11) Using the DD -AA framework, show the phenomenon of overshooting. Use a figure to explain when it is
taking place.
Answer: The figure below shows the phenomenon of overshooting. A permanent increase in the money supply
starting from full employment equilibrium will shift the AA curve to the right from AA1 to AA2. Now,
a steadily increasing price level shifts the AA and the DD schedules to the left until a new long-run equilibrium is reached. Note that point 3 is above point 1, because Ee is permanently higher after a permanent increase in the money supply. The expected exchange rate, Ee, has risen by the same percentage as Ms. Notice that along the adjustment path between the initial short-run equilibrium (point 2) and the long-run equilibrium (point 3) the domestic currency actually appreciates (from E2 to E3) following its initial sharp depreciation (from E1 to E2). This exchange rate behavior is an example of overshooting, in which the exchange rate's initial response to some change is greater than its long-run response.
Question Status: Previous Edition
12) Demonstrate how a permanent fiscal expansion will not increase output in the long run. Answer: (1) E on Y-axis, Y on X-axis
(2) DD shifts right
(3) temporary equilibrium where E lower and Y increased
(4) permanent increase in demand caused by increase in G causes currency to appreciate: AA shifts left
(5) therefore Y returns to original levels, E decreases even more
RESULT of permanent fiscal expansion: currency appreciation, output does not change. This effect is called \
Question Status: Previous Edition
13) Show the effects of a permanent increase in the money supply.
Answer: (1) AA-shifts right-increase in Y and E both higher than if money supply change was temporary
rising price level makes AD decrease, DD shifts left
(2) rising prices also reduce real money supply, so AA shifts left (although not all the way back to original position)
(3) AA and DD reach short run equilibrium at an E that is higher than initially, but lower than the short run effects of the shift.
(4) Output returns to initial level because higher prices reversed the effect of the initial depreciation on Aggregate Demand.
Question Status: Previous Edition
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14) Using the DD model, explain what happens to out put when Government demands increase. Use a figure to
explain when it is taking place.
Answer: The figure below shows the G 1 to G2 raises output at every level of the exchange rate. The change
shifts the DD to the right. Which in turns increases output to Y2.
Question Status: Previous Edition
16.10 Macroeconomic Policies and the Current Account
1) Which of the following are true in terms of the current account balance?
A) Monetary expansion increases the current account balance.
B) Monetary expansion decreases the current account balance.
C) Fiscal expansion increases the current account balance.
D) Fiscal expansion decreases the current account balance.
E) Both A and D.
Answer: E
Question Status: Previous Edition
2) In the short run:
A) monetary expansion causes the CA increase & fiscal expansion causes the CA to decrease.
B) monetary expansion causes the CA to decrease & fiscal expansion causes the CA to decrease.
C) monetary expansion causes the CA to increase & fiscal expansion causes the CA to increase.
D) monetary expansion causes the CA to decrease & fiscal expansion causes the CA to increase.
E) monetary expansion causes the CA to increase & the effects of fiscal expansion are ambiguous.
Answer: A
Question Status: Previous Edition
3) Which statement best describes the current account balance in the short run?
A) Monetary expansion lowers the current account balance.
B) Monetary expansion keeps the current account balance the same.
C) Fiscal expansion increases the current account balance.
D) Fiscal expansion keeps the current account balance the same.
E) Monetary expansion increases the current account balance.
Answer: E
Question Status: Previous Edition
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16.11 Gradual Trade Flow Adjustment and Current Account Dynamics
1) According to historical data, what is the effect of a sharp change in the current account on the exchange rate
(both in the short and long run)?
A) At first, home currency will depreciate as CA balance falls, but over time, currency will begin to
depreciate.
B) At first, home currency will appreciate as CA balance falls, but over time, currency will begin to
depreciate.
C) At first, home currency will appreciate as CA balance rises, but over time, currency will begin to
depreciate.
D) At first, home currency will depreciate as CA balance falls, but over time, currency will begin to
appreciate.
E) None of the above.
Answer: B
Question Status: Previous Edition
2) Which two time periods did the U.S. begin to experience a sharp increase in Current Account deficits?
A) 1981, mid -1990s B) 1971, mid -1990s C) 1961, mid -1990s D) 1971, mid -1980s E) None of the above.
Answer: A
Question Status: New
3) The J -curve illustrates which of the following?
A) the effects of depreciation on the home country's economy
B) the immediate increase in current account caused by a currency depreciation
C) the gradual adjustment of home prices to a currency depreciation
D) the short -term effects of depreciation on the current account E) the Keynesian view of international trade dynamics
Answer: D
Question Status: Previous Edition
4) The Marshall -Lerner Condition states that, all else equal,
A) nominal appreciation improves the current account if export and import volumes are sufficiently elastic
with respect to the real exchange rate.
B) real depreciation improves the current account if export and import volumes are sufficiently inelastic
with respect to the real exchange rate.
C) real appreciation improves the current account if export and import volumes are sufficiently elastic
with respect to the real exchange rate.
D) real depreciation improves the current account if export and import volumes are sufficiently elastic
with respect to the real exchange rate.
E) the sum of import and export elasticities must be equal to one in order for depreciation to occur.
Answer: D
Question Status: Previous Edition
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5) The percent by which import prices rise when the home currency depreciates by 1% is the degree of
A) pass -forward from exchange rates to import prices. B) pass -through from exchange rates to import prices. C) pass -on from exchange rates to import prices. D) roll -forward from exchange rates to import prices. E) None of the above.
Answer: B
Question Status: New
6) In practice, many U.S. import prices tend to rise by only around
A) 1/4 of a typical dollar depreciation over the following year
B) 1/3 of a typical dollar depreciation over the following year
C) 1/2 of a typical dollar depreciation over the following year
D) 2/3 of a typical dollar depreciation over the following year
E) None of the above.
Answer: C
Question Status: New
7) Describe what is a J Curve?
Answer: The time lag with which real currency depreciation improves the current account. The current account
is measured in terms of domestic output, and can drop quickly right after real currency depreciation because most import and export orders are placed several months in advance. In the first few months after the depreciation, export and import volumes therefore may reflect buying decisions that were made on the basis of the old real exchange rate.
Question Status: Previous Edition
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