set 5

Principles of Macroeconomics Problem Set 5 Due on 9/28/2015

1. In an open economy, national savings equals domestic investment

A. plus the net outflow of capital abroad.

B. minus the net exports of goods and services abroad.

C. plus the government’s budget deficit.

D. minus foreign portfolio investment.

2. The theory of purchasing-power parity says that higher inflation in a nation causes the nation’s

currency to______, leaving the ______ exchange rate unchanged.

A. appreciate, nominal

B. appreciate, real

C. depreciate, nominal

D. depreciate, real

3. How would each of the following transactions affect 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.

4. 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 were to 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?

5. Holding other things constant, an increase in a nation’s interest rate reduces

A. national saving and domestic investment.

B. national saving and the net capital outflow.

C. domestic investment and the net capital outflow.

D. national saving only.

6. A civil war abroad causes foreign investors to seek a safe haven for their funds in the United

States, leading to ______ US interest rates and a _______ US dollar.

A. higher, weaker

B. higher, stronger

C. lower, weaker

D. lower, stronger

7. Suppose that Congress is considering an investment tax credit, which subsidizes domestic

investment.

A. How does this policy affect national saving, domestic investment, net capital outflow, the

interest rate, the exchange rate, and the trade balance?

B. Representatives of several large exporters oppose the policy. Why might that be the case?

8. Suppose that real interest rates increase across Europe. Explain how this development will

affect US net capital outflow. Then explain how it will affect US net exports. What will happen

to the US real interest rate and real exchange rate?