AP Macro Unit 6

Which of the following is recorded in a country’s balance of payments accounts?

• The monthly payments by the country’s residents on domestic loans

• Financial capital flows between the country and the rest of the world

• The value added by each industry in the country at each stage of production

• The aggregate spending of the country’s residents on consumer goods

Answer explanation

The balance of payments records the country’s international transactions, which include financial capital flows between the country and the rest of the world.

Which of the following transactions is recorded as a credit entry in the country’s current account?

• Imports of capital goods

• Exports of consumer goods

• Purchases of foreign government bonds

• Income transfers from the country’s residents to recipients abroad

Answer explanation

Exports are recorded in the current account balance and increase a country’s current account balance because exports cause money to flow into the country and therefore they are a credit entry in its current account.

The table shows Country X’s balance of payments data for 2018. Which of the following is true about Country X’s current account balance and financial capital flows?

• Country X has a current account deficit of −$65

  million and has net financial capital inflows.

• Country X has a current account surplus of $65 million and has net financial capital outflows.

• Country X has a current account deficit of −$60

  million and has net financial capital inflows.

• Country X has a current account surplus of $60 million and has net financial capital outflows.

Answer explanation

The current account balance is the sum of net exports (exports − imports), net income from abroad, and net unilateral transfers, which is equal to $235 million−$300 million + $20 million + (−$15 million)=−$60 million. Therefore, the current account is in deficit of $60 million. Financial capital flows move in the opposite direction to the goods and services trade claims that give rise to them. Thus, a country with a current account deficit necessarily has a financial capital account surplus (i.e., net financial capital inflows).

The table shows the exchange rate for the British pound (£) against the dollar ($) and the euro (€) in 2015 and 2018. Which of the following is true?

• The dollar has depreciated against the British pound.

• The British pound has depreciated against the dollar.

• The British pound has appreciated against the dollar.

• The British pound has depreciated against the euro.

Answer explanation

The exchange rate of the British pound decreased from $1.52 to $1.36. It takes fewer dollars to buy the pound. Therefore, the British pound has depreciated against the dollar, or the dollar has appreciated against the British pound.

The graph shows the foreign exchange market for British pounds (GBP) . If the exchange rate is $1.70, which of the following is true?

• The surplus of British pounds will cause the exchange rate to depreciate.

• The shortage of British pounds will cause the exchange rate to depreciate.

• The surplus of British pounds will cause the exchange rate to appreciate.

• The shortage of British pounds will cause the exchange rate to appreciate.

Answer explanation

The exchange rate of $1.70 per pound is a disequilibrium exchange rate as it is above the equilibrium exchange rate. It creates a surplus of British pounds in the foreign exchange market and puts downward pressure on the exchange rate, driving the exchange rate toward equilibrium at $1.50 per pound. Therefore, the pound will depreciate.

Assuming the government of a country imposes a tariff on its imports of foreign goods, what is the likely effect on the country’s currency in foreign exchange markets?

• The supply of the currency will increase and the currency will depreciate.

• The supply of the currency will increase and the currency will appreciate.

• The supply of the currency will decrease and the currency will appreciate.

• The demand for the currency will decrease and the currency will appreciate.

Answer explanation

Tariffs imposed on imports of foreign goods increase the price of imported goods and cause domestic consumers to buy fewer foreign goods, which decreases the demand for foreign currency and decreases the supply of the domestic currency, causing the currency to appreciate.

Assume Country X’s economy is experiencing high rates of inflation. Which of the following policies will control the problem of inflation, and what is the consequent effect on the value of Country X’s currency in foreign exchange markets?

• A contractionary monetary policy will increase interest rates, which will cause the currency to depreciate.

• A contractionary monetary policy will increase interest rates, which will cause the currency to appreciate.

• An expansionary monetary policy will decrease interest rates, which will cause the currency to appreciate.

• An expansionary monetary policy will decrease interest rates, which will cause the currency to depreciate.

Answer explanation

A contractionary monetary policy will decrease aggregate demand, real output, and the price level, which will decrease inflation. A contractionary monetary policy will decrease the money supply and increase interest rates, attracting foreign financial capital (financial capital inflows), increasing the demand for the country’s currency, and causing the currency to appreciate.

Assume that a nation’s government uses an expansionary fiscal policy to restore full employment. What effect will the resulting change in the price level have on the supply and demand of the nation’s currency in the foreign exchange market?

• The supply and demand will both increase.

• The supply and demand will both decrease.

• The supply will increase and the demand will decrease.

• The supply will decrease and the demand will increase.

Answer explanation

An expansionary fiscal policy will increase aggregate demand, which increases the price level. The higher domestic price level will make domestic goods more expensive relative to foreign goods, which increases the supply of the nation’s currency so that residents can buy relatively less expensive foreign goods and decreases the demand for the nation’s currency by foreigners because goods become more expensive.

Which of the following will happen to aggregate demand in the United States if the United States dollar appreciates in foreign exchange markets?

• Aggregate demand will decrease because net exports will decrease.

• Aggregate demand will decrease because imports will decrease.

• Aggregate demand will increase because exports will increase.

• Aggregate demand will increase because imports will decrease.

Answer explanation

An appreciation in the dollar increases the purchasing power of the dollar, which makes imports relatively cheaper for domestic consumers and makes domestic goods (or exports) relatively expensive for foreign consumers. This causes an increase in imports and a decrease in exports, which causes net exports to fall and aggregate demand to decrease.

Which of the following changes in the United States will most likely increase aggregate demand in Japan?

• An increase in the demand for Japanese financial assets by American investors

• A decrease in the United States price level

• A quota imposed by the United States on goods imported from Japan

• An appreciation of the United States dollar relative to the yen

Answer explanation

An appreciation of the dollar is a depreciation of the yen, which makes Japanese goods (Japanese exports) relatively less expensive than American goods; this increases net exports in Japan and so increases aggregate demand in Japan.