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Name             Testbank Chapter 12: The Open Economy Revisited: The Mundell-Fleming Model and the Exchange-Rate Regime

Description Question pool for Testbank Chapter 12: The Open Economy Revisited: The Mundell-Fleming Model and the Exchange-Rate

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Compared to a closed economy, an open economy is one that:

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The Mundell-Fleming model assumes that:

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The Mundell-Fleming model is a ______ model for a ______ open economy.

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In the Mundell-Fleming model:

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In the Mundell-Fleming model, the domestic interest rate is determined by the:

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In a small open economy with perfect capital mobility, if the domestic interest rate were to rise above the world interest rate, then ______ would drive the domestic interest rate back to the level of the world interest rate.

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Assuming there is perfect capital mobility, compared to a large open economy, a small open economy is one in which the:

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In a small open economy, a decrease in its exchange rate will ______ net exports and shift the _____ curve.

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If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the IS* curve:

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In the Mundell-Fleming model on a Ye graph, the curves labeled IS* and LM* are labeled that way as a reminder that:

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If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the LM* curve:

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In the Mundell-Fleming model, the exogenous variables are the:

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The intersection of the IS* and LM* curves shows the ______ and the ______ at which both the goods market and the money market are in equilibrium.

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Under a floating system, the exchange rate:

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In a small open economy with a floating exchange rate, an effective policy to increase equilibrium output is to:

In a small open economy with a floating exchange rate, an effective policy to decrease equilibrium output is to:

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In a small open economy with a floating exchange rate, the exchange rate will appreciate if:

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In a small open economy with a floating exchange rate, the exchange rate will depreciate if:

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In a small open economy with a floating exchange rate, if the government adopts an expansionary fiscal policy, in the new short-run equilibrium:

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-In a small open economy with a floating exchange rate, a rise in government spending in the new short- run equilibrium:

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In a small open economy with a floating exchange rate, the supply of real money balances is fixed and a rise in government spending:

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(Exhibit: IS*–LM*) A small open economy with a floating exchange rate is initially at equilibrium A with IS* , LM* ,

1. 1 equilibrium exchange rate e, and equilibrium output Y. If there is an increase in government spending to IS* , the
2. 1             2

new equilibrium will be at ______, holding everything else constant.

 Question

(Exhibit: IS*–LM*) A small open economy with a floating exchange rate is initially at equilibrium A with IS* , LM* ,

1. 1 equilibrium exchange rate e, and equilibrium output Y. If there is a monetary expansion to LM* , the new equilibrium
2. 1             2

will be at ______, holding everything else constant.

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In a small open economy with a floating exchange rate, if the government decreases the money supply, then in the new short-run equilibrium:

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In a small open economy with a floating exchange rate, if the government increases the money supply, then in the new short-run equilibrium the:

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According to the Mundell-Fleming model for a small open economy with flexible exchange rates, if the Federal Reserve cannot alter domestic interest rates, changes in the money supply could still influence aggregate income through changes in the:

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In a small open economy with a floating exchange rate, if the government imposes an import quota, then in the new short-run equilibrium the IS* curve shifts to the right, raising the exchange rate:

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In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, then in the new short-run equilibrium:

 Question

(Exhibit: Risk Premium) A small open economy with a floating exchange rate is initially in equilibrium at A with IS* ,

1

LM* . Holding all else constant, if the government imposes a tariff on imports in order to protect domestic jobs, then the

1

______ curve will shift to ______.

 Question

(Exhibit: Risk Premium) A small open economy with a floating exchange rate is initially in equilibrium at A with IS* ,

1

LM* . Holding all else constant, if domestic consumers develop greater preferences for imported goods, then the

1

_____ curve will shift to _____.

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Under a fixed system, the exchange rate:

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To maintain a fixed-exchange-rate system, if the exchange rate moves below the fixed-exchange-rate level, then the central bank must:

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If the Fed announced it would fix the exchange rate at 100 yen per dollar, but with the current money supply the equilibrium exchange rate was 150 yen per dollar, then:

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Under a fixed-exchange-rate system, the central bank of a small open economy must:

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If there is a fixed-exchange-rate system, then in the short run described by the Mundell-Fleming model:

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If there is a fixed-exchange-rate system, then in the long run:

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During the era of the gold standard, the price of gold in England:

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In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the new short-run equilibrium:

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In a small open economy with a fixed exchange rate, if the government increases government purchases, then in the process of adjusting to the new short-run equilibrium, the money supply:

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In a small open economy with a fixed exchange rate, an effective policy to increase equilibrium output is to:

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(Exhibit: IS*–LM*) A small open economy with a fixed exchange rate e is initially at equilibrium A with IS* , LM* , and

2       1                      1

equilibrium output Y. If there is an increase in government spending to IS* , the new equilibrium will be at ______,

1. 2

holding everything else constant.

 Question

(Exhibit: IS*–LM*) A small open economy with a fixed exchange rate e is initially at equilibrium A with IS* , LM* , and

1. 1                1

equilibrium output Y. If there is a monetary expansion to LM* , the new equilibrium will be at ______, holding

1     2

everything else constant.

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In a small open economy with a fixed exchange rate, if the central bank tries to increase the money supply, then in the new short-run equilibrium:

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In a small open economy with a fixed exchange rate, if the country devalues its currency, then in the new short-run equilibrium the exchange rate ______, and the LM* curve shifts to the ______. Choice    0  points

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In the Mundell-Fleming model with fixed exchange rates, attempts by the central bank to increase the money supply lead the exchange rate to fall, giving arbitrageurs the incentive to ______ the central bank, which causes the money supply to ______.

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In the Mundell-Fleming model with fixed exchange rates, attempts by the central bank to decrease the money supply:

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A revaluation of a currency under a fixed-exchange-rate system occurs when the level at which the currency is fixed is:

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A devaluation of a currency under a fixed-exchange-rate system occurs when the level at which the currency is fixed is:

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During the Great Depression, countries that devalued their currencies generally ______ whereas countries that maintained the old exchange rate ______.

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In a small open economy with a fixed exchange rate, if the government imposes an import quota, then net exports:

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In the Mundell-Fleming model with fixed exchange rates, the imposition of trade restrictions results in an increase in net exports because:

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According to the Mundell-Fleming model, under:

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According to the Mundell-Fleming model, under floating exchange rates a fiscal expansion:

Question

According to the Mundell-Fleming model, under fixed exchange rates expansionary fiscal policy causes income to ______, and under flexible exchange rates expansionary fiscal policy causes income to ______.

Question

According to the Mundell-Fleming model, in an economy with flexible exchange rates, expansionary fiscal policy causes the exchange rate to ______ and expansionary monetary policy causes the exchange rate to ______.

Question

According to the Mundell-Fleming model, in an economy with flexible exchange rates, expansionary fiscal policy causes net exports to ______ and expansionary monetary policy causes net exports to ______.

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According to the Mundell-Fleming model, import restrictions in an economy with flexible exchange rates cause net exports to ______ and in an economy with fixed exchange rates import restrictions cause net exports to ______.

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According to the Mundell-Fleming model, under flexible exchange rates expansionary monetary policy ______ increase income and under fixed exchange rates expansionary monetary policy ______ increase income.

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The risk premium included in the interest rate of small open economies incorporates:

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Country risk included in the risk premium in interest rates refers to the:

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(Exhibit: Risk Premium) A small open economy with a floating exchange rate is initially in equilibrium at A with IS* ,

1

LM* . If there is an increase in the risk premium, then LM* will shift to ______ and IS* will shift to ______.

1. 1                  1

Question

(Exhibit: Risk Premium) A small open economy with a floating exchange rate is initially in equilibrium at A with IS* ,

1

LM* . If the establishment of a new government in the country decreases the risk premium, then LM* will shift to

1. 1

______ and IS* will shift to ______.

1

Question

In order to compensate for an expected future decline in the Japanese yen relative to the U.S. dollar, the interest rate in Japan must be ______ the interest rate in the United States.

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In the Mundell-Fleming model, if political turmoil raises the risk premium in a country's interest rate, then the exchange rate will:

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In the Mundell-Fleming model, expectations that a currency will lose value in the future will cause the current exchange rate to:

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An increase in income generated by an increase in the country risk premium will not occur if there is a(n) ______ sufficient to offset the decline in the demand for money caused by the higher risk premium.

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An increase in income generated by an increase in the country risk premium will not occur if there is a(n) ______ sufficient to offset the decline in the demand for money caused by the higher risk premium.

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According to the Mundell-Fleming model with floating exchange rates, political uncertainty in Mexico in 1994 caused the risk premium on Mexican interest rates to ______ and the Mexican exchange rate to ______.

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At the end of 1994 the Mexican government was unable to maintain a fixed exchange rate because it:

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“Crony capitalism” refers to situations in which banks make loans to those borrowers with the most:

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One argument favoring a floating-exchange-rate system is that it:

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One argument favoring a fixed-exchange-rate system is that it:

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A monetary union with a common currency is an example of a:

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Some economists argue that monetary union will not work as well in Europe as it does in the United States for all of the following reasons except:

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If the exchange rate of currency A is fixed to a unit of currency B, then a potential problem for the central bank in charge of currency A is:

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A speculative attack on a currency occurs when:

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A change in investors' perceptions that make a fixed exchange rate untenable is known as:

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An arrangement by which a central bank holds enough foreign currency to back each unit of the domestic currency is called a:

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When a country abandons its national currency and adopts the currency of the United States, this is known as:

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The principal economic loss when a country dollarizes is the loss of:

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The “impossible trinity” refers to the idea that it is impossible for a country to simultaneously have:

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If a country chooses to have free capital flows and to conduct an independent monetary policy, then it must:

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If a country chooses to have free capital flows and to maintain a fixed exchange rate, then it must:

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If a country chooses to restrict international capital flows and to maintain a fixed exchange rate, then it must:

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Between 1995 and 2005, China chose to:

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Which of the following would be evidence that a country with a fixed exchange rate has an undervalued currency?

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In the Mundell-Fleming model, if the price level falls, then the equilibrium income

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In the Mundell-Fleming model, if the economy is operating at or below the natural level in the short run, then in the long run the price level will fall, the exchange rate will ______, and net exports will ______ to restore the economy to its natural rate.

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In the Mundell-Fleming model with flexible exchange rates, an increase in the price level results in a( n) ______ in the real exchange rate and a(n) ______ in net exports.

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(Exhibit: Risk Premium) A small open economy with a floating exchange rate is initially in equilibrium at A with IS* ,

1

LM* . Holding all else constant, if the domestic price level increases then the ______ curve will shift to ______. 1

 Question

(Exhibit: Risk Premium) A small open economy with a floating exchange rate is initially in equilibrium at A with IS* ,

1

LM* . Holding all else constant, if the domestic price level decreases then the ______ curve will shift to ______.

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In a large open economy with a floating exchange rate, such as in the United States, in the short run a monetary contraction:

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In a short-run model of a large open economy with a floating exchange rate, net capital outflow ______ as the domestic interest rate increases and is just equal to ______.

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In a short-run model of a large open economy, after net capital outflow is substituted for net exports in the IS curve:

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In a short-run model of a large open economy with a floating exchange rate:

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In a short-run model of a large open economy with a floating exchange rate, a fiscal expansion causes an increase in:

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In a short-run model of a large open economy with a floating exchange rate, a monetary expansion causes a decrease in the interest rate and:

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A fall in consumer confidence about the future, which induces consumers to spend less and save more, will, according to the Mundell-Fleming model with floating exchange rates, lead to:

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A fall in consumer confidence about the future, which induces consumers to spend less and save more, will, according to the Mundell-Fleming model, with fixed exchange rates, lead to:

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The introduction of a stylish new line of Toyotas, which makes some consumers prefer foreign cars over domestic cars, will, according to the Mundell-Fleming model with floating exchange rates, lead to:

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The introduction of a stylish new line of Toyotas, which makes some consumers prefer foreign cars over domestic cars, will, according to the Mundell-Fleming model with fixed exchange rates, lead to:

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The introduction of automatic teller machines, which reduces the demand for money, will, according to the MundellFleming model with floating exchange rates, lead to:

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The introduction of automatic teller machines, which reduces the demand for money, will, according to the MundellFleming model with fixed exchange rates, lead to:

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In the Mundell-Fleming model with a floating exchange rate, a rise in the world interest rate will lead income:

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In the Mundell-Fleming model with a fixed exchange rate, a rise in the world interest rate will lead income:

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The goods produced in U.S. industry may be made more competitive in world markets by:

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If investors in a large open economy become more willing to substitute foreign and domestic assets, then this will make the net capital outflow function:

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Assume that the LM curve for a small open economy with a floating exchange rate is given by Y = 200r – 200 + 2(M/P) , while the IS curve is Y = 400 + 3G – 2T + 3NX – 200r. The function for the net exports is NX = 200 – 100e, where e is the exchange rate. The price level (P) is fixed at 1.0. The international interest rate is r* = 2.5 percent.

1. Using the LM curve, find the equilibrium level of Y in the small open economy, if M = 100.
2. Given this value of Y, if G = 100 and T = 100, what must be the equilibrium value of NX?
3. If this value of NX is to be achieved, what must be the equilibrium exchange rate, e?

Question

Assume that the LM curve for a small open economy with a fixed exchange rate is given by Y = 200r – 200 + 2(M/P). This IS curve is given by Y = 400 + 3G – 2T + 3NX – 200r. The function for the net exports is NX = 200 – 100e, where e is the exchange rate. The price level is fixed at 1.0, the world interest rate is r* = 2.0 percent, and the exchange rate

is initially 1.0.

1. If M = 100, G = 100, and T = 100, solve for the equilibrium short-run values of Y and NX. Is the initially given exchange rate equal to the equilibrium exchange rate?
2. If the Fed buys bonds in order to raise the money supply, will equilibrium Y increase?

Question

Assume that a large open economy with a floating exchange rate is described in the short run by the equations:

C = 0.5(YT)

T = 1,000

I = 1,500 – 250r

G = 1,500

NX = 1,000 – 250e

C + I + G + NX = Y

M/P = 0.5Y – 500r

M = 1,000

CF = 500 – 250r      NX = CF

The last two equations specify that CF, net capital outflow, decreases with r, the interest rate, and that NX, the net exports, is equal to net capital outflow. NX is also related to the exchange rate, e, and falls when e appreciates. The price level (P)  is fixed at  1.0.

Calculate short-run equilibrium values of Y, r, C, I, CF, NX, e, private saving, public saving, and foreign saving. Foreign saving is defined here as minus NX. Check your work by ensuring that C + I + G = Y and private saving plus public saving plus foreign saving equals domestic investment. (Hint: As in the appendix to textbook Chapter 12, form the IS curve from C + I + G + NX = Y, and then substitute CF for NX to get C + I + G + CF = Y. Combine with the LM curve and solve for Y, r, and CF and then use NX = CF to get NX and the equation relating NX to e to get e.)

Question

Suppose Congress cuts government spending in order to balance the budget. Use the Mundell-Fleming model with floating exchange rates to illustrate graphically the short-run impact of the cuts in government spending on the dollar exchange rate and output in the United States. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question

Suppose the government of a small open economy with a floating exchange rate imposes 50 percent tariffs on all imports. Use the Mundell-Fleming model to illustrate graphically the short-run impact of the tariffs on the exchange rate and output in the country. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question

In early 1994, Mexico was adhering to a fixed-exchange-rate system. Use the Mundell-Fleming model to illustrate graphically the short-run impact on the exchange rate and level of output of increased country risk caused by the Chiapas uprising and the assassination of presidential candidate Colosio. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question

1. You are the chief economic adviser in a small open economy with a floating-exchange-rate system. Your boss, the president of the country, wishes to increase the level of output in the short run in order to win reelection. Do you recommend using expansionary or contractionary, monetary or fiscal policy?
2. Use the Mundell-Fleming model to illustrate graphically your proposed policy. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question

Economic expansion throughout the rest of the world raises the world interest rate. Use the Mundell-Fleming model to illustrate graphically the impact of an increase in the world interest rate on the exchange rate and level of output in a small open economy with a floating-exchange-rate system. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Question

Two small open economies, Fixed and Flex, can be described by the Mundell-Fleming model. The countries are otherwise identical except that Fixed maintains a fixed exchange rate, while Flex maintains a flexible exchange-rate regime. The governments of both countries increase spending by the same amount. Compare what happens in the two countries to:

1. the exchange rate,
2. equilibrium output, and
3. net exports.

Question

Macroland is a small open economy with perfect capital mobility and a flexible exchange-rate system. Macroland is initially in equilibrium at the natural level of output with balanced trade. Compare the impact of a tax cut in the short run (when prices are fixed) and in the long run (when prices are flexible) on: a) output, b) consumption, c) investment, d) net exports, and e) the exchange rate.

Question

The government of a small open economy with perfect capital mobility wants to establish a “stronger” currency by moving its exchange rate higher. Suggest both an appropriate monetary policy adjustment and an appropriate fiscal policy adjustment that would allow the economy to move to a higher exchange rate. What are the consequences of these adjustments on domestic output and net exports?

Question

A U.S. Congressman wants to reduce the U.S. trade deficit by imposing tariffs on imports. Use a model of a large open economy with a flexible exchange rate to predict the impact of tariffs on U.S. imports, exports, net exports, the exchange rate, and the interest rate.

Question

Explain how net capital outflows change in a large open economy when there is a: a.               monetary contraction, and

b. fiscal contraction.

Question

Holding everything else constant, compare the impact of a monetary expansion in a small open economy with a floating exchange rate and in a large open economy with a floating exchange rate on: a. domestic investment, and

b. domestic output.

Question

During periods of economic downturn, there is frequently pressure to protect domestic production from foreign competition in the belief that protectionist policies will save domestic jobs. Will protectionist policies increase or decrease domestic production in a large open economy with a floating exchange rate, holding all else constant? Illustrate your answer graphically and explain in words.

Question

What type of monetary or fiscal policy will generate both a “stronger” economy (increased Y)  and a “stronger” dollar (increased e) in a large open economy with a floating exchange rate? Explain.

Question

Graphically illustrate and explain how a steep decline in the value of the stock market and housing prices would affect the level of domestic output, the interest rate, and the exchange rate in a large open economy with a floating exchange rate.

Question

The “impossible trinity” refers to the idea that a country can simultaneously pursue only two of the three following policies: free international-capital flows, monetary policy for domestic stabilization, and a fixed exchange rate. For each of the following combinations indicate what the economy gives up by selecting the combination and why the omitted policy cannot be achieved:

1. a fixed exchange rate and free international-capital flows
2. a monetary policy for domestic stabilization and a fixed exchange rate
3. a monetary policy for domestic stabilization and free international-capital flows

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