. Large members of the EU would be mo re likely to benefit from currency union if (a) there were large external imbalances between memb ers. (b) there was a high degree o f coordination between membe rs in fiscal and monetary policy. (c) there was a low level of capital and labor mobility between mem ber nations. (d) none of the above. 29. Which was not a cause of the collapse of the Bretton Woods system. (a) The US wished to have control over the exchange value of the dollar. (b) Falling confidence in the value of the dollar in private exchange markets. (c) A resistance of Germany and Japan to revalue their currencies. (d) A sustained raise in the value of the pound and the french franc. 30. The floating exchange rate system was successful in coping with the oil shocks of the 1970s because: (a) It allowed each country to pick its own inflation rate. (b) It ensured that inflation was the same in all countries. (c) It stabilized global inflation at less than 3% per annum. (d) It led to a sustained fall in energy prices. Part Two points each

5 2.1 Com plete the following table )X MPM MPS MPC )K )Y )M )S )C )(X-M)

6 2.2 Consider the above diagram of a private open economy. S is the savings function, M the imports function, I and X are the investment and exp ort functions. 1. What determines the slope of the S+M function. 2. What does the representation of X and I as horizontal lines mean in economic terms. 3. Initially exports are X 1. Label the equilibrium level of income Y 1. What co ndition is satisfied at this point. 4. Does this country have a trade deficit or a trade surplus. 5. Is saving greater than investm ent. 6. Is it a capital importer or a capital exporter. 7. Now the country experiences an export boom. Exports rise to X 2. Show the new equilibrium level of income. 8. Does this country now have a trade deficit or a trade surplus. 9. Is saving greater than investm ent. 10. Is it a capital importer or a capital exporter

7 2.3 What are the automatic adjustment mechanisms that occur in an economy with a fixed exchange rate which act to restore the balance of international payments after a shock. Start with an exogenously caused fall in exports that creates a balance of payments deficit. Trace both the consequences expenditures and the money supply. Give reasons at each stage of your argument.

8 2.4 Imagine yourself in a position of policy-making in a country with a fixed exchange rate that has been beset by a chronic balance of payments problem. Automatic processes have not worked and deflationary discretionary policy has not corrected the problem. Your reserves are running out. What do you do? What conditions must be satisfied and what policy mix must you adopt to ensure a successful outcome? What has absorption approach got to do with this? Your brother-in-law is a monetarist. What d oes he think about devaluation as a p ermanent so lution.

9 2.5 Consider the above diagram for commo dity X and Country U. In the absence of any trade the domestic price is P d and the domestic output is Q d. The world price of the good is WP. A tariff of magnitude T is imposed, and the domestic price rises to P t. 1. Is U a small country or a large one. W hy? 2. What is the gain in producers surplus for U s manufacturers. 3. How much revenue is taken by U s finance authorities. 4. What is the deadweight loss of the tariff. 5. Define what the equivalent quota would be. Now consider X to be a normal good and suppose income rises in U by a substantial amount 6. What curve shifts in the above diagra m. Show it. 7. Show the new equilibrium price under assuming the tariff is unchanged. 8. Show the new government revenue. 9. Has the deadweight increased or decreased. 10. If a quota had been in effect not a tariff would the deadweight loss have been larger or smaller.

10 Part 3 (20 points). In the blue book answer one of : 3.1 What is an optimal currency area? What does a nation gain and what does it lose when it enters a currency area. Discuss with resp economy. How do issues like the similarity of economic structures enter the issue. What is the role of capital and labor mobility. Fina and how do they relate to this issue. 3.2 The recent WTO meeting in Seattle saw American Unionists, environmentalists and non-governmental proponents for the developm apparently finding common cause. Analyze the effect of free trade in goods on these groups and suggest whether, in your opinion, the a REMEMBER YOU ARE WRITING AN ESSAY. YOU MUST HAVE A PLAN. YOU MUST ORGANIZE YOUR POINTS. YOU PERS UASIV ELY. IF YOU FAIL T O DO THE SE TH INGS YOU R GRA DE W ILL SUFFER.