Unit 6 and 7 Exam Review KEY
1.
2.
3.
4.
The real GDP per capita is the key measure used to track economic growth. WHY is this the most appropriate measure?
Because it measures the total value of an economy’s production/income adjusted for inflation, and removes the effect of
population changes. Real GDP per capita represents a “typical” family’s income and normally grows in proportion to per
capita income.
Complete the following chart using the Rule of 70.
Average
GDP doubling
Growth rate
time (in years)
Country A
1%
70
Country B
10%
7
Country C
2%
35
Country D
3.5%
20
Country E
7%
10
What is the key to long-run growth? Increase in PRODUCTIVITY!!!!!! (output per worker)
What are the three factors that contribute to growing productivity (name/define)? How does each contribute to long-run
growth?
Physical capital—increases in manufactured goods used to produce other goods and services allow for higher output per
worker
Human capital—improvements in education, knowledge and health of work force lead to each laborer achieving more
output in less time
Technology—progress in technical means for production allows producers to increase the amount of outputs with the same
number of inputs
5. What is meant by “diminishing returns” on investments in physical capital?
Increases in the amount of physical capital leads to smaller increases in productivity. The payoff in the beginning for
increasing physical capita is large, buy that payoff becomes smaller with each additional increase over time.
6. How can governments encourage long-run growth?
Adding to physical capital—high rates of savings and investment spending (creating incentives for businesses to
invest/funding infrastructure and public health)
Adding to human capital—making education a priority through funding public education
Promoting technological progress—influencing the private and public sector to translate scientific knowledge into practical
use; this requires research and development (R&D)
It is also crucial that governments promote a secure financial system, political stability, and protect property rights.
7. In what way is resource scarcity “solved” by market forces?
Resource scarcity typically leads to higher resource prices. These higher prices, in turn, provide strong incentives to
conserve the scarce resource and find alternatives through R&D.
8. China exports $300 billion of goods and services and imports $230 billion of goods and services. If there is no other factor
income or transfers, what is China’s current account balance?
$300 billion falls under China’s credit and $230 billion falls under debit. Net Exports = Exports – Imports. $300 billion - $230
billion = $70 billion is China’s current account surplus.
9. How are transactions in the financial account different from transactions in the current account?
Transactions in the financial account create liabilities because they are the sales or purchases of assets.
10. Categorize the following transactions as CA (current account) or FA (financial account) for the United States balance of
payments accounting, as well as (+) Credit or (-) Debit:
CA/FA
+/CA
+
a. A family from Peru eats in a restaurant in Salt Lake City.
FA
b. An investor from Los Angeles purchases bonds issued by the Peruvian government.
CA
+
c. U.S. citizen Bill sells his car to a friend in Canada.
CA
d. Inez sends part of the paycheck she earned in the U.S. home to her family in Canada.
FA
+
e. A French businessman purchases a professional hockey team located in the U.S.
FA
+
f.
A U.S. company sells assets to its supplier in Germany.
11. CA + FA = 0. Therefore, if a country has a negative balance in the financial account, they must have a positive balance in the
current account.
12. The equilibrium interest rate for loanable funds in Genovia is 9% and the equilibrium interest rate for loanable funds in the
U.S. is 5%. Assuming that lenders in both nations see loan risk as equal in both countries, capital flow to (Genovia/United
States) would increase and this would result in (rising/falling) interest rates in that country. The geno would
(appreciate/depreciate) as a result, and the U.S. dollar would (appreciate/depreciate) in relation to the geno. As a result,
Genovian exports would (increase/decrease) and Genovian imports would (increase/decrease). Genovia would have a
balance of trade (surplus/deficit). You can check yourself by thinking if capital is flowing into Genovia, they must have an
increase in their financial account, which means to balance their payments, there must be a decrease in their current
account.
13. For each of the following, indicate whether this would increase the supply (S) or demand (D) for genos and its effect (+/-) on
the value of the geno.
Increased Value of
S/D
geno
+/S
a. Genovian purchases of imported goods and services
S
b. Genovian investment in foreign companies
D
+
c. An increase in Genovian exports
D
+
d. Rising interest rates in Genovia
S
e. Genovian purchases of foreign assets
D
+
f. The U.S. lowers trading restrictions that had limited imports from Genovia
14. The value of the geno in May 2013 was US $3.10. The value of the geno in December 2013 was US $3.85. The geno has
(appreciated/depreciated) and the U.S. dollar has (appreciated/depreciated) in relation to the geno. The exchange rate for
the dollar in May 2013 was .32 geno and it moved to .26 geno in December.
This would make Genovian exports to the United States (cheaper/more expensive) and the quantity of Genovian exports
would likely (increase/decrease). Genovia would have a balance of trade (surplus/deficit). U.S. exports to Genovia would be
(cheaper/more expensive) and the quantity of U.S. exports would likely (increase/decrease). The United States would have
a balance of trade (surplus/deficit).
15. What are the options for a country whose equilibrium exchange rate falls below the fixed exchange rate target?
 Buy surplus of currency in the FOREX (exchange market intervention)
 Increase interest rates through monetary policy
 Establish foreign exchange controls to limit individuals from buying foreign currency
16. What are the options for a country whose equilibrium exchange rate rises above the fixed exchange rate target?
 Sell currency to eliminate shortage in the FOREX (exchange market intervention)
 Decrease interest rates through monetary policy
 Establish foreign exchange controls to limit foreigners from buying your currency
17. How does a fixed exchange rate limit monetary policy options?
If a country chooses to stabilize an exchange rate by adjusting monetary policy rather than through intervention, it must
divert monetary policy from other goals, notably stabilizing the economy and managing the inflation rate.
18. Suppose American buyers want more Genovian apples. This will (increase/decrease) demand for genos, and the geno will
(appreciate/depreciate) as a result. The U.S. dollar will (appreciate/depreciate) in relation to the geno. The Genovian
balance of payments on the current account will (rise/fall) and their financial account balance will (rise/fall).
19. Complete the following chart depicting the effects of monetary policy actions.
Monetary Policy
Effect on
Effect on capital
Effect on
Effect on AD
Contractionary
Expansionary
interest rates
Increase
Decrease
inflows
Increase
Decrease
value of dollar
Appreciate
Depreciate
Decrease
Increase
20. In May 2013, the geno was valued at US $3.00. By December 2013, the geno’s value fell to US $1.50. During that same time
period, the price level in Genovia increased by 50% while there was no change in the price level in the United States. What
is the real exchange rate in December 2013, and how does it compare to the real price level in May?
Equation: Real XR = XR (X per Y) x Price Level Y/ Price Level X
real XR = US dollars per geno x Price index of Genovia/Price index of US
Dec. 2013 real exchange rate = $3.00 x (100/100) = $3
May 2013 real exchange rate = $1.50 x (150/100) = $2.25
The exchange rate between Dec and May 2013 increased by 100%. Simultaneously, the price level of Genovia increased by
50%, so the Genovian price index went from 100 to 150. While the nominal exchange rate increased, it was exaggerated by
Genovia’s inflation. As a result the change in the real exchange rate was not as large as the change in the nominal exchange
rate.
21. What are the advantages and disadvantages of a floating exchange rate?
Advantages
Disadvantages
Certainty of future value of currency facilitates trade
Required to keep large stores of foreign currency
Commitment to control inflation
Use of monetary policy to stabilize XR may conflict
with other goals
Foreign exchange controls distort trade balance
22. Inflation tends to exaggerate the differences in relative values of currency. Countries with high inflation have currency
(appreciation/depreciation) in comparison with more stable currencies.
23. How are tariffs and import quotas similar? How are they different?
Both limit the amount of imported foreign goods into one country. Both protect domestic industries from competitive
foreign goods. Both lead to an increase in the price of imported goods in comparison to the world price. The main
difference is that a tariff is a tax that also creates revenue for the government, whereas quotas place a cap or limit on the
amount of importation that can take place.