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PS - Chapter 31

This document provides information about open-economy macroeconomics concepts including how various transactions would affect exports, imports, net exports, and net capital outflow. It also discusses the differences between foreign direct investment and foreign portfolio investment. Additional topics covered include real exchange rates, purchasing power parity, and the relationship between inflation, exchange rates, and interest rates in different countries.

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Minh Anh
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577 views3 pages

PS - Chapter 31

This document provides information about open-economy macroeconomics concepts including how various transactions would affect exports, imports, net exports, and net capital outflow. It also discusses the differences between foreign direct investment and foreign portfolio investment. Additional topics covered include real exchange rates, purchasing power parity, and the relationship between inflation, exchange rates, and interest rates in different countries.

Uploaded by

Minh Anh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Chapter 31/Open-Economy Macroeconomics: Basic Concepts

1. How would the following transactions affect U.S. exports, imports, and net exports?
a. An American art professor spends the summer touring museums in Europe.
b. Students in Paris flock to see the latest movie from Hollywood.
c. Your uncle buys a new Volvo.
d. The student bookstore at Oxford University in England sells a pair of Levi’s 501 jeans.
e. A Canadian citizen shops at a store in northern Vermont to avoid Canadian sales taxes.

2. Would each of the following transactions be included in net exports or net capital outflow?
Be sure to say whether it would represent an increase or a decrease in that variable.
a. An American buys a Sony TV.
b. An American buys a share of Sony stock.
c. The Sony pension fund buys a bond from the U.S. Treasury.
d. A worker at a Sony plant in Japan buys some Georgia peaches from an American farmer.

3. Describe the difference between foreign direct investment and foreign portfolio
investment. Who is more likely to engage in foreign direct investment—a corporation or an
individual investor? Who is more likely to engage in foreign portfolio investment?

4. How would the following transactions affect U.S. net capital outflow? Also, state whether
each involves direct investment or portfolio investment.
a. An American cellular phone company establishes an office in the Czech Republic.
b. Harrods of London sells stock to the General Electric pension fund.
c. Honda expands its factory in Marysville, Ohio.
d. A Fidelity mutual fund sells its Volkswagen stock to a French investor.

5. The business section of most major newspapers contains a table showing U.S. exchange
rates. Find such a table in a paper or online and use it to answer the following questions.
a. Does this table show nominal or real exchange rates? Explain.
b. What are the exchange rates between the United States and Canada and between the United
States and Japan? Calculate the exchange rate between Canada and Japan.
c. If U.S. inflation exceeds Japanese inflation over the next year, would you expect the U.S.
dollar to appreciate or depreciate relative to the Japanese yen?

6. Would each of the following groups be happy or unhappy if the U.S. dollar appreciated?
Explain.
a. Dutch pension funds holding U.S. government bonds
b. U.S. manufacturing industries
c. Australian tourists planning a trip to the United States
d. An American firm trying to purchase property overseas

7. What is happening to the U.S. real exchange rate in each of the following situations?
Explain.
a. The U.S. nominal exchange rate is unchanged, but prices rise faster in the United States
than abroad.
b. The U.S. nominal exchange rate is unchanged, but prices rise faster abroad than in the
United States.
c. The U.S. nominal exchange rate declines, and prices are unchanged in the United States
and abroad.
d. The U.S. nominal exchange rate declines, and prices rise faster abroad than in the United
States.

8. A can of soda costs $0.75 in the United States and 12 pesos in Mexico. What would the
eso-dollar exchange rate be if purchasing-power parity holds? If a monetary expansion
caused all prices in Mexico to double, so that soda rose to 24 pesos, what would happen to
the peso-dollar exchange rate?

9. Assume that American rice sells for $100 per bushel, Japanese rice sells for 16,000 yen per
bushel, and the nominal exchange rate is 80 yen per dollar.
a. Explain how you could make a profit from this situation. What would be your profit per
bushel of rice? If other people exploit the same opportunity, what would happen to the price
of rice in Japan and the price of rice in the United States?
b. Suppose that rice is the only commodity in the world. What would happen to the real
exchange rate between the United States and Japan?

10. A case study in the chapter analyzed purchasingpower parity for several countries using
the price of Big Macs. Here are data for a few more countries:
a. For each country, compute the predicted exchange rate of the local currency per U.S.
dollar. (Recall that the U.S. price of a Big Mac was $3.57.)
b. According to purchasing-power parity, what is the predicted exchange rate between the
Hungarian forint and the Canadian dollar? What is the actual exchange rate?
c. How well does the theory of purchasingpower parity explain exchange rates?

11. Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the
only commodity is Spam.
a. In 2000 a can of Spam costs 2 dollars in Ectenia and 6 pesos in Wiknam. What is the
exchange rate between Ectenian dollars and Wiknamian pesos?
b. Over the next 20 years, inflation is 3.5 percent per year in Ectenia and 7 percent per year in
Wiknam. What will happen over this period to the price of Spam and the exchange rate?
(Hint: Recall the rule of 70 from Chapter
c. Which of these two nations will likely have a higher nominal interest rate? Why?
d. A friend of yours suggests a get-rich-quick scheme: Borrow from the nation with the lower
nominal interest rate, invest in the nation with the higher nominal interest rate, and profit
from the interest-rate differential. Do you see any potential problems with this idea? Explain.

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