The Open Economy: International Trade and Finance — Practice Quiz
A Macroeconomics cheat sheet for The Open Economy: International Trade and Finance — every key formula with its symbols defined — plus a medium-level practice quiz to test recall.
Formulas & key concepts
A summary of a country's transactions with the rest of the world over a period.
The part of the balance of payments recording trade in goods and services, factor income, and transfers with other countries.
The difference between a country's exports and imports of both goods and services.
The difference between a country's exports and imports of goods alone, ignoring services.
The part of the balance of payments recording sales and purchases of assets between a country and the rest of the world.
The market in which currencies are traded and exchange rates are determined.
The price of one country's currency expressed in terms of another country's currency.
A rise in the value of a currency relative to other currencies.
A fall in the value of a currency relative to other currencies.
The exchange rate at which the quantity of a currency demanded equals the quantity supplied in the foreign exchange market.
The nominal exchange rate adjusted for the two countries' price levels; the current account responds to this, not to the nominal rate.
The exchange rate that would make a basket of goods and services cost the same in two countries; it is a good predictor of changes in the nominal exchange rate.
The set of rules a government follows in managing its currency's exchange rate.
A regime in which the government acts to hold the exchange rate at a target level.
A regime in which the exchange rate is left free to fluctuate with market forces.
Government buying or selling of its own currency to keep a fixed exchange rate, which requires holding foreign exchange reserves.
Stocks of foreign currency a government holds so it can intervene in the foreign exchange market.
Legal restrictions on the buying and selling of foreign currency, sometimes used to defend a fixed exchange rate.
Stable exchange rates bring benefits, but the tools to fix them are costly: intervention ties up reserves, controls distort incentives, and using monetary policy to defend the rate makes it unavailable for domestic goals.
A reduction in the target level of a fixed exchange rate, which eliminates a currency surplus and increases aggregate demand.
An increase in the target level of a fixed exchange rate, which eliminates a currency shortage and reduces aggregate demand.
Expansionary monetary policy lowers interest rates, depreciating the currency, which raises exports and cuts imports and so increases aggregate demand; contractionary policy does the reverse.
Because one country's imports are another's exports, business cycles are linked across countries, though floating exchange rates can weaken that link.
International flows of savings connect countries' loanable funds markets, so capital inflows and outflows help shape domestic interest rates and the balance of payments.
Practice quiz
Which of the following best describes the purpose of the Balance of Payments Accounts?
- A. To summarize a country's transactions with the rest of the world over a period.
- B. To record only a country's exports and imports of goods.
- C. To track the government's budget surplus or deficit.
- D. To measure the total value of goods and services produced domestically.
Answer: A. To summarize a country's transactions with the rest of the world over a period.
A country selling a significant amount of its government bonds to foreign investors would primarily be recorded in which part of its Balance of Payments?
- A. The Current Account
- B. The Merchandise Trade Balance
- C. The Financial Account
- D. The Balance of Payments on Goods and Services
Answer: C. The Financial Account
If the exchange rate changes from $1$ U.S. dollar = $0.85$ Euro to $1$ U.S. dollar = $0.95$ Euro, what has occurred to the U.S. dollar relative to the Euro?
- A. Appreciation
- B. Depreciation
- C. Devaluation
- D. Revaluation
Answer: A. Appreciation
The Real Exchange Rate is crucial for understanding a country's international competitiveness because it:
- A. Is the nominal exchange rate adjusted for the two countries' price levels.
- B. Directly reflects the difference between a country's exports and imports of goods.
- C. Is the exchange rate at which the quantity of a currency demanded equals the quantity supplied.
- D. Predicts changes in the nominal exchange rate based on a basket of goods.
Answer: A. Is the nominal exchange rate adjusted for the two countries' price levels.
According to the concept of Purchasing Power Parity (PPP), the exchange rate that would make a basket of goods and services cost the same in two countries is a good predictor of:
- A. The long-term trend of the nominal exchange rate.
- B. Short-term fluctuations in the real exchange rate.
- C. The level of foreign exchange reserves.
- D. The balance of payments on goods and services.
Answer: A. The long-term trend of the nominal exchange rate.
Which of the following is a characteristic of a Floating Exchange Rate regime?
- A. The government acts to hold the exchange rate at a target level.
- B. It requires the government to hold significant foreign exchange reserves.
- C. The exchange rate is left free to fluctuate with market forces.
- D. It often involves legal restrictions on buying and selling foreign currency.
Answer: C. The exchange rate is left free to fluctuate with market forces.
For a government to successfully maintain a Fixed Exchange Rate through Exchange Market Intervention, it primarily requires:
- A. A high domestic interest rate.
- B. Large stocks of foreign currency (foreign exchange reserves).
- C. A persistent current account surplus.
- D. Strict foreign exchange controls.
Answer: B. Large stocks of foreign currency (foreign exchange reserves).
A government decides to implement a Devaluation of its currency. What is the expected immediate effect on the economy?
- A. An increase in aggregate demand.
- B. A reduction in aggregate demand.
- C. An increase in the target level of the fixed exchange rate.
- D. A currency shortage.
Answer: A. An increase in aggregate demand.
Under a Floating Exchange Rate regime, if a central bank implements an expansionary monetary policy, how does this typically affect aggregate demand?
- A. It raises interest rates, appreciating the currency, and decreasing aggregate demand.
- B. It lowers interest rates, depreciating the currency, and increasing aggregate demand.
- C. It lowers interest rates, appreciating the currency, and increasing aggregate demand.
- D. It raises interest rates, depreciating the currency, and decreasing aggregate demand.
Answer: B. It lowers interest rates, depreciating the currency, and increasing aggregate demand.
What is the key distinction between the Merchandise Trade Balance and the Balance of Payments on Goods and Services?
- A. The Merchandise Trade Balance includes factor income and transfers, while the other does not.
- B. The Balance of Payments on Goods and Services includes only goods, while the other includes both goods and services.
- C. The Merchandise Trade Balance considers only goods, while the Balance of Payments on Goods and Services includes both goods and services.
- D. The Merchandise Trade Balance is part of the Financial Account, while the other is part of the Current Account.
Answer: C. The Merchandise Trade Balance considers only goods, while the Balance of Payments on Goods and Services includes both goods and services.
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