2009 Fall Macro Quiz 1.
1. Consider “Wayne” and “Garth”.
In one hour, Wayne can make either 5 guitars or 6 amps.
In one hour, Garth can make either 3 guitars or 2 amps.
a. What is the price of 1 guitar in units of amps for Garth? Show work.
It takes Garth 20 minutes to make 1 guitar and 30 minutes to make one amp. In the time it takes
Garth to make 1 guitar, he could have made 20/30 = 0.667 amps.
b. What is the price of 1 guitar in units of amps for Wayne? Show work.
It takes Wayne 12 minutes to make 1 guitar and 10 minutes to make one amp. In the time it takes
Wayne to make 1 guitar, he could have made 12/10 = 1.2 amps.
c. Using the answers to parts a and b, explain the patterns of trade: What does Wayne export to
Garth, what does Garth export to Wayne, and why.
Garth exports guitars because he is the relatively low cost producer: He only foregoes 0.667 amps
to make 1 guitar, whereas Wayne foregoes 1.2 amps to make 1 guitar. Wayne exports amps.
2. The yearly interest rate on assets is 8 percent. Given yearly income of $100, write down the budget
constraint linking consumption today Ct and consumption next year Ct+1. The budget constraint you
write down should look like: x1 = x2* Ct + x3* Ct+1, where you fill in numerical values for the x1, x2 and
x3.
Ct+1 = (1.08)*($100 - Ct). This implies $108 = 1.08* Ct + Ct+1.
(It is acceptable to divide this equation by 1.08)
3. What is a trade deficit? Why do trade deficits occur? Do not tell me about exchange rate
manipulation – stick to what we directly discussed in class.
A trade deficit occurs when, on-net, goods and services are exchanged for assets. A trade deficit
occurs when one country has a comparative advantage in producing future consumption (relative to
current consumption). Prior to trade, this country will have a higher interest rate.
4.
Consider the US and Japan. The inflation rate in the U.S. is 2.5 percent per year and the inflation
rate in Japan is 1 percent year. The real return to assets in both the U.S. and Japan is 5 percent per
year.
a. What is the annual nominal interest rate in the United States and Japan.
US:
1+i = (1.05)(1.025) = 1.07625, iUS = 7.625%
Japan: 1+i = (1.05)(1.01) = 1.0605, iJ = 6.05%
b. According to covered interest parity, a forward contract would call for an appreciation or
depreciation of the dollar relative to the Yen?
Depreciation. The inflation rate in US is greater than the inflation rate in Japan.
c. If 1 dollar buys 100 Yen at the start of the year, then what is the exchange rate (yen per
dollar) that you can lock-in using a forward rate at the end of the year?
(1.07625)(1/100) = 1.0605x implies x = 0.01015. Forward rate = (1/0.0105) = 98.54 Yen/Dollar
d. Given your answer to (c), by what percentage did the dollar appreciate / depreciate relative
to the Yen.
(98.54-100)/100 = -1.46 percent.