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Chapter 32

A Macroeconomic Theory of the Open Economy

Educators


Problem 1

Japan generally runs a significant trade surplus. Do you think this is most related to high foreign
demand for Japanese goods, low Japanese demand for foreign goods, a high Japanese saving rate
relative to Japanese investment, or structural barriers against imports into Japan? Explain your answer.

Kaylee M.
Numerade Educator

Problem 2

Suppose that Congress is considering an investment tax credit, which subsidizes domestic
investment.
a. How does this policy affect national saving, domestic investment, net capital outflow, the interest rate, the exchange rate, and the trade balance?
b. Representatives of several large exporters oppose the policy. Why might that be the case?

Kaylee M.
Numerade Educator

Problem 3

The chapter notes that the rise in the U.S. trade deficit during the 1980s was due largely to the
rise in the U.S. budget deficit. On the other hand, the popular press sometimes claims that the
increased trade deficit resulted from a decline in the quality of U.S. products relative to foreign
products.
a. Assume that U.S. products did decline in relative quality during the 1980s. How did this affect net
exports $at$ $any$ $given$ $exchange$ $rate$?
b. Draw a three-panel diagram to show the effect of this shift in net exports on the U.S. real exchange
rate and trade balance.
c. Is the claim in the popular press consistent with the model in this chapter? Does a decline in the
quality of U.S. products have any effect on our standard of living? ($Hint:$ When we sell our goods
to foreigners, what do we receive in return?)

Yi Chun L.
Washington University in St Louis

Problem 4

An economist discussing trade policy in $The$ $New$ $Republic$ wrote: "One of the benefits of the United States removing its trade restrictions [is] the gain to U.S. industries that produce goods for export. Export industries would find it easier to sell their goods abroad$-$even if other countries didn't follow our example and reduce their trade barriers." Explain in words why U.S. $export$ industries would benefit from a reduction in restrictions on $imports$ to the United States.

Kaylee M.
Numerade Educator

Problem 5

Suppose the French suddenly develop a strong taste for California wines. Answer the following questions in words and with a diagram.
a. What happens to the demand for dollars in the market for foreign-currency exchange?
b. What happens to the value of the dollar in the market for foreign-currency exchange?
c. What happens to U.S. net exports?

Kaylee M.
Numerade Educator

Problem 6

A senator renounces his past support for protectionism: "The U.S. trade deficit must be
reduced, but import quotas only annoy our trading partners. If we subsidize U.S. exports instead, we can
reduce the deficit by increasing our competitiveness." Using a three-panel diagram, show the effect of an
export subsidy on net exports and the real exchange rate. Do you agree with the senator?

Yi Chun L.
Washington University in St Louis

Problem 7

Suppose the United States decides to subsidize the export of U.S. agricultural products, but it does not
increase taxes or decrease any other government spending to offset this expenditure. Using a three-panel diagram, show what happens to national saving, domestic investment, net capital outflow, the interest rate, the exchange rate, and the trade balance. Also explain in words how this U.S. policy affects the amount of imports, exports, and net exports.

Yi Chun L.
Washington University in St Louis

Problem 8

Suppose that real interest rates increase across Europe. Explain how this development will affect U.S. net capital outflow. Then explain how it will affect U.S. net exports by using a formula from the chapter and by drawing a diagram. What will happen to the U.S. real interest rate and real exchange rate?

Yi Chun L.
Washington University in St Louis

Problem 9

Suppose that Americans decide to increase their saving.
a. If the elasticity of U.S. net capital outflow with respect to the real interest rate is very high, will
this increase in private saving have a large or small effect on U.S. domestic investment?
b. If the elasticity of U.S. exports with respect to the real exchange rate is very low, will this increase in
private saving have a large or small effect on the U.S. real exchange rate?

Yi Chun L.
Washington University in St Louis