INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 15
1. On August 8 2002 Brazil received a 30-billion dollar loan from the IMF.
a. Draw a graph to explain why Brazil may have needed the loan.
b. Outline all other options (in the graph) that Brazil had in order to avoid having to
take the IMF loan.
c. If other options existed, why were they not attractive to Brazil?
d. What type of policies are promised to the IMF in return for a reserve loan? Provide
support for each policy you mention.
e. How will Brazil ever repay the loan? Use a new graph.
2. Why is the IMF unpopular in exactly the countries to which it provides loans? Be
specific in your economic reasoning and provide graphs for all parts of your answer.
3. In February 2002 Uruguay had a massive balance of payments deficit. What would be
the effect on output if Uruguay had not allowed its exchange rate to float and had
maintained a fixed exchange rate in June, while following monetary approach to the
balance of payments? Draw a graph. Draw another graph indicating what happened
after the country allowed the currency to float.
4. Imagine the U.S. was following the monetary approach to the balance of payments.
Draw the effects of the increase in government expenditures associated with the 2001
Bush tax cut. Be sure to highlight the crowding-out effect. Given your answer, can you
explain why the tax cut was eventually followed by a reduction in employment (and
output)? Could this have been predicted last year?
5. In 2001, Argentina experienced a severe balance-of-payments crisis and defaulted on
its government loans.
a. Use the TB/Income diagram to outline all Argentinian policy options that could have
created the crisis.
b. Can you imagine why a country would engage in policies that create problems like
the ones Argentina experienced?
c. Use the TB/Income diagram to identify all policy options Argentina had at that point
in time to get out of the currency crisis.
d. Was it really Argentina’s fault? The Brazilian economy currency had lost one third of
its value against the dollar during the year prior to the Argentinian crisis. Could this
have caused the Argentinian crisis? Use the TB/Y diagram.
e. Which policies would the Argentinian government have had to engage in at that
point in time to maintain its exchange rate regime, given that the Brazilian currency
had lost value?
f. Many journalists suggest that the Brazilian economic collapse in 2002 was actually
due to the recession in Argentina, where Argentine consumers cut back on their
consumption. How might this have lead to the crisis in Brazil? Use the Y/Y* diagram
to explain your answer.
6. Repercussions. Assume two large countries, Cascadia and Sierra. The real exchange
rate is fixed. Cascadia’s economy is described by the following equations:
Consumption C = 220 + 0.7(Y–T)
Investment I = 200
Government spending G = 100
Tax T = 100
Imports M = 100 + 0.2Y
Exports X = 100 + 0.2Y* – Y* is Sierra’s income –
The economy is in equilibrium when income Y = C + I + G + X – IM. The specifications
for the equations in Cascadia are identical to those of Sierra, i.e. they share the same
values for the coefficients and the exogenous variables. As a result, Sierra’s model is
derived from the above model by taking all the asterisks from the variables with
asterisks and adding asterisks to the variables without asterisks.
a. For each country solve for equilibrium income as a function of the other country’s
income.
b. Now you have derived a system of 2 equations with 2 unknowns (Y and Y*)
Solve this system to obtain the simultaneous equilibrium income (a single number for
each country) in each of the two countries.
c. Illustrate your results on the graph below with Y on the Y-axis and Y* on the Y*-axis.
Draw curves I (for Cascadia) and II (for Sierra) corresponding to the above
equations. Report the value of the intercepts and of the slopes and show the joint
simultaneous equilibrium E for the two countries.
d. Calculate the balance of trade for each country.
e. Now assume that Cascadia uses expansionary fiscal policy: it increases G by 100.
Show the effect on the above graph: the shift(s) of the relevant curve(s) and the
new joint equilibrium income in E¢.
f. Calculate the small open-economy multiplier mso. This multiplier allows you to
calculate by how much Y increases when G increases, assuming that Cascadia is
small and cannot affect Sierra (i.e. no repercussions and Y* does not change). So
the increase in Y calculated with the small open-economy multiplier corresponds to
the shift of Cascadia’s Y=f(Y*) curve (it is the increase in its intercept).
g. What are the equations for curve I (Cascadia) and for curve II (Sierra) after
Cascadia’s fiscal expansion? What are the repercussions of Cascadia’s
expansionary fiscal policy on Sierra’s income Y*?
h. Calculate the multiplier for the large open-economy mlo for Cascadia using the
equation in the chapter and use the multiplier to calculate the new level of
Cascadia’s income. Then calculate Sierra’s corresponding income after the
repercussions have worked their way through and the two economies have reached
a new simultaneous equilibrium.
i. Calculate the new balance of trade for each country.
Advanced:
j. Assume that Cascadia has a target level of output of 2,000. Assuming that the
foreign government does not use any fiscal policy, what is the increase in
government spending G in Cascadia necessary to achieve their target output?
k. Suppose that each country has a target output of 2,000 and that each government
increases government spending (G and G*) by the same amount. What is the
common increase in G and G* necessary to achieve the target outputs of the two
countries? Solve for net exports and the budget deficit in each country.
INTERNATIONAL ECONOMICS, 7TH EDITION
Study Resources: Questions for Study & Review
Chapter 15: Answers
1.
a. Brazil must have run a balance of payments deficit, and was unable to generate
sufficient foreign reserves to stabilize its currency. The TB/Y diagram shows an
equilibrium below the TB=0 line.
3.
The country’s equilibrium is originally on an intersection of the two lines in the TB/Y
diagram that is below the TB=0 line. The country experiences a trade deficit resulting in
5.
a.
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b. Argentina had a high level of unemployment in early 2001. It may seem tempting for