2. A. CreditCapital B. CreditCurrent C. DebitCapital D. DebitCurrent E. DebitFinancial

3.  This transaction is counted as a debit for the US because US dollars are flowing out of the US and into Japan. To purchase those computers, the company must first exchange US dollars for Japanese yen. Then the US company spends that yen to buy the Japanese computers. When a transaction earns foreign currency, it is a credit. When a transaction uses foreign currency, it is a debit. Imports are debits and exports are credits.  It is part of the current account, which includes trade on goods and services, unilateral transfers, and income from financial assets.

4. 2. Country ___ has the _____________ advantage in the production of ham and the _____________ advantage in the production of cheese. A. AAbsoluteComparative AAbsoluteComparative B. AComparativeAbsolute AComparativeAbsolute C. AAbsoluteAbsolute AAbsolute D. BAbsoluteComparative BAbsoluteComparative E. BComparativeAbsolute BComparativeAbsolute

5.  Country B has the absolute advantage in the production of ham because it can produce more of ham (200 units of ham) than Country A can (100 units of ham).  Country B has the comparative advantage in the production of cheese because its opportunity cost in producing cheese is lower than Country A’s. For every 1 unit of cheese Country B produces, it has to give up ½ units of ham. For every 1 unit of cheese Country A produces, it has to give up 1 unit of ham. Country B has to give up ½ units less units of ham when producing a unit of cheese than Country A, so it has the comparative advantage in the production of cheese.

6. 3. If the Federal Reserve increased the money supply, what would happen to interest rates, the international value of the dollar, and exports? Interest ratesInternational valueExports A. DecreaseDepreciateIncrease DecreaseDepreciateIncrease B. DecreaseAppreciateIncreaseDecreaseAppreciateIncrease C. IncreaseDepreciateIncreaseIncreaseDepreciateIncrease D. IncreaseAppreciateDecreaseIncreaseAppreciateDecrease E. IncreaseDepreciateDecreaseIncreaseDepreciateDecrease

7.  An increase in the money supply causes the MS curve in the Money Markey diagram to shift to the right, leading to lower interest rates.  When the US has lower interest rates, less foreign investors will put their money into the dollar, because it has a lower rate of return. The demand curve on the FX diagram for dollars shifts to the left, and the dollar depreciates in value.  The depreciation of the dollar will cause US imports to increase because a foreign currency can be exchanged for more US dollars than before the dollar lost value, and so US goods will be cheaper for foreign consumers, increasing their demand for US goods and thus increasing US exports.

8. 4. If a country has a deficit in its current account, then it must have a: A. Deficit in its balance of payments Deficit in its balance of payments B. Deficit in its capital account Deficit in its capital account C. Deficit in its financial account Deficit in its financial account D. Surplus in its capital account Surplus in its capital account E. Surplus in its balance of payments Surplus in its balance of payments

9.  A country’s balance of payments has two accounts: the current account and the capital account. If one account were in a deficit, then the other account must be in a surplus. Money that flows out of a country must flow back in. If that country had deficits in both accounts, it would simply cut off all international economic transactions because money is only draining from their country and not returning.

10. 5. If US interest rates rise relative to those of foreign countries, what happens to the international value of the dollar and how does that affect US exports? International ValueExports A. AppreciateIncrease AppreciateIncrease B. AppreciateDecrease AppreciateDecrease C. DepreciateStays the same DepreciateStays the same D. DepreciateIncrease DepreciateIncrease E. DepreciateDecrease DepreciateDecrease

11.  If our interests rise faster compared to foreign countries, foreigners will want to invest into the dollar because they will get higher rates of return on interest for their investments. This will cause the demand curve on the FX diagram to shift to the right, making the dollar appreciate in value.  Our exports will decrease with increased interest rates because our goods now require more of a foreign currency to purchase than before. For example, say the price of a Snickers bar was $1 and a person living in Japan could exchange 100 yen for $1 to buy that Snickers bar. Now that the value of the dollar appreciated to say 125 yen per $1, that person in Japan now has to pay 125 yen for a Snickers bar rather than the 100 yen before the dollar appreciated.

12. 6. According to the graph above, Country A can produce 1 car for every 4 socks, and Country B can produce 5 cars for every 2 socks. Country A has the comparative advantage in the production of __________ should produce __________ and import __________. A. sockssockscars socks cars B. sockscarssocks sockscarssocks C. sockscarscars sockscars D. cars carssocks cars socks E. cars carscars cars cars

13.  Countries trade according to which country has the comparative advantage in the production of a certain product vs. another country. In this problem, Country A has the comparative advantage in producing socks because it only has to give up ¼ units of cars per 1 unit of sock, while Country B has to give up 2.5 units of cars per 1 sock. Thus Country A should produce socks and import cars from Country B.

14. 7. If Mexico’s economy grows faster than the economy of the US, which curve would shift in the Foreign Exchange Market for US dollars and in which direction? A. DemandRight DemandRight B. DemandLeft DemandLeft C. SupplyRight SupplyRight D. Supply Left Supply Left E. No curves would shift on the FX diagram.No curves would shift on the FX diagram.

15.  As Mexico’s economy grows, Mexicans become wealthier and will thus increase their demand for US goods as well as increase their visits to the US. To purchase these goods and pay for the hotels, travel, food, etc. during their visits, they will need US dollars. This causes an increase in demand for US dollars in the Foreign Exchange market.

16. 8. All of the following are disadvantages when the dollar loses international value (depreciates) except: A. US consumers have to pay more for foreign goods/services US consumers have to pay more for foreign goods/services B. US consumers find traveling to foreign countries more expensive US consumers find traveling to foreign countries more expensive C. US investors/companies find it harder to invest in foreign markets US investors/companies find it harder to invest in foreign markets D. US exports increase US exports increase E. Cost of living in the US increases Cost of living in the US increases

17.  When a country’s currency depreciates, its exports are increased because now foreign consumers have more purchasing power and will increase their demand for that country’s goods/services.  An increase in exports is an advantage because it makes that country’s net exports either more positive or less negative. Net exports contribute to a country’s GDP and thus economic wellbeing. There are four components that make up GDP: consumer spending, government spending, investment spending, and net exports.

18. 9. If the US government increased government spending without increasing taxes, what would happen to the international value of the dollar and to the current account? International valueCurrent account A. AppreciateMove towards a surplusAppreciateMove towards a surplus B. AppreciateMove towards a deficitAppreciateMove towards a deficit C. AppreciateNot enough information to determineAppreciateNot enough information to determine D. DepreciateMove towards a surplusDepreciateMove towards a surplus E. DepreciateMove towards a surplusDepreciateMove towards a surplus

19.  If the US government were to increase government spending but not taxes, it must increase its borrowing out of the loanable funds market, causing the demand curve to shift to the right and thus higher interest rates. When there are higher interest rates in the US, foreign investors put more of their money into US dollars because dollars have a higher rate of return, increasing demand for dollars on the FX diagram and thus causing the dollar to appreciate in value.  The current account moves towards a deficit because when the dollar appreciates, US exports decrease while US imports increase. Trade on goods and services make up a large portion of the current account. When exports decrease and imports increase, more money is flowing out of the US and less is flowing back in, moving the current account towards a deficit.

20. 10. If the rate of inflation in the US is higher than the rate of inflation in Mexico: A. Demand for pesos will increase and the supply of dollars will increase. Demand for pesos will increase and the supply of dollars will increase. B. Demand for pesos will increase and the supply of dollars will decrease. Demand for pesos will increase and the supply of dollars will decrease. C. Demand for pesos will decrease and the supply of dollars will increase. Demand for pesos will decrease and the supply of dollars will increase. D. Demand for dollars will increase and the supply of pesos will increase. Demand for dollars will increase and the supply of pesos will increase. E. Demand for dollars will decrease and the supply of pesos will increase. Demand for dollars will decrease and the supply of pesos will increase.

21.  If inflation in the US rises faster than inflation in Mexico, US dollars have lose purchasing power while Mexican pesos gain purchasing power. This will cause an increase in demand for Mexican pesos and thus appreciation of the peso. Higher rates of inflation cause a currency to depreciate while lower rates of inflation cause a currency appreciate.  Because pesos now have more purchasing power, international buyers will want to invest more into the peso, increasing demand on the FX diagram for pesos. To purchase these pesos, buyers must supply their own currency, in this case US dollars, thus increasing supply on the FX diagram for dollars.