Q: If the nominal exchange rate between the U.S. dollar and the euro is $$e = 0.86 ($$euros per dollar), the U.S. price level is $$P = 120$$, and the European price level is $$P^* = 100$$, what is the real exchange rate?

$$\text{Real exchange rate} = \frac{e \times P}{P^*} = \frac{0.86 \times 120}{100} = 1.032$$

Question 1

Suppose the United States exports $$500 billion worth of goods and imports 600 $$billion worth of goods in a given year. What is the value of net exports (NX) for the United States?

Accepted Answer

$$NX = 500 - 600 = -100$$ billion

Question 2

A U.S. company purchases $$200 million in Japanese government bonds, while Japanese investors purchase 150 $$million in U.S. stocks. What is the net capital outflow (NCO) for the United States?

Accepted Answer

$$NCO = 200 - 150 = 50$$ million

Question 3

If a country has a trade deficit, which of the following must be true?

Accepted Answer

Its net exports (NX) are negative.

Question 4

Which of the following transactions would increase U.S. net capital outflow (NCO)?

Accepted Answer

A U.S. resident buys shares in a German company.

Question 5

Given the accounting identity $$S = I + NCO$$, if a country’s saving ($$S) is$$ $$800$$ and its domestic investment ($$I) is$$ $$600$$, what is its net capital outflow ($$NCO$$)?

Accepted Answer

$$NCO = 800 - 600 = 200$$

Question 6

If the nominal exchange rate between the U.S. dollar and the euro is $$e = 0.86 ($$euros per dollar), the U.S. price level is $$P = 120$$, and the European price level is $$P^* = 100$$, what is the real exchange rate?

Accepted Answer

$$	ext{Real exchange rate} = \frac{e 	imes P}{P^*} = \frac{0.86 	imes 120}{100} = 1.032$$

Question 7

If the U.S. dollar appreciates against the Japanese yen, which of the following is most likely to occur?

Accepted Answer

U.S. goods become more expensive for Japanese consumers.

Question 8

Suppose the price of a Big Mac is $$P = 5$$ USD in the U.S. and $$P^* = 600$$ yen in Japan. According to purchasing-power parity (PPP), what should the nominal exchange rate ($$e) be ($$yen per dollar)?

Accepted Answer

$$e = \frac{P^*}{P} = \frac{600}{5} = 120$$

Question 9

If the U.S. has higher inflation than the Eurozone, what does purchasing-power parity (PPP) predict will happen to the nominal exchange rate ($$e) $$between the dollar and the euro (euros per dollar)?

Accepted Answer

$$e$$ will fall; the dollar will depreciate against the euro.

Question 10

Which of the following is NOT a reason why purchasing-power parity (PPP) may not hold perfectly in the real world?

Accepted Answer

All goods are easily tradable across borders.

Question 11

If a U.S. resident buys a car produced in Germany, how does this transaction affect U.S. net exports (NX) and net capital outflow (NCO)?

Accepted Answer

NX decreases and NCO decreases.

Question 12

Suppose the U.S. government increases its budget deficit, reducing national saving. According to the identity $$S = I + NCO$$, what is a likely consequence?

Accepted Answer

Net capital outflow (NCO) will decrease, possibly becoming negative.

Question 13

If the real exchange rate between the U.S. and Mexico rises, what is the most likely effect on U.S. exports to Mexico?

Accepted Answer

U.S. exports to Mexico will decrease because U.S. goods become more expensive.

Question 14

Which of the following best describes foreign direct investment (FDI)?

Accepted Answer

A U.S. company opens a factory in Brazil and manages its operations.

Question 15

Suppose the nominal exchange rate between the U.S. dollar and the Canadian dollar is $$e = 1.37 ($$Canadian dollars per U.S. dollar). If the U.S. price level is $$P = 120$$ and the Canadian price level is $$P^* = 150$$, what is the real exchange rate?

Accepted Answer

$$	ext{Real exchange rate} = \frac{e 	imes P}{P^*} = \frac{1.37 	imes 120}{150} = 1.096$$

Question 16

If the law of one price holds for a good, what is the implication for arbitrage opportunities?

Accepted Answer

There are no arbitrage opportunities because prices are equalized across markets.

Question 17

Which of the following best illustrates the concept of foreign portfolio investment?

Accepted Answer

A U.S. resident buys shares in a British company.

Question 18

If U.S. net capital outflow (NCO) is negative, what does this indicate about the flow of capital?

Accepted Answer

Foreigners are purchasing more U.S. assets than U.S. residents are purchasing foreign assets.

Question 19

Suppose the U.S. price level rises by 10% while the Japanese price level remains constant. According to PPP, what should happen to the nominal exchange rate ($$e) $$between the dollar and the yen (yen per dollar)?

Accepted Answer

$$e$$ should fall by approximately 10%.

Question 20

Which of the following is an example of a situation where the law of one price does NOT hold?

Accepted Answer

A haircut costs $$20 in New York and 10 in $$Mexico City.

International Trade, Capital Flows, and Exchange Rates

Study Guide - Practice Questions

Study Guide - Flashcards