Question 1

Suppose Canada has net exports of $50 billion and domestic investment of $200 billion. According to the open-economy saving-investment identity, if national saving is $260 billion, what is the value of net capital outflow (NCO)?

Accepted Answer

$50 billion

Question 2

If the nominal exchange rate between the Canadian dollar (CAD) and the US dollar (USD) is $E = 0.8$ USD per CAD, the price level in Canada is $P = 120$, and the price level in the US is $P^* = 100$, what is the real exchange rate ($e$) of CAD to USD?

Accepted Answer

$e = 0.96$

Question 3

Which of the following best describes the relationship between net exports (NX) and net capital outflow (NCO) in an open economy?

Accepted Answer

Net exports always equal net capital outflow: $NX = NCO$

Question 4

According to the theory of purchasing-power parity (PPP), the nominal exchange rate $E$ is given by which of the following formulas?

Accepted Answer

$E = \frac{P^*}{P}$

Question 5

If the Bank of Canada increases the money supply, what is the expected effect on the nominal exchange rate of the Canadian dollar according to PPP theory?

Accepted Answer

The Canadian dollar will depreciate

Question 6

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

Accepted Answer

All goods are perfectly tradable and have no transportation costs

Question 7

In a small open economy with perfect capital mobility, if the domestic real interest rate $r$ is lower than the world real interest rate $r^*$, what is likely to happen?

Accepted Answer

Capital will flow out of the domestic economy, increasing $r$

Question 8

Suppose the nominal exchange rate between the euro and the Canadian dollar is $E = 1.5$ euros per CAD, the price of a basket of goods in Canada is $P = 200$, and in Europe is $P^* = 300$. According to PPP, what should the nominal exchange rate be?

Accepted Answer

$E = 1.0$

Question 9

Which of the following statements about net capital outflow (NCO) is correct?

Accepted Answer

NCO is positive when domestic residents purchase more foreign assets than foreigners purchase domestic assets

Question 10

If the real exchange rate between Canada and the US is greater than 1, what does this imply about the relative price of Canadian goods?

Accepted Answer

Canadian goods are more expensive than US goods

Question 11

Which of the following is an example of arbitrage that would enforce the law of one price?

Accepted Answer

Buying wheat in Canada where it is cheaper and selling it in the US where it is more expensive

Question 12

If national saving in an open economy is less than domestic investment, what must be true?

Accepted Answer

Net capital outflow is negative and the country is borrowing from abroad

Question 13

Which of the following would cause the Canadian dollar to appreciate in nominal terms?

Accepted Answer

An increase in the nominal exchange rate (more foreign currency per CAD)

Question 14

Which of the following is a limitation of the interest rate parity condition in the real world?

Accepted Answer

Differences in default risk and tax rates across countries

Question 15

Suppose the price of a basket of goods in Canada is $P = 150$, in the US is $P^* = 100$, and the nominal exchange rate is $E = 0.7$ USD per CAD. What is the real exchange rate?

Accepted Answer

$e = 1.05$

Question 16

If the US runs a trade deficit with China, what does this imply about the US net capital outflow?

Accepted Answer

US net capital outflow is negative; the US is borrowing from abroad

Question 17

Which of the following best describes a small open economy with perfect capital mobility?

Accepted Answer

It takes the world interest rate as given and can borrow or lend freely in world markets

Question 18

If the real exchange rate between Canada and the US is less than 1, what does this suggest about Canadian goods relative to US goods?

Accepted Answer

Canadian goods are less expensive than US goods

Question 19

Which of the following would NOT be considered a reason for deviations from purchasing-power parity (PPP)?

Accepted Answer

All goods are perfectly tradable and have no transportation costs

Question 20

If the domestic price level rises while the nominal exchange rate remains constant, what happens to the real exchange rate?

Accepted Answer

The real exchange rate increases, making domestic goods more expensive relative to foreign goods

Open-Economy Macroeconomics: Basic Concepts (Chapter 12) – Study Notes

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