Unit 5 - The Macroeconomics of Open Economics

Question 1

Benefits of being Open International Trade

Answer 1

Trade allows people to produce what they produce best and to consume the great variety of goods and services produced around the world.

Question 2

What is a Closed Economy

Answer 2

an economy that does not interact with other economies in the world

Question 3

What is a Open Economy

Answer 3

an economy that interacts freely with other economies around the world

Question 4

How does an Open Economy interact with other economies?

Answer 4

Buys and sells goods and services in world product markets.

Buys and sells capital assets such as stocks and bonds in world financial markets.

Question 5

Exports

Answer 5

are domestically produced goods and services that are sold abroad

Question 6

Imports

Answer 6

are foreign-produced goods and services that are sold domestically

Question 7

Net Exports

Answer 7

the value of a nation’s exports minus the value of its imports; also called the trade balance

net exports tell us whether a country is, in total, a seller or a buyer in world markets for goods and services

Net Exports = Value of country’s exports - Value of country’s imports

Question 8

Trade Balance

Answer 8

the value of a nation’s exports minus the value of its imports; also called net exports

Question 9

T or F

If net exports are positive, exports are greater than imports, indicating that the country sells more goods and services abroad than it buys from other countries

Answer 9

True

Question 10

Trade Surplus

Answer 10

an excess of exports over imports

Question 11

T or F

If net exports are negative, exports are less than imports, indicating that the country sells fewer goods and services abroad than it buys from other countries.

Answer 11

True

Question 12

Trade Deficit

Answer 12

an excess of imports over exports

Question 13

T or F

If net exports are zero, its exports and imports are exactly equal, and the country is said to have balanced trade.

Answer 13

True

Question 14

Balanced Trade

Answer 14

A situation in which exports equal imports

Question 15

Factors that might influence a country’s exports, imports, and net exports.

Answer 15

-tastes of consumers for domestic and foreign goods

-prices of goods at home and abroad

-exchange rates at which people can use domestic currency to buy

-foreign currencies

-incomes of consumers at home and abroad

-cost of transporting goods from country to country

-government policies toward international trade

Question 16

T or F

Technological progress has also fostered international trade by changing the kinds of goods that economies produce.

Answer 16

True

Question 17

T or F

The Canada–U.S. Auto Pact, signed in 1965, made it possible for automobile manufacturers to move auto parts and finished automobiles across the Canada–U.S. border without having to pay import duties.

Answer 17

True

Question 18

T or F

International agreements, such as NAFTA and those negotiated with the World Trade Organization, have gradually lowered tariffs, import quotas, and other trade barriers.

Answer 18

True

Question 19

Net Capital Outflow

Answer 19

the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners

Net Capital Outflow = Purchase of foreign assets by domestic residents - Purchase of domestic assets by foreigners

Question 20

T or F

The imposition of trade barriers makes such specialization harder and, as described in the following newspaper article, may lead to higher costs of production and, ultimately, higher prices for consumers.

Answer 20

True

Question 21

T or F

When a Canadian buys stock in Telmex, the Mexican phone company, the purchase raises Canadian net capital outflow. When a Japanese resident buys a bond issued by the Canadian government, the purchase reduces Canadian net capital outflow.

Answer 21

True

Question 22

If Tim Hortons opens a fast-food outlet in Russia, that is an example of

Answer 22

foreign direct investment

Question 23

if a Canadian buys stock in a Russian corporation, that is an example of

Answer 23

foreign portfolio investment

Question 24

T or F

Canadian residents are buying assets located in another country, so both purchases increase Canadian net capital outflow.

Answer 24

True

Question 25

T or F

When the Net Capital Outflow is positive, domestic residents are buying more foreign assets than foreigners are buying domestic assets.

Answer 25

True

Question 26

T or F

When the net capital outflow is negative, domestic residents are buying less foreign assets than foreigners are buying domestic assets.

Answer 26

True

Question 27

T or F

when net capital outflow is negative, a country is experiencing a capital inflow.

Answer 27

True

Question 28

T or F

Net exports measure an imbalance between a country’s exports and its imports

Answer 28

True

Question 29

T or F

Net capital outflow measures an imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners

Answer 29

True

Question 30

T or F

Net Capital Outflow always = Net Exports
NCO = NX

Answer 30

True

Question 31

identity

Answer 31

an equation that must hold because of the way the variables in the equation are defined and measured.

Question 32

Current Balance

Answer 32

= Net exports + Net inflow of dividends and interest payments

the current account balance measures payments received from abroad in exchange for goods and services—including interest and dividend payments—minus analogous payments made to foreigners

Question 33

T or F

all saving in the Canadian economy shows up as investment in the Canadian economy or as Canadian net capital outflow.

Answer 33

True

Question 34

Positive Net Capital Outflow

Answer 34

indicating that the nation is using some of its saving to buy assets abroad

Question 35

Net Capital Outflow is Negative

Answer 35

indicating that foreigners are financing some of this investment by purchasing domestic assets.

Question 36

Nominal Exchange Rate

Answer 36

the rate at which a person can trade the currency of one country for the currency of another

Question 37

Appreciation

Answer 37

an increase in the value of a currency as measured by the amount of foreign currency it can buy

Question 38

Depreciation

Answer 38

a decrease in the value of a currency as measured by the amount of foreign currency it can buy

Question 39

T or F

When a currency appreciates, it is said to strengthen because it can then buy more foreign currency

Answer 39

True

Question 40

T or F

when a currency depreciates, it is said to weaken because it can then buy fewer units of foreign currency.

Answer 40

True

Question 41

T or F

when economists talk about the dollar appreciating or depreciating, they often are referring to an exchange rate index that takes into account many individual exchange rates.

Answer 41

True

Question 42

T or F

The Canadian-dollar effective exchange-rate index (CERI) is a weighted average of the exchange rates between the Canadian dollar and the currencies of Canada’s major trading partners.

Answer 42

True

The index is currently based on six foreign currencies: the U.S. dollar, the European Union euro, the Japanese yen, the U.K. pound, the Chinese yuan, and the Mexican peso.

Question 43

Real Exchange Rate

Answer 43

the rate at which a person can trade the goods and services of one country for the goods and services of another

Real Exchange Rate = Nominal Exchange Rate X Domestic Price / Foreign Price

Using Price Indexing:
Real Exchange Rate = (e x P) / P*

This real exchange rate measures the price of a basket of goods and services available domestically relative to a basket of goods and services available abroad.

e = Canadian Dollar and foreign currencies

Question 44

T or F

the real exchange rate is a key determinant of how much a country exports and imports.

Answer 44

True

Question 45

T or F

If you decide where to vacation by comparing costs, you are basing your decision on the real exchange rate.

Answer 45

T

Question 46

Purchasing Power Parity

Answer 46

a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries

Question 47

Law of One Price

Answer 47

This law asserts that a good must sell for the same price in all locations.

Question 48

Arbitrage

Answer 48

The process of taking advantage of differences in prices in different markets

Question 49

Small Open Economy

Answer 49

an economy that trades goods and services with other economies and, by itself, has a negligible effect on world prices and interest rates

Question 50

Perfect Capital Mobility

Answer 50

full access to world financial markets

r=rw

Question 51

Interest Rate Parity

Answer 51

a theory of interest rate determination whereby the real interest rate on comparable financial assets should be the same in all economies with full access to world financial markets

Question 52

T or F

a theory of interest rate determination whereby the real interest rate on comparable financial assets should be the same in all economies with full access to world financial markets

Answer 52

True

Question 53

T or F

An economy’s saving can be used either to finance investment at home or to buy assets abroad. Thus, national saving equals domestic investment plus net capital outflow.

Answer 53

True

Question 54

T or F

The nominal exchange rate is the relative price of the currency of two countries, and the real exchange rate is the relative price of the goods and services of two countries. When the nominal exchange rate changes so that each dollar buys more foreign currency, the dollar is said to appreciate or strengthen. When the nominal exchange rate changes so that each dollar buys less foreign currency, the dollar is said to depreciate or weaken.

Answer 54

T

Question 55

T or F

According to the theory of purchasing-power parity, a dollar (or a unit of any other currency) should be able to buy the same quantity of goods in all countries. This theory implies that the nominal exchange rate between the currencies of two countries should reflect the price levels in those countries. As a result, countries with relatively high inflation should have depreciating currencies, and countries with relatively low inflation should have appreciating currencies.

Answer 55

T

Question 56

T or F

Most economists prefer to use a model that describes Canada as a small open economy with perfect capital mobility. In such economies, interest rate parity is expected to hold. Interest rate parity is a theory that predicts interest rates in Canada will equal those in the rest of the world. Due to differences in tax rates and concerns about default risk, interest rates in Canada are not expected to exactly equal those in the rest of the world, but we do expect Canadian interest rates to rise and fall with increases and decreases in world interest rates.

Answer 56

T