Assignment 4& 5
1. Suppose the French suddenly develop a strong taste for California wines. Answer the following questions in words and with a diagram.
a. What happens to the demand for dollars in the market for foreign currency exchange? DEMAND FOR DOLLARS INCREASES
b. What happens to the value of dollars in the market for foreign currency exchange?
RISES
c. What happens to the quantity of net exports? NX INCREASES
2. Suppose the United States decides to subsidize the export of U.S. agricultural products, but it does not increase taxes or decrease any other government spending to offset this expenditure. Using a 3-panel diagram, show what happens to national savings, domestic investment, net capital outflow, the interest rate, the exchange rate, and the trade balance. Also explain in words how the U.S. policy affects the amount of imports, exports and net exports.
a. FIGURE 6
3. Suppose that reasl interest rates increase across Europe. Explain how this development will affect net capital outflow. Then explain how it will affect US net exports by using a formula from this chapter and drawing a diagram. What will happen to the US real interest rate and the real exchange rate.
a. NCO BECOMES NEGATIVE FOR EUROPE, REDUCES SUPPLY OF EUROS, MAKES EUROPEAN ASSETS MORE ATTRAC TIVE
b. INCREASES US NCO FOR ANY INTEREST RATE, SUPPLY OF DOLLARS INCREASES MORE PEOPLE TRYING TO BUY EUROS, DEMAND FOR LOANABLE FUNDS INCREASES MORE PEOPLE TRYING TO GET LOANS TO GET EUROPEAN ASSETS, INTEREST RATES RISE. EXCHANGE RATE FALLS.
4. A case study in the chapter analyzed purchasing power parity for several countries using the price of big macs. Here is the data for a few more countries: (Country, price of a big mac in that countries currency, predicted exchange rate, actual exchange rate): (chile, 2050 pesos, ? peso/$, 472peso/$), (Hungary, 830 forints, ?forints/$, 217 forits/$), (Czech republic,70 korunas, n?korunas/$, 18.9 korunas/$), (Brazil, 11.25 real, ?real/$, 1.99real/$), (Canada, 5.41C$, ?C$/$, 1.00 C$/$).
a. For each country, compute the predicted exchange rate of the local currency per U.S. dollar. (Recall that the U.S. price of a big mac was $4.37.)
PESO=(472*4.37)/2050
b. According to the purchasing power parity, whaT is the predicted exchange rate between the Hungarian forint and the canadian dollar? What is the actual exchange rate?
c. How well does the theory of purchasing power parity explain exchange rates?
5. A can of soda costs $1 in the United States and 16 pesos in Mexico. What is the peso-dollar exchange rate if purchasing-power parity holds? If a monetary expansion caused all prices in Mexico to double, so that the soda rose to 32 pesos, what would happen to the peso-dollar exchange rate?
6. How would the following transactions affect US net capital outflow? Also state whether each involves direct investment or portfolio investment.
a. An American cellular phone company establishes an office in the Czech republic.
b. Harrods of London sells stock to the general electric pension fund.
c. Honda expands its factory in Marysville ohio.
d. A fidelity mutual fund sells its volkswagon stock to a French investor.
7. If the tax rate is 40%, compute the before tax real interest rate in each of the following cases.
a. Nominal interest rate is 10%, and the inflation rate is 5%.
b. Nominal interest rate is 6% and the inflation rate is 2%
c. Nominal interest rate is 4% and inflation is 1%
8. Suppose that people expect inflation to equal 3% but in fact prices rise by 5%. Describe how this unexpectedly high inflation rate would help or hurt the following:
a. The government
b. A homeowner with a fixed rate mortgage
c. A union worker in the second year of a labor contract
d. A college that has invested some of its endownment on government bonds
9. It is sometimes suggested that the fed should try to achieve zero inflation. If we assume that velocity is constant, does this zero inflation goal require that the rate of money growth equal 0? If yes explain why. If no, explain what the rate of money grown should equal.