International Economics Final

 Distinguish the current account from the financial account.

Current account is goods and services. Financial account is assets (stocks, bonds, and property)

Explain how the current account balance *a*) equals net foreign investment (i.e. net capital outflow); (*b*) equals the difference between national saving and domestic investment; (*c*) equals the difference between domestic production (Y) and domestic expenditure (C + I + G).

Current account = Net exports

NX = Y – \[C+I+G\]

NX = National Saving – Investment

NX = Net Capital Outflow

NX = Net Foreign Investment

What transactions lead to a demand for (or supply of) a currency on the foreign exchange market? 

Exports and sale of assets lead to a demand for a country’s currency. Imports and purchase of assets lead to a supply of currency.

Distinguish a flexible exchange rate from a fixed exchange rate. 

A flexible rate is market determined. The government is not intervening. A fixed rate is when the government sets the rate. The government has to intervene (buy and sell) to keep that rate stable.

What is the relationship between two ways to quote the exchange rate between two currencies?

They are Reciprocals.

How would a central bank intervene directly in the forex market achieve a lower (higher) value of its currency?

To lower the value the central bank will add directly to the supply of the in the foreign market by selling. The central bank will intervene and buy its currency to get a higher value.

Distinguish hedging, speculation, and arbitrage.

Hedging is to reduce risk. Speculation is taking on risk and trying to profit. Arbitrage has no risk.

Explain locational (two-point) arbitrage and three-point arbitrage.

Two-Point Arbitrage - Two currencies trading at different rates in different markets.

Three-Point Arbitrage – Three currencies and three exchange rates. If you know two, you should be able to predict the third as an orderly cross rate.

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Explain the difference between the spot and forward markets.  Give an example when someone may wish to use the spot market; to use the forward market.

The spot market is for current delivery. (Could be up to two business days). Forward market is when you enter into the contract now, but you exercise it in the future. (Ex.30 days). You use the forward market to hedge (lock in the exchange rate today but exercise it in the future).

Suppose you work for a firm that has excess funds that the firm can lend in the U.S. or elsewhere.  Explain the transactions if you lent these funds in another country for a year under two scenarios: (*a*) you use only spot market transactions; (*b*) you use spot market and forward market transactions.  What is the risk associated with the first scenario that is not present in the second scenario? What about return possibilities under both scenarios?

a)     Today, we would go to the bank and convert dollars to bot. Buy a bot denominated asset. Asset would be there for a year and at the end of the year, we would get back the principle and the return. In one year, we could convert bot (return) back to dollars at the spot rate. 

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b)    Today, we would go to the bank and convert dollars to bot. Buy a bot denominated asset. Enter into a forward contract. Asset would be there for a year and at the end of the year, we would get back the principle and the return. In one year, we could convert bot (return) back to dollars at the forward rate that was locked in a year earlier. 

Explain the covered interest arbitrage parity condition?

Relationships between 4 variables. US interest rate (domestic). Foreign interest rate. Spot exchange rate. Forward exchange rate. Any gain in higher interest rates will be offset by the fact that the currency will be at a forward discount. All variables are related so they all equal out in the end.

What is a Eurocurrency?

Deposits in currencies other than the currency of the country accepting the deposit.

Explain how a change in the domestic interest rate should affect the value of the domestic currency on the foreign exchange market, all else equal.

US interest rates start to rise, initially will attract funds into the US. Raise the demand for the dollar on the foreign exchange market. Dollar will appreciate on foreign exchange markets.

In London, interest rates go down, investors will take pounds and sell them on the foreign exchange market. Increase supply of the pound. Causes a depreciation of the currency.  

How should a depreciation (or appreciation) affect a country’s exports of goods and services and imports of goods and services, all else equal?

If a counties currency depreciates, goods become cheaper to foreign buyer and their exports will rise. Imports will become more expensive and decrease.

If a counties currency appreciates, their exports will fall. Imports will become less expensive and rise.

How should a depreciation (or appreciation) affect a country’s inflation rate, all else equal?

Depreciation will tend to raise inflation. Appreciation will reduce inflation.

Distinguish the law of one price from relative purchasing power parity.  Give examples explaining each of the concepts.

Law of one Price - Take one good, if its identical, it should cost the same everywhere. (ex. Gas) Taxes, property value, demand, income can all impact prices.

How should a change in a country’s inflation rate affect the value of a country’s currency, all else equal.

Looks at the prices of all goods and services. Higher inflation – their goods become less attractive comparatively. High inflation leads to a drop in demand of goods. Currency will depreciation. Lower inflation leads to more attractive goods and the demand for their currency will go up. Currency will appreciate.

Currency Board

When a government changes its country’s current change rate to a different currency

Dollarization

When a country recognizes the dollar as a suitable currency for exchanging. This usually happens when a country's present currency loses its use as a means of exchange in market transactions. Doesn’t have to be a dollar, just a foreign currency to the country.

Adjustable Peg System

When a government establishes its country's exchange rate (a par value) and permits the rate to vary within a tight band. If the par value becomes unsustainable, the par value, along with the bands, will be changed. (pegged currency to the US dollar) (the US pegged our currency to gold)

Crawling Peg

When a currency is modified in modest amounts against another currency at pre-announced regular time intervals.

Managed Floating Exchange Rate

When government has the choice to either engage or not engage in the foreign exchange market.

Monetary Union

An international arrangement in which two or more countries share the same currency. A great example of this was the creation of the Euro.

 What are benefits and costs of the Euro?

These include: the ease with which prices can be compared between countries, which boosts competition between businesses, thereby benefiting consumers. price stability. the euro makes it easier, cheaper and safer for businesses to buy and sell within the euro area and to trade with the rest of the world.

Explain the operation of the Bretton Woods system, including the responsibility of the U.S.

Have some stability and not worry about major changes of exchange rates. Have a fixed rate, but some counties could make adjustments. Other counties tied their currency to the dollar. The US tied the dollar to gold. (1940- early 1970s)

What are purposes of the International Monetary Fund (IMF)?

Sets guidelines and rules for countries to follow. The goal is for developed counties to provide resources to developing counties.

Mali, a tropical country in western Africa, can produce snow sleds, but there is no domestic demand for them. Focusing on the market for snow sleds, Mali can gain from international trade because of

an increase in producer surplus

If the (MYR) exchange rate changes from $.25 per MYR to $.22 per MYR, the dollar has _______ __against the ringgit and the ringgit has__ ______ against the dollar.

appreciated; depreciated

Before Brexit, Great Britain used

the pound as domestic currency and was a member of the European Union

According to David Ricardo’s theory, it is not possible for a country engaged in international trade to have

a comparative advantage in all goods

According to David Ricardo’s theory, Chile which is in South America, will import transport equipment if it has a ______ __opportunity cost than its trading partners and export grapes if it has a__ ______ opportunity cost than its trading partners.

higher; lower

The US currently has a trade ______. Hence, the US is a net__ ______ of assets with respect to the rest of the world.

deficit, seller

China holds approximately 19% of the world’s population and about 10% of its farmable land. When Deng Xiaoping opened China to international trade in the late 1980s, China became a net _______ __of light manufactured goods, and populations in urban areas__ ___________.

exporter; increased

The Mercantilists advocated:

stimulating the nation’s exports

Consider a model of an economy with two goods (food and clothes) and two factors (land and labor) and that participates in international trade. Suppose there is an increase in the world demand for clothings and a decrease in the world demand for food. Production of clothing increases in the economy, and production of food declines in the economy.

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In the short run, when land and labor are immobile between industries,

Labor and landowners in the food industry loose while labor and landowners in the clothes industry gain.

Consider a model of an economy with two goods (food and clothes) and two factors (land and labor) and that participates in international trade. Suppose there is an increase in the world demand for clothings and a decrease in the world demand for food. Production of clothing increases in the economy, and production of food declines in the economy. 

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In the long run, when land and labor are mobile between industries, and considering the Stolper Samuelson Theorem:

All labor gains while all landowners lose

Major product categories can be broken down into primary products, manufactured products, and services. Countries can be broken down broadly as developed and developing. Data shows that relatively speaking,

Developing countries are large exporters of primary products and textile and clothing; developed countries are large exporters of services and chemicals.

A country has an endowment (total supply) of 10 units of labor and 2 units of land, whereas the rest of the world has 200 units of labor and 50 units of land. The country is

labor abundant

Specialization and international trade allows a country to _____________ beyond its production frontier

produce and consume

Thailand’s currency is in baht. Suppose the Thai government levies an ad valorem tariff of 20% on imports of dishwashers, which enter Thailand at Baht 18,000. Given the tariff, Thailand imports 6,000 dishwashers per month. What is the comparable specific tariff that yields the same tariff as the ad valorem tariff of 20%?

baht 3,600.

“Carrots are fruit, snails are fish, and Men are not human.”In the US the domestic price of sugar is twice as high as the world price. These outcomes show the result of the

lobbying efforts of politically connected producers to influence trade policy.

Looking at the product cycle, _____ __countries are more apt to export non-standardized products at__ _______ stages of the product cycle.

developed; earlier

Suppose that the US is a “large country” with respect to imports of lawnmowers. If the US government imposes a $50 specific tariff on imports of lawnmowers, then the price of lawnmowers in the US will

rise by less than $50

Suppose the Vietnamese government grants an export subsidy to Vietnamese firms that export toys to the US. The WTO considers an export subsidy an unfair trade practice. Specifically, the WTO considers that the export subsidy in this case is unfair to

sellers of toys in the United States

At a recent G-20 summit that Biden attended, the US agreed to ease tariffs on European steel and aluminum imports that date back to the Trump administration. Appliance manufactures use steel and aluminum in the production of appliances. What impact will the lowering of these tariffs have on the effective rate of protection on appliance industries in the US?

increases it

According to the model of international trade of external scale economies, knowledge spillovers and labor market pooling contribute to cost advantages to firms that locate ____ __each other in a country, and countries with these locations will be net__ ________ of this product.

Close to; exporters

Suppose the Swedish government wishes to increase production of domestic steel to increase military-preparedness in case of military conflict with Russia. The government is considering a production subsidy to the steel industry and an import quota on steel imports, where the quota licenses are granted to steel importers based on their historic market shares of imports. The production subsidy and quota are different in that

the quota will raise the domestic price of steel, while the production subsidy will not raise the domestic price of steel

As viewed by the WTO, dumping constitutes an unfair trade practice. Suppose Malaysian producers engage in dumping of radios in the US. Under WTO rules, what would the US government be permitted to do in response to the dumping?

Levy a tariff on imports of radios from Malaysia

Suppose designer drapes is a monopolistically competitive industry in Finland and the rest of the world, but initially there is no trade in luxury drapes between Finland and the rest of the world. Suppose that each firm produces only one brand of luxury drapes. Based on the predictions of the monopolistically competitive model discussed in class and the textbook, compared with no international trade, how should opening internal trade affect

the number of brands of luxury drapes available to Finnish consumers

more.

Suppose designer drapes is a monopolistically competitive industry in Finland and the rest of the world, but initially there is no trade in luxury drapes between Finland and the rest of the world. Suppose that each firm produces only one brand of luxury drapes. Based on the predictions of the monopolistically competitive model discussed in class and the textbook, compared with no international trade, how should opening internal trade affect

the average price of luxury drapes in Finland

lower.

Suppose designer drapes is a monopolistically competitive industry in Finland and the rest of the world, but initially there is no trade in luxury drapes between Finland and the rest of the world. Suppose that each firm produces only one brand of luxury drapes. Based on the predictions of the monopolistically competitive model discussed in class and the textbook, compared with no international trade, how should opening internal trade affect

the average size of a firm in Finland producing a given brand of luxury drapes

larger.

In 2016, Japan exported $8 million worth of household clothes washing machines and imported $749 million worth of household clothes washing machines. In 2016, Japan exported $2,407 million worth of motorcycles and imported $603 million worth of motorcycles. In which product did Japan have more total trade _______? In which product did Japan have more intra-industry trade_____?

Motorcycles; Motorcycles

Suppose a subsidiary of a multinational company (MNC) in Peru (a high-tax country) buys components from another subsidiary of the MNC in Paraguay (a low tax country). The Peru subsidiary uses the components to produce a final product, which it sells in Peru. All else equal, the MNC’s after-tax profits will be higher.

if the MNC sets a high transfer price for the components

a US firm buys microchips from a Taiwanese exporter. The NTD is the currency. This transaction leads on the foreign exchange market to

an increase in the demand of NTD

A US importer scheduled to make a payment of 100,000 euros in three months can hedge her foreign exchange risk by

purchasing 100,000 euros in the forward market for delivery in three months

What is the current account balance of a nation with a government budget surplus of $100 billion, private saving of $400 billion and domestic investment of $900 billion?

deficit of $400 billion.

Which of the following people or firms would be pleased by a depreciation of the Canadian dollar agains the Euro? (Germany, Greece, France, and Spain use the euro)

a) A German importer of cars from Canada

b) A Canadian tourist visiting Greece

c) A Canadian importer of wine from France

d) A Canadian company that wishes to expand abroad by a building a factory in Spain

A german importer of cars from canada

The 30-day forward rate is $1.00 per pound, and you believe that the spot rate in 30 days will be $.95 per pound. If you wish to earn your profit in dollars, then you can try to maximize speculative gains by

selling dollars in the spot market in 30 days and buying dollars forward.

Suppose that Pakistan’s current account (net exports) was in balance. Then a firm in Pakistan that had not previously exported clothing begins exporting clothing to other countries. Al else equal Pakistan’s current account will

be in surplus

Which of the following is NOT a reason why cartels often lack success over the long term?

Non-members of the cartel not becoming members of the cartel.

Policymakers in developing countries generally believe that industrialization will lead to greater economic growth and rising incomes for people in their countries. One reason they believe this about industrialization is that compared with primary products, the income elasticity of demand generally is ______ for manufactured goods

higher

Suppose a developing country perviously followed an import-substitution policy to industrialize and now wishes to begin an export promotion policy to industrialize. Accordingly, policymakers in the developing country are more likely to begin

lowering tariffs on imports

In a recent year, a country had (in millions of dollars) government revenue of $120; government expenditures of $105; exports of $40; and imports of $45. The government had a budget ____ __and the country had a trade__ ________

surplus; deficit

If a country’s production of goods and services (Y) exceeds it domestic spending on goods and services (C+I+G), then net exports are ____ __and national saving is__ ___ domestic investment

positive; greater than

In which industries is foreign direct investment more prevalent?

a)clothing and paper products

b)pharmaceuticals and electronic products

pharmaceuticals and electronic products

The Federal reserve Bank of St. Louis reported that on March 27th, 2023, that the US dollar to one NZD exchange rate was .625. Accordingly, the US dollars one was equal to NZD:

1\.60

Suppose you work at Able Inc with produces and sells in the US specialized earthmoving equipment. Able is considering expanding its sales to a country in Asia. You are a member of Able’s management team considering three methods of penetrating the foreign market in Asia:

i. Exporting from its US facility

ii. Licensing a foreign firm to produce and sell the specialized earthmoving equipment in the Asian country.

iii. foreign direct investment in the Asian country.

Which of the methods that Able is considering penetrating the Asian country becomes directly more attractive by a reduction in transportation costs between the US and the Asian country?

exporting

Suppose you work at Able Inc with produces and sells in the US specialized earthmoving equipment. Able is considering expanding its sales to a country in Asia. You are a member of Able’s management team considering three methods of penetrating the foreign market in Asia: 

i. Exporting from its US facility

ii. Licensing a foreign firm to produce and sell the specialized earthmoving equipment in the Asian country.

iii. foreign direct investment in the Asian country.

Which of the methods that Able is considering penetrating the Asian country becomes directly less attractive with the possibility that a foreign partner will obtain technology or other know-how from Able and export it for its own commercial advantage?

licensing

Covered interest parity on a one-year loan includes a relationship among four variables. Which variables?

Foreign annual interest rate

domestic annual interest rate

Forward exchange rate to be exercised in one year

Current spot exchange rate