26) What is the real exchange rate? What is its relationship to the current account?
Answer: Defined as: EP ?/P (the exchange rate multiplied by foreign prices, divided by domestic prices).
While the nominal exchange rate measures how much of a foreign currency one can buy with a unit of domestic currency, the real exchange rate measures how many goods and services one could buy. A rise in the real exchange rate (a depreciation of domestic currency) means that domestic goods are cheaper compared to foreign goods, so exports increase and imports decrease. Aggregate demand increases and the CA rises. A fall in the real exchange rate has the opposite effect: Aggregate demand decreases and the CA falls.
Question Status: Previous Edition
27) Monetary expansion causes the current account balance to increase in the short run . Discuss. Is the same the case for fiscal expansion?
Answer: Am increase in the money supply leads to an increase in Y and E (output increases and the currency
depreciates, respectively). Because of the currency depreciation, domestic goods are now cheaper compared to foreign goods. Exports increase and imports decrease, therefore the CAB increases.
An expansion of fiscal policy actually reduces the CAB: the DD curve is shifted right. Therefore Y rises, but E falls (output rises but the currency appreciates.) Domestic goods are more expensive, and the CAB falls.
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28) Find the real exchange rate for the following case: Assume that the representative basket of European goods
and services costs 40 euros and the representative U.S. basket costs $50, and the dollar/euro exchange rate is $0.90 per euro, then the price of the European basket in terms of U.S. basket is ________. Answer: [(0.9 $/euro) (40 euro per a European basket)]/[(50 $/U.S. basket)]
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29) Find the real exchange rate for the following case: Assume that the representative basket of European goods
costs 150 euros and the representative U.S. basket costs $90, and the dollar/euro exchange rate is $0.80 per euro, then the price of the European basket in terms of U.S. basket is:
Answer: [(0.80 $/euro) (150 euro per a European basket)]/[(90 $/U.S. basket)] = 1.33 U.S. baskets/European
basket.
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30) Find the real exchange rate for the following case: Assume that the representative basket of European goods
costs 150 euros and the representative U.S. basket costs $200, and the dollar/euro exchange rate is $1.20 per euro, then the price of the European basket in terms of U.S. basket is:
Answer: [(1.20 $/euro) (150 euro per a European basket)]/[(200 $/U.S. basket)] = 0.9 U.S. baskets/European
basket.
Question Status: Previous Edition
31) Find the real exchange rate for the following case: Assume that the representative basket of European goods
costs 100 euros and the representative U.S. basket costs $125, and the dollar/euro exchange rate is $0.75 per euro, then the price of the European basket in terms of U.S. basket is:
Answer: [(0.75 $/euro) (100 euro per a European basket)]/[(125 $/U.S. basket)] = 0.60 U.S. baskets/European
basket.
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32) Fill in the following table:
Answer:
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33) Fill in the following table
Answer:
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16.2 The Equation of Aggregate Demand
1) How does a rise in real income affect aggregate demand?
A) Y ↑ implies Yd ↑ implies Im ↑ implies CA ↓ implies AD ↓, but Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ by more B) Y ↑ implies Yd ↑ implies Im ↓ implies CA ↓ implies AD ↓, but Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ by more C) Y ↑ implies Yd ↑ implies Im ↑ implies CA ↑ implies AD ↑, and Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ D) Y ↑implies Yd ↑ implies Im ↑ implies CA ↓ implies AD ↓, but Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ by less E) Y ↑ implies Yd ↑ implies Im ↓ implies CA ↓ implies AD ↓, but Y ↑ implies Yd ↑ implies C ↑ implies AD ↑ by less Answer: A
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2) Which one of the following statements is the most accurate?
A) A rise in domestic real income raises aggregate demand for home output.
B) A rise in domestic real income decreases aggregate demand for home output because of the increase
demand for import.
C) A rise in domestic real income keeps aggregate demand for home output at the same level.
D) It is difficult to tell whether a rise in domestic real income affects positively or negatively aggregate
demand for home output. E) None of the above.
Answer: A
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3) The aggregate demand for home input can be written as a function of: I. Real exchange rate. II. Government spending. III. Disposable income. A) I only
B) III only
C) I and III
D) II and III
E) I, II, and III
Answer: E
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4) What is an accurate implication resulting from an increase in income?
A) an increase in exchange rate
B) a decrease in exchange rate
C) a decrease in consumption
D) a decrease in output
E) an increase in consumption
Answer: E
Question Status: Previous Edition
5) Explain how does a rise in real income affect aggregate demand?
Answer: A rise in domestic real income, Y, leads to a rise in disposable income, Yd. This raises the spending on
imports, IM, thus lowering the current account, CA, and reducing aggregate demand, AD. However, the rise in Yd also causes a rise in consumption, C, and raises aggregate demand, AD, by more than the corresponding decrease.
Question Status: Previous Edition
6) Explain the difference between the following two expressions: Y = C(Yd) + I + G + CA(EP?/P, Yd) and
Y = C + I +G + CA
Answer: The first one represents a behavioral equation and thus may express equilibrium condition for the
output market or the aggregate desired demand for output. The second equation is only an identity that is always true.
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16.3 How Output is Determined in the Short Run
1) Which one of the following statements is most accurate?
A) Factors of production can only be over -employed in the short run. B) Factors of production can only be under -employed in the short run. C) Factors of production can be over - or under-employed in the long run. D) Factors of production can be over - or under-employed in the short run. E) None of the above.
Answer: D
Question Status: Previous Edition
2) In the short -run, any rise in the real exchange rate, EP?/P, will cause
A) an upward shift in the aggregate demand function and a reduction in output
B) an upward shift in the aggregate demand function and an expansion of output
C) a downward shift in the aggregate demand function and an expansion of output
D) an downward shift in the aggregate demand function and a reduction in output
E) an upward shift in the aggregate demand function but leaves output intact
Answer: B
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3) In the short -run, any fall in EP?/P, regardless of its causes, will cause
A) an upward shift in the aggregate demand function and an expansion of output
B) an upward shift in the aggregate demand function and a reduction in output
C) a downward shift in the aggregate demand function and an expansion of output
D) an downward shift in the aggregate demand function and a reduction in output
E) an upward shift in the aggregate demand function but leaves output intact
Answer: D
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4) The unique output level in the short -run is found at the intersection of the following curves: A) aggregate demand and aggregate supply
B) aggregate demand and 45 degree line
C) aggregate supply and 45 degree line
D) aggregate demand and short -run aggregate supply E) None of the above.
Answer: B
Question Status: New
5) Why is the economy at full employment in the long run?
A) Only wages have the ability to adjust.
B) Only price can adjust.
C) Prices don't adjust.
D) Wages and the price level eventually adjust to develop full employment.
E) Wages don't adjust.
Answer: D
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