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© University of New South Wales This material cannot be used for commercial purposes. Sample Multiple Choice Questions for parts covered after the midterm Choose the best answer. (2 marks each) 1. Assuming sticky prices and given expectations of future exchange rates, what is the short-run effect on the exchange rate of the U.S. dollar (purchasing euros) and on domestic and foreign rates of return if there is a temporary increase in the quantity of U.S. dollars? a. R ates of return on domestic and foreign assets diverge, as the dollar appreciates. b. Domestic and foreign rates of return both fall, as the dollar depreciates. c. Domestic and foreign rates of return converge, as the dollar depreciation lowers returns for U.S. investors who purchase euro-based assets. d. Rates of return on euro assets fall, causing investors to switch into U.S. assets and, therefore, the U.S. dollar appreciates against the euro. 2. The asset approach basically looks at ____ as the fundamental variable affecting _____ exchange rates. a. interest rates; short-run b. interest rates; long-run c. the price level; short-run d. the price level; long-run 3. The monetary approach basically looks at ____ as the fundamental variable affecting _____ exchange rates. a. interest rates; short-run b. interest rates; long-run c. the price level; short-run d. the price level; long-run 4. When there is a permanent fall in the foreign money supply, the exchange rate: a. falls in the short run and rises slightly over the long run. b. falls in the short run and falls more over the long run. c. rises in the short run and falls slightly over the long run. d. rises in the short run and rises more over the long run. 5. If you observe that the dollar is appreciating because of a permanent change in the U.S. monetary supply, then the money supply must have: a. fallen . b. stayed the same. c. risen. © University of New South Wales This material cannot be used for commercial purposes. 1

© University of New South Wales This material cannot be used for commercial purposes. d. Not enough information is provided to answer the question. 6. When the exchange rate appreciates in the short run and then depreciates to its original level in the long run, it implies that the foreign money supply has: a. temporarily risen. b. permanently risen. c. temporarily fallen. d. permanently fallen . 7. When an increase in the quantity of money is considered to be permanent and prices are sticky, then in the short run the exchange rate depreciates and overshoots because: a. domestic nominal returns fall relative to foreign returns, and traders expect a permanent depreciation in future exchange rates. b. traders do not change their expectations of the exchange rate, and lower domestic rates make it easier to borrow. c. inflationary expectations eventually cause a rise in domestic real returns. d. traders quickly realize that their expectations of future exchange rates are incorrect and eventually prices will become unstuck. 8. Overshooting occurs because: a. expectations adjust slower than prices. b. expectations adjust at the same rate as prices. c. expectations adjust faster than prices. d. expectations do not adjust. 9. If a country has a $100 million debt and the interest rate on the debt is 5% and the debt is serviced each year, this would result in: a. an interest payment of $5 million and a reduction in the debt amount by $10 million each year. b. an interest payment of $15 million and a reduction in the debt amount by $10 million each year. c. an interest payment of $5 million and no change in the debt amount. d. an interest payment of $1 million and an increase in the debt amount by $10 million each year. 10. The long-run budget constraint indicates that, in the long run, a country's initial external wealth must be offset by (i.e., equal to): © University of New South Wales This material cannot be used for commercial purposes. 2

© University of New South Wales This material cannot be used for commercial purposes. a. the present value of its future trade balances. b. the future value of its future trade balances. c. the current value of its future trade balances. d. the present value of its future external wealth. 11. If you are scheduled to receive a $10,000 payment in two years and the interest rate is 10%, then the present value of this payment is: a. $9,000. b. $8,264. c. $12,000. d. $5,000. 12. Suppose that the present discounted value of a stream of payments is $1,000. If the interest rate is 10%, what is the constant payment per year? a. 100 b. 10 c. 11 d. 1,000 13. The United States has been experiencing trade deficits on the order of $600–$800 billion during the past several years. Which of the following is an implication of these trade deficits? a. U.S. GDP has been larger than U.S. GNE. b. U.S. GDP has been smaller than U.S. GNE. c. U.S. net external wealth has been increasing. d. U.S. exports are greater than U.S. imports. 14. The key lesson from the Long-Run Budget Constraint (LRBC) model is: a. nations can safely run trade deficits as long as they can cover the interest each year. b. nations must balance their current account year by year. c. nations must maintain a balance between the present value of deficits and the present value of surpluses that satisfy the LRBC. d. nations may lend externally but it is dangerous to borrow. 15. The present value of GDP: a. equals GNE. © University of New South Wales This material cannot be used for commercial purposes. 3

© University of New South Wales This material cannot be used for commercial purposes. b. equals GNE only when the country begins with positive initial wealth. c. equals GNE only when the country begins with negative initial wealth. d. plus the present value of initial wealth must equal the present value of GNE. 16. If the percentage of change in total spending (C + G) is lower than the percentage change in income, an economy has some degree of: a. financial autonomy. b. consumption smoothing. c. imminent recession. d. prosperity. 17. Investment will occur in an open economy more often than in a closed economy because: a. investment decisions have fewer constraints because investors and borrowers will compare the marginal product of capital in any nation with the world real interest rate. b. without information, investors often make poor investment decisions. c. governments like to subsidize overseas investment for domestic firms. d. international financial organizations prefer to lend for international investments rather than domestic ones. 18. If the long-run budget constraint is upheld, an investment expenditure will increase the present value of consumption only if: a. the present value of debt is equal to zero. b. the present value of output is greater than the present value of the investment expenditure. c. the present value of exports is greater than the present value of imports. d. output is increasing faster than the growth of population. 19. If capital flows freely throughout the world, one would expect it would flow: a. from the rich nations, where it is abundant and cheap, to the poor nations, where it is scarce and dear. b. from the poor nations, where it has less value, to the rich nations, where it has more value. c. from the savers to financial institutions. d. from international lenders to international borrowers. © University of New South Wales This material cannot be used for commercial purposes. 4

© University of New South Wales This material cannot be used for commercial purposes. 20. If production functions are identical, low-income nations have a ____ capital per worker than high-income nations, _____ labor productivity, and a ____ marginal product of capital. a. lower; lower; higher. b. lower; higher; higher. c. lower; lower; lower. d. higher; higher; lower. 21. If the production functions of rich and poor nations are NOT identical, resulting in lower marginal products of capital for poor nations, then: a. capital markets are basically dysfunctional. b. it must mean the labor productivity for poor nations is higher. c. capital markets cannot be relied on to bring about convergence. d. capital markets may be functioning efficiently and correctly after all. 22. When poor nations cannot compete with rich nations to attract capital because of their lower overall productivity, it creates: a. convergence. b. long-run divergence. c. externalities. d. opportunities for cross-border investment. 23. As long as at least some output shocks are asymmetric, it is possible to: a. avoid all risk. b. lower the volatility of income by international diversification of capital assets. c. lower the risk of default. d. avoid any consumption declines as a result of the shocks. 24. Two nations each own 50% of the capital of the other nation (diversification). What is the situation when labor comprises over 50% of available resources? a. In order to achieve perfect diversification, labor must move from one nation to the other. b. No gain will occur from the diversification. c. The risk from economic shock will be eliminated by the diversification of assets. d. Some risk from economic shocks can be eliminated, but not all. 25. A result of an exchange rate depreciation, would occur as the spending patterns © University of New South Wales This material cannot be used for commercial purposes. 5

© University of New South Wales This material cannot be used for commercial purposes. change in response to a change in the exchange rate. a. expenditure switching from domestic to foreign products b. expenditure switching from foreign to domestic products c. expenditure switching from rural to urban producers d. terms-of-trade deterioration 26. Data on the relationship between the U.S. multilateral real exchange rate and the U.S. trade balance shows a. a surprising result that the decrease in the trade balance is correlated with an increase (depreciation) of the U.S. dollar multilateral real exchange rate. b. a predictable result that the increase in the trade balance is correlated with an increase (depreciation) of the U.S. dollar multilateral real exchange rate. c. a correlation that is so weak it cannot be used to support the theory that the trade balance is related to the real effective exchange rate of the U.S. dollar. d. a surprising result that the increase in the U.S. trade balance occurs with a decrease (appreciation) in the real effective exchange rate of the dollar. 27. The devaluation of a currency results in a(n): a. initial increase in trade balance, but an eventual decline in trade balance. b. permanent decline in trade balance. c. permanent increase in trade balance. d. initial decrease in trade balance, but an eventual increase in trade balance. 28. The J-curve effect means that import prices are higher, thus revenues paid out increase while export prices are lower and incoming revenues decrease. Therefore, after a currency depreciation: a. the trade balance will improve, then decline, then improve, and then decline, appearing to be a series of J shapes. b. the trade balance will increase, then decrease, then jump higher, which economists call the J-curve effect. c. the nation will cut back on imports immediately causing the trade balance to improve, which gives the curve an inverted J shape. d. the trade balance decreases and then increases over time giving the curve a J shape. 29. The trade balance component of aggregate demand is a function of all the following EXCEPT : a. foreign disposable income. b. domestic disposable income. c. the real exchange rate. © University of New South Wales This material cannot be used for commercial purposes. 6

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