PS07___Answers_ - EC 340 Spring 2011 Problem Set 7 Divide a...

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Unformatted text preview: EC 340 Spring 2011 Problem Set 7 Divide a sheet of paper into four quadrants. Label the columns of the resulting table as credits (+) and debits (‐), and label the rows as current account and financial account. You should then have a table that resembles the following: Credits (+) Debits (‐) Current Account Financial Account This table represents the U.S. balance of payments statement. Place each of the following entries in the proper cell in the table. 1. An auto assembly plant in Michigan buys $1 million of parts from a Canadian supplier. This is a debit in the current account since it is an import of goods. 2. The auto assembler pays for the parts by writing a check drawn on an account at Michigan National Bank. This is a credit in the financial account. An increase in foreign holdings of U.S. assets is recorded as a credit in the financial account. The check is an instruction to the bank to transfer ownership of the account from the American to the Canadian. 3. A U.S. Mutual Fund buys $10 million of shares of stock in a Brazilian company. This is a debit in the financial account. An increase in U.S. holding of foreign assets is recorded as a debit in the financial account. 4. The U.S. Mutual Fund pays for the stock by writing a check on a bank account that it maintains in Brazil. This is a credit in the financial account. The logic is the same as in the answer to question 2. It does not matter where the checking account is maintained. In either case, it was an asset initially owned by an American, then ownership changed to a foreigner. 5. The American Red Cross donates $5 million of medical supplies to earthquake relief efforts in Japan. (Hint: there should be two entries for this item.) The credit and debit are both in the current account. The credit is essentially an export of medical supplies. The debit is the offset required by double‐entry bookkeeping and is considered a “unilateral transfer”. 6. An American pension fund receives $1 million of interest income from British bonds that it owns. This is a credit in the current account. Investment income received is recorded as a credit in the current account. Investment income paid is a debit in the current account. 7. The interest income on British bonds is paid with a check written on a U.S. bank account that the bond issuer holds. This is a debit in the financial account. This is the reverse of the examples in questions 2 and 4. In those questions, the American was writing the check. In this example, the American receives the check. 8. A Canadian university hires an American architect to design a new residence hall. This is a credit in the current account. This is an export of architectural services. 9. The Canadian university pays the architect $1 million with a check written on a U.S. bank account. This is a debit in the financial account. The logic is the same as in the answer to question 7. 10. An American company pays $1 million to its Indian employees who staff its call center in Bangalore. This is a debit in the current account. It is an import of services. 11. The company pays with checks drawn on its British bank account. This is a credit in the financial account. The logic is the same as in questions 2 and 4. 12. Having entered all of the above information, calculate the balances of the current account and the financial account of the U.S. balance of payments. The balance of both accounts is zero in this situation. 13. Suppose that national saving is $1,000 and investment spending is $1,200. What is the value of net exports? Net Exports = National Saving – Investment =$ 1,000 – $1,200 = ‐$200 14. Suppose that net exports are $400, private saving is $1,500, and government saving is ‐$600. What is the value of investment spending? Net Exports = Private Saving + Government Saving – Investment, so: ‐$400 = $1,500 ‐$600 ‐ Investment. Solving for Investment: Investment = $1,500 ‐ $600 + $400 = $1,300 15. Suppose that the government reduces taxes by $100. Further suppose that this does not change government spending, private saving, or investment. What will be the impact on net exports? Net exports will fall by $100 since Net Exports = Private Saving + (Taxes – Government Spending) – Investment. 16. Suppose that GDP is $14,000, consumption spending is $10,000, Investment spending is $3,000, and government spending is $2,000, and exports are $1,000. What is the value of imports? GDP = C + I + G + (EX – IM), so: $14,000 = $10,000 + $3,000 +$2,000 + ($1,000 – IM) Which implies that IM = $10,000 + $3,000 + $2,000 + $1,000 ‐ $14,000 = $2,000. ...
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This note was uploaded on 11/11/2011 for the course EC 340 taught by Professor Ballie during the Spring '10 term at Michigan State University.

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