Question 1

In the context of a small open economy with perfect capital mobility, which of the following equations correctly represents the relationship between national saving, domestic investment, and net capital outflow?

Accepted Answer

$$S = I + NCO$$

Question 2

Suppose the world interest rate increases. According to the model, what is the most likely effect on the real exchange rate and net exports in a small open economy?

Accepted Answer

The real exchange rate depreciates and net exports rise.

Question 3

If a government budget deficit increases in a small open economy, what is the sequence of effects according to the model?

Accepted Answer

National saving falls, net capital outflow decreases, the real exchange rate appreciates, and net exports fall.

Question 4

Which of the following best describes the effect of an import quota on the trade balance in a small open economy?

Accepted Answer

It does not change the trade balance because the real exchange rate appreciates, offsetting the initial increase in net exports.

Question 5

A sudden increase in political instability causes capital flight from a country. What are the likely effects on the country’s interest rate and currency value?

Accepted Answer

Interest rates rise and the currency depreciates.

Question 6

If national saving in a small open economy is less than domestic investment, what can be inferred about net capital outflow and the trade balance?

Accepted Answer

Net capital outflow is negative and the country is running a trade deficit.

Question 7

Which of the following policies would most likely cause the domestic currency to appreciate in the foreign-currency exchange market?

Accepted Answer

A decrease in net capital outflow due to increased foreign investment in domestic assets.

Question 8

Suppose Parliament passes an investment tax credit, subsidizing domestic investment. What is the effect on the real exchange rate and net exports?

Accepted Answer

The real exchange rate appreciates and net exports decrease.

Question 9

Which of the following identities must always hold in the model of a small open economy?

Accepted Answer

$$NCO = NX$$

Question 10

If the Canadian government increases the tax on corporate profits, reducing domestic investment, what is the likely effect on the real exchange rate and net exports?

Accepted Answer

The real exchange rate depreciates and net exports rise.

Question 11

Which of the following best explains why trade policies such as tariffs or quotas do not affect the overall trade balance in a small open economy?

Accepted Answer

Because the real exchange rate adjusts, offsetting any initial change in net exports caused by the policy.

Question 12

If Europeans suddenly become very interested in investing in Canada, what is the likely long-run effect on Canada’s capital stock?

Accepted Answer

Canada’s capital stock will increase due to higher domestic investment.

Question 13

Which of the following is the best example of capital flight?

Accepted Answer

Investors rapidly sell domestic assets and buy foreign assets due to political instability.

Question 14

In the market for foreign-currency exchange, what determines the supply of domestic currency?

Accepted Answer

Net capital outflow

Question 15

If the supply of loanable funds increases in a small open economy, what is the likely effect on net capital outflow and the real exchange rate?

Accepted Answer

Net capital outflow increases and the real exchange rate depreciates.

A Macroeconomic Theory of the Small Open Economy: Loanable Funds, Foreign Exchange, and Policy Impacts

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