8th Exercise list
Q1. Use 4-Graph model where there are only two countries and all supply curves in each market
are perfectly elastic. Which of the following is wrong about the descriptions of the secondary
effect of currency appreciation/ depreciation?
(A) Price effect will shift only supply curve and income effect will shift only demand curve.
(B) According to price effect, firms in the country with appreciated currency will experience
lower production cost and so increase in supply.
(C) According to income effect, consumers in the country with depreciated currency will
experience increase in net export and in turn increase in GDP and finally decrease in import.
(D) Secondary effects such as price effect and income effect are opposite or counterbalancing
effects to primary effect as an effect upon import/export of the two countries.
(E) The final total effect of appreciation/depreciation on trade position is unclear because it
depends on relative multitude between primary effect and secondary effect.
Q2. Which of the following is not correct as an explanation of gold standard system?
(A) Gold standard system sacrificing external equilibrium in order to accomplish internal
equilibrium.
(B) Gold standard system is an example of fixed exchange rate system.
(C) Trade surplus country can have gold inflow and increase in money supply. In turn, it will
undergo inflation and increase in export and decrease in import.
(D) Trade deficit country can have gold outflow and decrease in money supply. In turn, it will
undergo decrease in interest rate and increase in investment.
(E) Under gold standard system, the government declares parity between national currency and
gold.
Q3. Explain do you agree with the statement: under gold standard, external equilibrium is
sacrificed to maintain internal equilibrium.
Q4. A country with a pegged exchange rate is likely to be forced to devalue if
A) Speculators believe that it will devalue.
B) Its rate of inflation is smaller than inflation in other countries.
C) It has no comparative advantage in trade.
D) Its workers are less productive than workers elsewhere.
Q5. Before doing the exercise, please review your notes and make sure you understand the 4graph analysis for the effect of change in exchange rate and the secondary effect.
If the US Dollar appreciates relative to the euro, US export to Europe
a.
b.
c.
d.
And European export to the US rise
And European exports to the US fall
Rise, and European exports to the US fall
Fall, and European exports to the US rise
Q6. Under fixed exchange rate, which one of the following statements is the most accurate?
a. Depreciation domestic currency causes a decrease in output, a decrease in official
reserves of foreign currency, and a contraction of the money supply.
b. Depreciation domestic currency causes a rise in output, a rise in official reserves of
foreign currency, and an expansion of the money supply.
c. Depreciation domestic currency causes a decrease in output, a rise in official reserves
of foreign currency, and an contraction of the money supply.
d. Depreciation domestic currency causes a rise in output, a decrease in official reserves
of foreign currency, and an expansion of the money supply.
Q7. Under gold standard which of the following is true?
a. When a country has trade surplus, interest rate increases.
b. When a country has trade deficit, money supply decreases.
c. When a country has trade surplus, gold outflow from the country.
d. When a country has trade deficit, interest rate decreases.
Q8. Which of the following statement is not true?
a. If country A uses fixed exchange rate system, then money supply of country A should
increase if it demand more exported goods.
b. If country A uses fixed exchange rate system, then money supply of country A should
increase if foreign currency depreciates.
c. If country A uses fixed exchange rate system, then money supply of country A should
increase if foreign country uses contractionary fiscal policy.
d. If country A uses floating exchange rate system, then money supply of country A
should increase if foreign currency depreciates.
Q9. Suppose our country have a trade surplus under gold standard system. Which one is true?
a.
b.
c.
d.
The money supply will go up because Gold Reserves will go down
The money supply will go up because gold was given in exchange for US$
The money supply will not be affected
The money supply will decrease because of gold outflow.
Q10. Suppose country Alpha u s e s a p e g g e d e x c h a n g e r a t e system, and that it is facing
a trade deficit. Which one is true?
a.
b.
c.
The national currency will have to depreciate
The demand for foreign currency is higher than it was supposed to be, so
the government should increase the supply of foreign currency to keep the
pegged exchange rate.
The supply of foreign currency is higher than it was supposed to be, so
the government should buy the excess of foreign currency to keep the
pegged exchange rate.
Q11. Suppose country Alpha u s e s a p e g g e d e x c h a n g e r a t e system, and that it is facing
a trade deficit. Which one is true?
a.
b.
The national currency will have to depreciate
The demand for foreign currency is higher than it was supposed to be, so
the government should increase the supply of foreign currency to keep the
c.
pegged exchange rate.
The supply of foreign currency is higher than it was supposed to be, so
the government should buy the excess of foreign currency to keep the
pegged exchange rate.
Q12. Explain how the suppliers of exported goods can be most benefitted in a situation where
they are going to increase their amount supplied taking into account the elasticity of demand.
Q13. Explain the how can the price effect can counterbalance an initial trade surplus.
Q14. If a country have exported $200 and imported $300, then its GDP increased by $100
(assuming that C+I+G haven’t changed). How can the income effect change that increase in the
GDP if the marginal propensity to import is .8?
Answer.
Q1. (C) Import will increase because it is a function of GDP and marginal propensity of import is
positive.
Q2. (D) Interest will go up and so investment will go down. Thus, there will be boom (i.e.,
increase in GDP) and in turn import will increase further.
Q3. Not agree. Under gold standard, internal equilibrium is sacrificed to maintain external
equilibrium.
Money supply decreases in the trade deficit country because their domestic currency is
exchanged for gold to payoff the debts. (Ms  and gold flows out)
And according to MV=PQ, general price will decrease. (P)
Overall decrease in price makes the goods in deficit country more competitive and hence lead
to an increase in export and a decrease in import. That results in a decrease in trade deficit.
(X and M)
Interest rate will increase as money supply decreases. (i-rate )
An increase in interest rate causes a decrease in investment and consumption and hence a
decrease in Y. (Y)
If we assume marginal propensity to import is positive, as Y, import will decrease, which
helps to balance the trade deficit.
Q4. A
Say country A’s currency is pegged to dollar. If speculators believe that it will devalue, they will
buy more dollars and hence demand for dollar increase. Under pegged exchange rate regime,
excess demand for dollar will be supplied by A’s government by decreasing dollar reserve and
the dollar reserve may eventually run out and force A’s currency to devalue.
Q5. D
Q6. B
Q7. B
Q8. C
Q9. B
Q10. ANS B (If the country has a deficit, it is importing more than exporting, so it demands more
foreign currency than what is available. Therefore, to keep the same exchange rate, the
Government can sell part of its reserves of foreign currency to satisfy the excess demand in the
market.)
C is what the Government would do in the case of a trade surplus
Q11. A
NOTE on C; in the case of a trade deficit, the Government could auction Imports permits.
Q12. If the supply is increasing, then the price is decreasing. Therefore, to keep the same revenue
(or even increase) the change in price has to make a high impact in the demand. That is,
consumers must demand a lot more of this product in order to compensate the fall in the price.
Thus an elastic demand would be better than an inelastic demand for the suppliers when they are
decreasing their prices.
Q13. An initial depreciation of the currency (say dollar) makes the foreign products more
expensive and at the same time the American products get more attractive to other countries. So
there is a trade surplus. However, the US still imports some goods from abroad: either food or
goods that are used as inputs in the US production. If those inputs are more expensive, costs of
production (and prices) in the US increase, that is, inflation happens in the US counterbalancing
the initial advantage of the US in the international trade.
Q14. Y = (C0 +MPC*Y) + I + G + X – (M0+MPM*Y), where C0= autonomous consumption,
MPM is marginal propensity to import and M0=autonomous imports.
Therefore, from this $100 increase in Y, part will be spent on more imports (that is, as income
increases in a country its imports also increases), counterbalancing a piece of the initial trade
surplus. Since MPM = .8 then the decrease in Y will be in the magnitude of $80 (compensating a
fraction of the initial increase of $100)