OPEN ECONOMY MACROECONOMICS

Question 1

What are the two main branches of economics that international economics draws from?

Answer 1

International economics is partly micro-economics and partly macro-economics

Question 2

Why is international economics considered partly micro-economics?

Answer 2

It addresses fundamental micro-economic questions such as: which products will be produced; by which methods; with which technology; and how the products will be shared among people.

Question 3

Why is international economics considered partly macro-economics?

Answer 3

It is a macro-economic issue because foreign spending is added when determining total spending in an economic system, alongside consumption, investment, and government expenditures.

Question 4

How does increased spending by foreigners impact a domestic economy?

Answer 4

If foreigners spend more on a country’s goods and services, total spending increases, leading to economic growth.

Question 5

Define international trade.

Answer 5

International trade can be defined as trade relation between a country and the rest of the world, or the exchange of capital, goods, and services across international borders or territories

Question 6

Are the reasons for international trade different from the reasons individuals trade within a country?

Answer 6

: No, the reasons for trade between countries are not in any way different from the reasons individuals trade within a country. International trade is essentially trade between individuals who live in different countries.

Question 7

How do imports serve domestic industry?

Answer 7

Imports are crucial for domestic industries as they meet the need for basic raw materials, machinery, and other essential requirements that may not be available domestically

Question 8

What benefit do imports provide to domestic consumers?

Answer 8

International trade enlarges the range of consumers’ choices of goods and services. Without it, consumers would have fewer options

Question 9

Why are exports vital to many domestic producers?

Answer 9

The market for a nation’s exports is very important because without international trade, the market for domestically produced goods would be limited to the domestic economy

Question 10

How do exports serve as a foreign exchange earner?

Answer 10

Exports of goods and services act as a foreign exchange earner for the domestic economy. Foreign exchange availability is essential for the survival of any national economy.

Question 11

How do exports act as an agent of growth for a domestic economy?

Answer 11

Demand from other countries for a domestic economy’s goods and services acts as a catalyst to the growth of total spending and, consequently, the Gross National Product (GNP).

Question 12

What is the Theory of Absolute Advantage?

Answer 12

According to Adam Smith, the basis of international trade lies in Absolute Advantage, which is the ability of a country to produce a good or service more efficiently or produce more than another country, or produce the same amount with fewer resources

Question 13

Who is the proponent of the Theory of Comparative Advantage?

Answer 13

David Ricardo propounded the theory of Comparative Advantage.

Question 14

What is the core principle of the Theory of Comparative Advantage?

Answer 14

A country should specialize in the production of a commodity or service in which it has a lower opportunity cost

Question 15

Define comparative disadvantage.

Answer 15

Comparative disadvantage is the situation where a country has a higher opportunity cost of producing a good or service

Question 16

Explain the concept of opportunity cost using the consultant example.

Answer 16

Spending time on one activity (typing, earning N4,000/hour) incurs an opportunity cost of the income forgone from another activity (consultancy, earning N15,000/hour). The rational choice is to focus on the activity with the lower opportunity cost.

Question 17

How does the consultant example relate to international trade?

Answer 17

Just as a consultant should focus on their lower opportunity cost activity, countries should produce and export goods and services that can be produced at a lower opportunity cost and import goods or services with a higher opportunity cost of production

Question 18

According to David Ricardo’s example, what determined the basis of trade between England and Portugal?

Answer 18

The basis of trade was the labor cost of producing wine and cloth in each country, illustrating the principle of comparative advantage.

Question 18

Is absolute advantage or comparative advantage the basis of trade according to David Ricardo?

Answer 18

Comparative advantage forms the basis of trade. Countries should specialize in and export goods where their opportunity cost is lower and import goods where their opportunity cost is higher

Question 19

What is the relationship between international trade and a world economy?

Answer 19

International trade gives rise to a world economy, where prices and supply and demand are affected by global events

Question 20

How does international trade affect consumer choice and prices?

Answer 20

International trade allows for expanded markets and greater competition, leading to more competitive prices and cheaper products for consumers.

Question 21

What are gains from trade?

Answer 21

Gains from trade are the net benefits to agents from allowing an increase in voluntary trading with each other. Technically, it’s the increase in consumer surplus plus producer surplus from trade liberalization.

Question 22

What are some common sources of gains from trade?

Answer 22

Gains from trade commonly result from specialization in production, division of labor, economies of scale and scope, agglomeration, and the relative availability of factor resources

Question 23

According to the law of comparative advantage, how do countries benefit from trade?

Answer 23

Countries benefit from trade with a rise in world output without additional factor inputs when they specialize in the production of goods in which their opportunity cost is lower

Question 24

What are terms of trade?

Answer 24

Terms of trade is basically expressed as a relationship between the unit price of a country's export to the unit price of the country's import.

Question 25

What determines the level of exports?

Answer 25

Exports depend on spending decisions made by foreign consumers or overseas firms purchasing domestic goods and services. These decisions are influenced by foreign income level, price level, taste, and fashion.

Question 26

What are the two components of import demand?

Answer 26

Import demand has two components: one that is fixed (exogenous), such as basic investment goods and raw materials, and one that varies with income.

Question 27

How are net exports related to national income/national output?

Answer 27

Net exports are negatively related to national income/national output because while exports are often exogenous, a part of imports increases with rising income

Question 28

How are international transactions typically paid for when goods are imported?

Answer 28

Importers typically need to purchase the imported goods with the currency of the foreign country from which the goods are bought, even if they pay in local currency in the local market

Question 29

Define exchange rate.

Answer 29

Exchange rate is the quantity of domestic currency that can be exchanged for a unit of foreign currency in order to allow international transactions.

Question 30

What is exchange rate appreciation?

Answer 30

Exchange rate appreciation is when the domestic currency falls in value relative to a foreign currency. (Note: This is likely a typo in the source, as a fall in exchange rate usually means the domestic currency has strengthened or appreciated. A rise in exchange rate usually indicates depreciation.)

Question 31

What is exchange rate depreciation?

Answer 31

Exchange rate depreciation is when the domestic currency rises in value relative to a foreign currency. (Note: This is likely a typo in the source, as a rise in exchange rate usually means the domestic currency has weakened or depreciated. A fall in exchange rate usually indicates appreciation.)

Question 32

How does exchange rate appreciation (domestic currency strengthening) affect import and export demand?

Answer 32

Appreciation of domestic currency makes imports cheaper and exports expensive.

Question 33

How does exchange rate depreciation (domestic currency weakening) affect import and export demand?

Answer 33

Depreciation of domestic currency makes exports cheaper and imports expensive

Question 34

How does a rise in the domestic price level relative to the foreign price level affect net exports?

Answer 34

A rise in the domestic price level causes net exports to fall because domestic goods become more expensive for foreigners, and imports become cheaper for domestic residents

Question 35

How does a fall in the domestic price level relative to the foreign price level affect net exports?

Answer 35

A fall in the domestic price level causes net exports to rise because domestic goods become cheaper for foreigners, and imports become more expensive for domestic residents

Question 36

What are the components of aggregate demand in an open economy?

Answer 36

Aggregate demand (AD) in an open economy is the sum of consumption (C), investment (I), government spending (G), and net exports (NX).

Question 37

How is equilibrium output determined in an open economy?

Answer 37

Equilibrium output is the level of output at which desired aggregate demand equals national output/income (AD = Y)

Question 38

According to the example, how can a positive net export impact the economy?

Answer 38

A positive net export (current account surplus) can be used to recover the economy from recession

Question 39

According to the example, how can a negative net export impact the economy?

Answer 39

: A negative net export (current account deficit) can also plunge the economy into recession

Question 40

What implications do exchange rate policy and inflation have on a domestic economy's output performance?

Answer 40

Exchange rate policy, domestic inflation, and foreign inflation have implications on the output performance of the domestic economy. For example, a rise in domestic inflation can lead to a fall in net exports and potentially a recession.

Question 41

Learn how to calculate equilibrium in the open economy pg 168

Answer 41

Solve multiple example