Homework answers / question archive / 1)Which of the following transactions would not be included in the current account of the home country? CA = NX + NFP;  (goods or income receipts); CA + KFA = 0 A) A consumer good is imported into the home country

1)Which of the following transactions would not be included in the current account of the home country? CA = NX + NFP;  (goods or income receipts); CA + KFA = 0 A) A consumer good is imported into the home country

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1)Which of the following transactions would not be included in the current account of the home country? CA = NX + NFP;  (goods or income receipts); CA + KFA = 0

A) A consumer good is imported into the home country. – good

B) A home country resident makes a deposit in a foreign bank. – financial account.

• outflow or inflow of a financial asset.
• Just memorize the specific types of CA items. But generally, questions will deal with CA and the capital/financial account balancing out – just know that CA + KFA = 0

C) A foreign student pays tuition to a university in the home country. – income receipt to abroad

D) A home country resident receives income on his or her foreign assets. – income receipt

 

2. A negative value for the U.S. official reserve assets line in the balance of payments accounts means that

• Official reserve assets are assets that can be used in making international payments.
• Balance of payments is the net increase (domestic minus foreign) in a country’s official reserve assets
• A negative value for the reserve assets line means that the country is running at a balance of payments deficit – i.e., it has large holdings of foreign reserve assets relative to domestic reserve assets

A) U.S. residents have sold more gold to foreigners than they bought.

B) U.S. residents bought more gold from foreigners than they sold.

C) the U.S. central bank has increased its holdings of foreign reserve assets.

D) the U.S. central bank has decreased its holdings of foreign reserve assets.

 

3. Assume that an increase in Costa Rica's government budget deficit reduced desired national saving by 10 million colon. Assuming Costa rice is a small open economy, you would expect the government's action to //

• In a closed economy, there are no net exports. Therefore, to clear the market, desired savings must equal desired investment.
• In an open economy, the current account (basically net exports) can make up the difference between the two. CA = desired savings – desired investment = NX
• So if desired savings decreases, CA will decrease by that amount exactly for a small economy.
• If you’re considering a large economy- a change in their savings would actually cause a change in the world’s real interest rate and cause the CA to change in an indeterminate (not an exact) way

A) increase the current account balance by exactly 10 million colon.

B) increase the current account balance by less than 10 million colon.

C) reduce the current account balance by exactly 10 million colon.

D) reduce the current account balance by more than 10 million colon.

 

 

 

 

 

 

 

 

 

 

4. For each of the following transactions, explain what happens to the merchandise trade balance, current account balance, and financial account balance in both the United States and Mexico. The exchange rate is 2 Mexican pesos per U.S. dollar.

(a)  A Mexican firm spends 4 million pesos to buy radiology equipment from a U.S. firm.

• US firm sells a good to the Mexican firm and receives 4 million Mexican pesos.
  • 4 million pesos divided by 2 pesos/USD = 2 million dollars
  • Merchandise and trade balance and current account both go up by $2 million dollars
  • Financial account will go down by that same amount. The book makes a really strange assumption that the US firm will then turn around and either buy a Mexican good, Mexican financial asset, or cause the US’s central bank to increase its holdings of the peso relative to the USD. But in any case, there is an opposite and inverse effect in the financial account.
    • US firm, after receiving pesos, will either trade its pesos for USD at a bank (with the bank to doing the same thing with the central bank), which causes the official reserve assets to go down OR the firm will purchase a Mexican financial asset. Either way, financial account will go down
    • Effectively, US reserve assets goes down - US’s holdings of US currencies relative to foreign currencies goes down.
• The opposite for the Mexican firm.
  • Imports goods, so its merchandise and trade account will go down
  • Mexico will then benefit from whatever the US firm decides to do with its revenue – so its financial account will go up by the same amount.
    • America buys Mexican bonds

 

(b)  A U.S. firm buys 20,000 sombreros at 20 pesos each.

• Same exact thing with different numbers

(c)  Mexican computer firms send 200 programmers to universities in the United States, paying tuition and expenses of $3000 each.

• Only difference here is that it doesn’t affect the merchandise and trade account, since goods aren’t being traded. But the same inverse relationship between current account and financial account.

(d) A Mexican entrepreneur gives 50,000 pesos to the United Way of San Antonio, Texas.

• Net unilateral transfer, counts in current account. Same deal.

(e)  Mexican investors buy $10 million worth of 30-year U.S. Treasury bonds.

• Just a rise and fall within the financial account
• Mexican investor converts pesos to USD (Mexican central bank will gain pesos and lose USD – reserve balance will go up), but then US bonds are bought so financial account goes down.

 

5. Suppose an economy has output of 2100, government spending of 40, consumption of 1600, and absorption of 1940. Calculate the equilibrium values of investment and net exports.

Answer:  Since absorption = C + I + G, then 1940 = 1600 + I + 40, so I = 1940 - 1640 = 300. Net exports = Y - absorption = 2100 - 1940 = 160.

 

6. A small open economy has a current account balance of zero. A rise in the world real interest rate causes

 

 

A) a current account surplus.

B) a financial account surplus.

C) net borrowing from abroad.

D) absorption to exceed income.

 

7. When future labor income falls in a small open economy, it causes the current account to ________ and investment to ________. //

Income effect – if future labor income falls, you’ll increase your current savings relative to consumption, so the current account will go up. This doesn’t affect investment.

A) fall; rise

B) rise; remain unchanged

C) fall; remain unchanged

D) rise; rise

 

8. In a small open economy,

Sd = $5 billion + ($100 billion) rw,

Id = $10 billion - ($50 billion) rw,

Y = $50 billion,

G = $3 billion,

rw = .06.

(a)  Calculate the current account balance.

CA = Sd – Id , where rw is given as .06

Solve it out, you get savings = 11 billion – investment = 7 billion = 4 billion

(b)  Calculate net exports.

CA = NX + NFP + NUT // last two not given, so CA = NX  

(c)  Calculate desired consumption.

Sd = Y – Cd – G

11 billion = 50 billion – Cd – 3 billion

Cd = 36 billion

(d) Calculate absorption.

Absorption = C + I + G

36 billion + 7 billion + 3 billion = 46 billion

 

 

9. Consider a small open economy in equilibrium with a current account deficit.

 

(a)  Draw a diagram showing this situation.

 

 

(b)  What happens to national saving, investment, and the current account balance in equilibrium if government expenditures rise temporarily? Show this result in your diagram.

 

10. A large open economy increases its desired saving. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) fall; fall

B) remain unchanged; rise

C) fall; rise

D) remain unchanged; fall

 

 

 

 

 

 

 

 

 

 

 

 

11. A large open economy has desired national saving of Sd = 20 + 200rw, and desired national investment of Id = 30 - 200rw. The foreign economy has desired national saving of  = 40 + 100rw, and desired national investment of  = 75 - 400rw.

(a)  Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor, and IFor.

• At equilibrium, Sd – Id = Id_for - Sd_for
  • Desired savings of one country = desired lending of another
  • All of those four functions are given as functions of rW
• Solve for rW
• Plug rW back into those four equations to find values for S, I, S_for and I_for
• CA = S – I ; solve for that for each country

(b)  Suppose Sd rises by 45, so that now Sd = 65 + 200rw. Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor, and IFor.

• Same exact thing with different a different number for Sdomestic. Note that savings domestic will not equal savings from part a + 45. Because when a country changes its desired saving, it will affect the world interest rate, which will feed back into a different savings.
• You have to solve through the equation again, find the new rW, and repeat the same process.

(c)  Suppose, with Sd back to Sd = 20 + 200rw, as in part (a), that Id rises by 45, to Id = 75 - 200rw. Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor, and IFor.

• Again solve the equation
• I think equally important to solving the equation would be noting the trends
  • CA can swing from pos to negative depending on the world interest rate
  • When a large open economy changes its desired savings or investment by x amount, current account doesn’t change by that exact x amount (as is the case in a small open economy)
  • Current account balance in country 1 is the negative CA balance of country 2