Chapter 18

Question 1

What is the balance of trade

Answer 1

The value of exports minus the value of imports

Question 2

What is a trade deficit

Answer 2

When a country imports more than it exports so there is a negative balance of trade

Question 3

What is trade surplus

Answer 3

When a country exports more than it imports so its balance of trade is positive

Question 4

What are Canada’s major trading partners

Answer 4

1. The US
2. European Union
3. China

Question 5

What is foreign direct investment (FDI)

Answer 5

When a firm runs part of its operation abroad or invests in another company abroad

Question 6

What is foreign portfolio investment

Answer 6

Investment funded by foreign sources but operated domestically

Question 7

What is net capital flow

Answer 7

The net flow of funds invested outside of a country (the difference between capital inflows and capital outflows)

Question 8

What are capital outflows

Answer 8

Investments financed by savings from another country

Question 9

What is balance of payments identity

Answer 9

An equation that shows that the value of net exports equals net capital outflow

Question 10

What is the equation for the income expenditure identity

Answer 10

Y = C + I + G + NX

Question 11

What is net capital outflow

Answer 11

(NCO = NX)

Allows countries to sustain trade imbalances for long periods of time

Question 12

What does balance of payments identity tell us

Answer 12

That the net capital outflow of a country equals the value of its net exports

Question 13

How do higher outflows and lower inflows push net outflows

Answer 13

Higher

Question 14

How do lower outflows and higher inflows push net outflows

Answer 14

Lower

Question 15

What 3 things can foreign investment do

Answer 15

• increase the GDP of the host country by giving it access to additional resources
• increase the GDP of investing country by providing it with way to earn higher returns on its capital
• make the world a more efficient place by moving capital from places with low returns to places with high returns

Question 16

What is the exchange rate

Answer 16

The value of one currency expressed in terms of another currency

When examining the exchange rates between two nations currencies, the exchange rates will be reciprocals

Question 17

What is exchange rate appreciation

Answer 17

When the value of a currency increases relative to the value of another currency

Question 18

What is the effect of an increase in the government deficit

Answer 18

When the government spends more than it collects in revenue, it has to borrow money

This pushes the savings curve left, which results in an increase in the interest rate and lower quality investment

Question 19

What is exchange-rate depreciation

Answer 19

When the value of a currency decreases relative to other currencies

When a currency depreciates to can “buy” less of another currency

Question 20

What happens when the Canadian dollar appreciates against a foreign currency

Answer 20

Canadian goods become more expensive to people abroad and foreign goods become cheaper to Canadians. As a result we would expect net exports to decrease, trade deficit rises.

Question 21

What happens when the Canadian dollar depreciates against a foreign currency

Answer 21

Foreign goods become more expensive for Canadians and Canadian goods become cheaper for consumers. We would expect net exports to increase, trade deficit decreases.

Question 22

What 3 variables determine the supply & demand for a countries currency

Answer 22

1. Consumer Preferences
2. Interest rates
3. Perceived risk of investing in that country vs another country (confidence)

Question 23

What happens to supply & demand of dollars when the exchange rate increases

Answer 23

The quantity supplied of dollars increases and the quantity demanded of dollars increases

Question 24

What two ways does monetary police work on aggregate demand

Answer 24

Reducing investment and reducing net exports

Question 25

What is a floating exchange rate

Answer 25

Countries whose currency is determined by the market and currency can be freely traded

Question 26

What is the difference between floating vs fixed exchange rates

Answer 26

Floating: the market for foreign exchange will operate at the equilibrium pice and quantity

Fixed: excess demand for currency, which the government must cover by buying foreign currencies and selling local currency

Question 27

What is a fixed exchange rate

Answer 27

An exchange rate that is set by the government instead of determined by the market

Question 28

What is a speculative attack

Answer 28

When investors make profit by selling currency at a high price and then buy it back at a low price

When a country suffers a speculative attack, the supply of currency available shifts right

Question 29

What is one key point of a fixed exchange rate

Answer 29

It is impossible to conduct monetary policy and maintain a fixed exchange rate

Question 30

What is the nominal exchange rate

Answer 30

The stated rate at which one country’s currency can be traded for another country’s currency

Question 31

What is the real exchange rate

Answer 31

It expresses the value of goods in one country in terms of the same goods in another country

Question 32

How do you calculate real exchange rate

Answer 32

Real exchange rate = nominal exchange rate x (domestic price level/ foreign price level)

Question 33

What does the IMF do

Answer 33

It steps in as a lender of last resort, which makes loans to countries when private lenders flee