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# ps8ans - ECON 305 INTERMEDIATE MACROECONOMICS SPRING 2011...

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ECON 305: INTERMEDIATE MACROECONOMICS SPRING 2011 MARK MOORE PROBLEM SET 8 SOLUTIONS A. CHAPTER 18 Quick Check 1. a. True. b. False. c. False. d. False. e. False. f. The statement should read: “Given the definition of the exchange rate adopted in this chapter, if the dollar is the domestic currency and the euro the foreign currency, a nominal exchange rate of 1.10 means that one dollar is worth 1.1 euros.” This statement is True. g. False. 2. Domestic Country Balance of Payments (\$) Current Account Exports 25 Imports 100 Trade Balance -75 (=25-100) Investment Income Received 0 Investment Income Paid 15 Net Investment Income -15 (=0-15) Net Transfers Received -25 Current Account Balance -115 (=-75-15-25) Capital Account Increase in Foreign Holdings of Domestic Assets 80 (=65+15) Increase in Domestic Holdings of Foreign Assets -50 Net Increase in Foreign Holdings 130 (=80-(-50)) Statistical Discrepancy -15 (=115-130) Foreign Country Balance of Payments (\$) Current Account

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Exports 100 Imports 25 Trade Balance 75 (=100-25) Investment Income Received 15 Investment Income Paid 0 Net Investment Income 15 (=15-0) Net Transfers Received 25 Current Account Balance 115 (=75+15+25) Capital Account Increase in Foreign Holdings of Domestic Assets -50 Increase in Domestic Holdings of Foreign Assets 80 (=65+15) Net Increase in Foreign Holdings -130 (=-50-80) Statistical Discrepancy 15 (=130-115) 3. a. The nominal return on the U.S. bond is 10,000/(9615.38)–1=4%. The nominal return on the German bond is 6%. b. Uncovered interest parity implies that the expected exchange rate is given by E(1+i*)/(1+i)=0.75(1.06)/(1.04)=0.76 Euro/\$. c. If you expect the dollar to depreciate, purchase the German bond, since it pays a higher interest rate and you expect a capital gain on the currency. d. The dollar depreciates by 4%, so the total return on the German bond (in \$) is 6% + 4% =10%. Investing in the U.S. bond would have produced a 4% return. e. The uncovered interest parity condition is about equality of expected returns, not equality of actual returns. Dig Deeper 4. a. GDP is 15 in each economy. Consumers will spend 5 on each good. b. Each country has a zero trade balance. Country A exports clothes to Country B, Country B exports cars to Country C, and Country C exports computers to Country A. c. No country will have a zero trade balance with any other country. d. There is no reason to expect that the United States will have balanced trade with any particular country, even if the United States eliminates its overall trade deficit. A particularly large trade deficit with one country may reflect the pattern of specialization rather than trade barriers.
5. a. The relative price of domestic goods falls. Relative demand for domestic goods rises. The domestic unemployment rate falls in the short run. b.

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ps8ans - ECON 305 INTERMEDIATE MACROECONOMICS SPRING 2011...

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