18. Consider a small open economy that is currently experiencing a balanced current account. Suppose that the government, that until now had been running a balanced budget, runs a budget deficit by increasing government expenditure. In other words, before G = T¯ but now G > T¯.
a. Keeping Consumption and Investment constant, how will this increase in G affect domestic savings and net exports (current account)? Keeping Consumption and Investment constant: Domestic savings S = Y ? C ? G would decrease and Net Exports S = I + NX would decrease as well.
b. Is this an example of the Twin Deficits? Yes, starting from a balanced budget and a balanced current account, the budget deficit following an increase in G would be paired with a current account deficit
c. Suppose that forward-looking households, that wish to smooth their consumption over time, are concerned that their taxes will be increased in the future to pay for the debt accumulated by the government, and increase their private savings as soon as the government increases G. What would be the likely effect on net exports in this case, when compared to part (a)? Households would decrease C and increase private savings S P to offset the decrease in public savings. If they decrease C by the same amount as G increases, NX would stay the same
19. Consider the real exchange rate e = E·P ? P , where E is the nominal exchange rate E=2e/$, P is the price level for domestic output in terms of the domestic currency and P ? is the price level for foreign output. Suppose that in the short-run both P and P ? are fixed and equal to 1.
a. Compute the real exchange rate. How many units of domestic GDP can be traded for one unit of foreign GDP?
b. If the nominal exchange rate E increases to 4, how does this change the number of domestic goods that can be exchanged for foreign goods?
c. How would this increase in the nominal exchange rate likely affect the relative price of domestic goods vs foreign goods and how would it impact domestic net exports?
20. Consider the data below for Germany. The full line represents the current account balance as % of GDP for Germany (left axis), while the dashed line represents the ratio of GNP to GDP (right axis).
a. Using Y = C + I + G + (X ? IM), provide one explanation that is consistent with the relationship between the Current Account Balance and the ratio of GNP to GDP for Germany. Different options: C/GDP decreases, G/GDP decreases, I/GDP decreases. Any of these would increase the current account balance. Given the current account surplus, Germany accumulates foreign assets (claims on foreign production). Therefore, the ratio of GNP to GDP rises above one after a few years.
b. [Bonus] Plot data for Germany and check if your hypothesis appears to hold.
21. What happens in case that the government increases government spending in the monetary model?
a. The income increases and interest rate down.
b. The income increases and interest rate up.
c. The income decreases.
d. The domestic interest rate increases, which leads to an interest rate induced crowding out effect.
e. The domestic interest rate decreases.
f. The domestic goods price level increases.
g. None of the former answers is correct.
22. When we work in the diagram of the monetary model, we put the following variables on the axes:
a. e, m, y
b. e, p, y
c. m, p, y
d. E, Y
e. None of the former answers is correct
23. Suppose there are two goods, wheat and wood, that are produced in countries A and B. If country A has comparative advantage in wheat then
a. it produces wheat using less resources than country B.
b. it produces wheat and wood using less resources than country B.
c. it produces wood using less resources than it uses to produce wheat.
d. none of the former answers is correct.
24. According to the Heckscher-Ohlin theorem, in a world with 2 countries, 2 goods and 2 factors of production, a country will export
a. the good that uses less total resources to be produced.
b. the good that uses relatively intensively its relatively abundant factor of production.
c. the good that uses relatively intensively the relatively scarce factor of production.
d. the good with the highest price in international markets.
25. The opening of China, India and the former Soviet bloc in the 1980s and 1990s meant that the world economy faced for a while an ‘unlimited supply of labor’ at wages not far from the subsistence level. According to the Stolper-Samuelson Theorem, in capital abundant countries like Germany, this would have:
a. increased wages for labor and decreased rents for capital.
b. increased rents for capital and decreased wages for labor.
c. increased both rents for capital and wages for labor.
d. decreased both rents for capital and wages for labor
26. Which statement is WRONG related to an import tariff of the US against Mexico (large country case)?
a. The US producer surplus increases.
b. The US consumer surplus decreases.
c. The US government is able to generate revenues.
d. The overall welfare in the US definitely decreases.
e. The world market price decreases
27. Which statement is WRONG related to an import tariff of the US against Mexico (small country case)?
a. The producer surplus increases.
b. The consumer surplus decreases.
c. The government is able to generate revenues.
d. The overall welfare definitely decreases.
e. The world market price decreases.
28. Which statement is WRONG related to an export subsidy of China (small country case)?
a. The producer surplus increases.
b. The government is able to generate revenues.
c. The overall welfare decreases.
d. The world market price stays constant.
e. None of the former answers is correct
29. Consider the following article published in the Star Tribune on August 17, 2019 about the Trump tariffs (’Trade war has already added 5% to typical U.S. shopping basket’): Yet protective tariffs meant to hurt the Chinese ’typically’ raised import costs to U.S. businesses by 10% to 30%, Amiti, Redding and Weinstein found. Because those prices tracked with the size of the tariffs (10 to 25%), the researchers concluded that ’much of the tariffs were passed on to U.S. importers and consumers.’ Comparing these findings to the tariff models that we saw in class, they are consistent with the US being best represented as a:
a. Large Open Economy because import costs for businesses increased considerably less than the size of the tariffs.
b. Small Open Economy because import costs for businesses increased considerably less than the size of the tariffs.
c. Large Open Economy because import costs for businesses increased about the same as the size of the tariffs.
d. Small Open Economy because import costs for businesses increased about the same as the size of the tariffs