51. Refer to Figure 13.2. Starting at equilibrium income $50 billion, where (S-I)0 intersects (X-M)0,
suppose that changing preferences lead to an autonomous decrease in Australian imports of $5 billion.
Australian income thus ____ which leads to Australia’s trade account moving to a ____.
a.
Rises to $60 billion, surplus of $2.5 billion
b.
Rises to $60 billion, surplus of $5 billion
c.
Falls to $40 billion, deficit of $2.5 billion
d.
Falls to $40 billion, deficit of $5 billion
52. In explaining balance-of-payments adjustments, the classical economists
a.
Focused on interest rates exclusively
b.
Remained aware of the role of interest rates
c.
Only focused their attention on short-term interest rates
d.
Paid exclusive attention to long-tem interest rates
53. J. M. Keynes suggested that a trade deficit nation
a.
Would experience a fall in income
b.
Would experience a decline in imports
c.
Would require active intervention by the government
d.
Both a and b
54. The classical gold standard
a.
Existed from early 1800’s to early 1900’s
b.
Did not allow for imports and exports of gold
c.
Led to the outflow of gold from surplus nations
d.
Led to the inflow of gold to deficit nations
55. The classical economists assumed
a.
That the volume of final output is fixed at the full-employment level in the long-run
b.
The velocity of money is constant
c.
The velocity of money depends on physical, structural, and institutional factors
d.
All of the above
TRUE/FALSE
1. Under a fixed exchange rate system, adjustment mechanisms work for the automatic return to
current-account balance after the initial balance has been disrupted.
2. When a country’s current account moves into disequilibrium, automatic adjustments in tariffs and
quotas occur which move the current account back into equilibrium.
3. Prices, interest rates, and income are the automatic adjustment variables that help restore
current-account equilibrium under a system of fixed exchange rates.
4. That the balance of payments could be adjusted by prices and interest rates, under a fixed exchange
rate system, originated with Keynesian theory during the 1930s.
5. David Hume’s price-adjustment mechanism supported the mercantilist view that a nation could
maintain a trade surplus indefinitely.
6. Under the price-adjustment mechanism, a government’s efforts to maintain a current-account surplus is
self defeating over the long run because a nation’s current account automatically moves toward
equilibrium.
7. Under the gold standard of the 1800s, exchange rates were allowed to float freely in the currency
markets.
8. Under the gold standard, each participating nation defined the mint price of gold in terms of its
national currency was prepared to buy and sell gold at that price.
9. Under the gold standard, a nation with a current-account surplus would realize gold outflows, a
decrease in its money supply, and a fall in its domestic price level.
10. The essence of the classical price-adjustment mechanism is embodied in the quantity theory of money.
11. According to the equation of exchange, the total expenditures on final goods equals the monetary
value of the final goods sold.
12. Regarding the equation of exchange, the classical economists assumed that final output was below its
maximum level while the velocity of money was volatile.
13. According to the quantity theory of money, a change in the money supply will induce an inverse and
less-than-proportionate change in the price level.
14. Under the price-adjustment mechanism, a trade-surplus nation would realize gold inflows, an increase
in its money supply, and a loss of international competitiveness.
15. The price-adjustment mechanism’s relevance to the real world has been questioned on the grounds that
national output is generally not at the full-employment level and that the velocity of money is not
always constant.
16. According to the price-adjustment mechanism, trade deficits can occur only in the long run rather than
in the short run.
17. Under the price-adjustment mechanism, trade-deficit nations realize price inflation and a loss of
competitiveness while trade surplus nations realize price deflation and an improvement in
competitiveness.
18. Under the classical gold standard, adjustments in domestic prices and short-term interest rates
automatically promoted balance-of-payments equilibrium over the long run.
19. Under the classical gold standard, a trade surplus nation would realize gold inflows, an increase in its
money supply, rising interest rates, and net investment inflows.
20. The gold standard’s “rules of the game” required central bankers in a surplus country to initiate
contractionary monetary policies which lead to higher interest rates and net investment inflows.
21. The gold standard’s “rules of the game” required central bankers in a trade deficit nation to expand the
money supply, leading to falling interest rates and net investment outflows.
22. The “rules of the game” served to reinforce and speed up the interest-rate-adjustment mechanism under
a system of fixed exchange rates.
23. Refer to Figure 13.3. As U.S. interest rates rise relative to foreign interest rates, the U.S. slides upward
along schedule CA0, thus moving towards capital and financial account surplus.
24. Refer to Figure 13.3. Decreases in U.S. interest rates relative to foreign interest rates would shift U.S.
capital and financial account schedule CA0 downward toward CA1, resulting in net financial outflows
from the United States.
25. Refer to Figure 13.3. Falling investment profitability in the United States, relative to investment
profitability abroad, would shift the U.S. capital and financial account schedule downward from CA0
to CA1, resulting in net financial outflows from the United States.
26. Refer to Figure 13.3. As the U.S. government decreases taxes on income earned by U.S. residents from
foreign investments, the U.S. capital and financial account schedule shifts downward from CA0 to CA1
and the United States realizes net financial outflows.
27. Refer to Figure 13.3. If the political and economic stability of foreign countries worsens relative to that
of the United States, the U.S. capital and financial account schedule would shift downward from CA0
to CA1, resulting in net financial outflows from the United States.
28. According to the Keynesian income-adjustment mechanism, income differentials among nations
guarantee current-account equilibrium in a world of fixed exchange rates.
29. Keynesian theory asserts that, under a system of fixed exchange rates, the influence of income changes
in surplus and deficit countries will automatically promote current-account equilibrium.
30. The Keynesian income-adjustment mechanism contends that a trade-surplus nation tends to realize
falling income and falling imports, thus accentuating the trade surplus.
31. The foreign-trade multiplier equals the sum of the marginal propensity to import and the marginal
propensity to save.
32. If the marginal propensity to save equals 0.2 and the marginal propensity to import equals 0.3, the
foreign-trade multiplier equal 2.0.
33. For an open economy subject to international trade, equilibrium income occurs where saving plus
investment equals imports plus exports.
34. If the marginal propensity to save equals 0.1 and the marginal propensity to import equals 0.3, an
autonomous increase in exports of $1,000 would expand domestic income by $2,500 which leads to an
increase in imports of $750.
35. If the marginal propensity to save equals 0.2 and the marginal propensity to import equals 0.3, an
autonomous decrease in investment spending of $1 million leads to a $2 million decrease in domestic
income and a $600,000 decrease in imports.
36. For the income adjustment mechanism to reverse a trade deficit, economic policymakers must be
willing to permit domestic income to increase which leads to rising imports.
37. Reliance on an automatic adjustment process tends to be unacceptable in trade-deficit nations since it
requires them to accept price deflation and/or falling income as a cost of reducing imports.
38. An “automatic” adjustment mechanism would require a trade-surplus nation to accept price deflation
and/or falling income as the cost of increasing imports.
Figure 13.4. Canadian Economy Under a Fixed Exchange Rate System
39. Referring to Figure 13.4, Canada’s marginal propensity to save equals 0.25 and marginal propensity to
import equal 0.5.
40. Referring to Figure 13.4, Canada’s foreign-trade multiplier equals 2.0.
41. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S – I)0 intersects (X – M)0, an
autonomous decrease in Canadian imports of $10 billion leads to a $20 billion decrease in income and
a trade deficit of $5 billion.
42. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S – I)0 intersects (X – M)0, an
autonomous increase in Canadian investment of $10 billion leads to a $20 billion increase in income
and no change in the country’s trade account.
43. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S – I)0 intersects (X – M)0, an
autonomous decrease in saving of $10 billion leads to a $20 billion increase in income and a trade
deficit of $5 billion.
44. Refer to Figure 13.4. Starting at equilibrium income $100 billion, where (S – I)0 intersects (X – M)0, an
autonomous decrease in Canadian exports of $10 billion leads to a $20 decrease in income and a trade
deficit of $5 billion.
45. According to the monetary approach, balance-of-payments disequilibriums are the result of imbalances
in a country’s money supply and money demand.
46. The monetary approach contends that, under a fixed exchange rate system, an excess supply of money
leads to a trade surplus.
47. The monetary approach contends that, under a fixed exchange rate system, an excess demand for
money leads to a trade deficit.
48. The monetary approach contends that, under a fixed exchange rate system, policies that increase the
supply of money relative to the demand for money lead to a trade surplus.
SHORT ANSWER
1. Compared to classical economists, how did Keynesian economics change the discussion of trade
adjustment?
2. What is the foreign repercussion effect?
ANS:
ESSAY
1. Explain David Hume’s theory of automatic adjustment for balance of payments disequilibria.
2. Is the monetary approach to the balance-of-payments part of the traditional adjustment theories?
