Solutions to Fall 2014 Week 7 Tutorial Questions (Ch5)

Solutions to Fall 2014 Week 7 Tutorial Questions (Ch5)
Chapter 5:
Q1: Macroeconomics P.177 Review Questions #2
Q2: Macroeconomics P.177 Review Questions #4
Q3: Macroeconomics P.177 Numerical Problems #1
Q4: Macroeconomics P.177 Numerical Problems #3
Q5: Macroeconomics P.179 Analytical Problems #8
Q1:
What is the key difference that determines whether an international transaction
appears in the current account or the capital account?
Answer:
Q2:
How do a country’s current and capital account balances affect its net foreign
assets? If country A has greater net foreign assets per citizen than does country B,
is country A necessarily better off than country B?
Answer:
Q3:
The current account includes only the trade of currently produced goods
and services. Trades of existing assets are counted in the capital account.
In any period the net amount of new foreign assets that a country
acquires equals its current account surplus, which in turn must equal its
capital account deficit. A country with greater net foreign assets than
another is not necessarily better off. What really counts is total national
wealth, which consists of both net foreign assets and net domestic assets.
For example, Canada has lower net foreign assets than other countries,
but has a relatively high level of total national wealth per citizen.
Here are some balances of payment data (without pluses and minuses):
Merchandise exports, 100
Merchandise imports, 125
Service exports, 90
Service imports, 80
Investment income receipts from assets, 110
Investment income payment on assets, 140
Transfers from home country to other countries, 10
Increase in home country’s ownership of assets abroad, 160
Increase in foreign ownership of assets in home country, 200
Increase in home reserve assets, 30
Increase in foreign reserve assets, 35
Week 7
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Solutions to Fall 2014 Week 7 Tutorial Questions (Ch5)
Find the merchandise trade balance, net exports, the current account balance, the
capital account balance, the official settlement balance, and the statistical
discrepancy.
Answer:
The merchandise trade balance equals merchandise exports minus
merchandise imports, which equals 100 –125 = –25.
Current Account
Credits (+)
Debits (-)
Merchandise
100
120
Services
90
80
Income from/to foreigners
110
140
Net unilateral transfers
Total
10
300
355
Current account balance (CA) = 300 –355 = –55.
Net exports (NX) = (100 + 90) –(125 + 80) = –15.
Capital Account
Credits (+)
Increase in home country assets abroad
Debits (–)
160
Increase in foreign assets in home country 200
Total
200
160
Notice that the increase in home reserve assets is just a subcategory of the increase in
home country assets, so it is not included separately. Similarly, the
increase in foreign reserve assets is just a subcategory of the increase in
foreign assets in the home country. The information about the changes
in home and foreign reserve assets is included Jot calculation of the
official settlements balance only; it does not affect the capital account.
Capital account balance (KA) = 200 –160 = 40.Statistical discrepancy
(SD): CA + KA + SD = 0–55 + 40 + SD = 0SD = 15
Official settlements balance = increase in home official reserve assets minus increase
in foreign official reserve assets = 30 –35 = –5.
Q4:
Week 7
In a small open economy,
Desired national saving, Sd = $10 billion + ($100 billion)rw
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Solutions to Fall 2014 Week 7 Tutorial Questions (Ch5)
Desired investment, Id = $15 billion – ($100 billion)rw
Output, Y = $50 billion
Government purchases, G = $10 billion
World real interest rate, rw = 3%
a. Find the economy’s national saving, investment, current account surplus, net
exports, desired consumption, and absorption.
Answer:
All variables but interest rates are in billions of dollars.
S = 10 + (100 ×0.03) = 13
I = 15 – (100 x 0.03) = 12
NX = CA = S –I = 13 –12 = 1
C = Y – (I + G + NX) = 50 – (12 + 10 + 1) = 27
A = C + I + G= 27 + 12 + 10 = 49
b. Owing to a technological innovation, the country’s desired investment rises by $2
billion at each level of the world real interest rate. Repeat part (a).
Answer:
S = 13, as before.
I = 17 – (100 x 0.03) = 14
NX = CA = S –I = 13 –14 = –1
C= Y–(1 + G + NX) = 50 – (14 + 10 –1) = 27
A = C + I + G=27 + 14 + 10= 51
Q5:
Analyze the effects on a large open economy of a temporary adverse supply shock
that hits only the foreign economy. Discuss the impact on the home country’s
national saving, investment, and current account balance – and on the world real
interest rate. How does your answer differ if the adverse supply shock is worldwide?
Answer:
Week 7
A temporary adverse supply shock hitting the foreign economy causes
the foreign saving curve to shift up, from S1Forto S2Forin Fig. 5.7.
This raises the equilibrium world real interest rate, increasing home
country saving and decreasing home country investment. Since saving
rises and investment falls, the home country's current account balance
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Solutions to Fall 2014 Week 7 Tutorial Questions (Ch5)
increases. If the shock is worldwide, then the effect on the current
account depends on how big the shift to saving is in the home country
relative to the foreign country, as well as on the slope of the investment
curve. If the saving curves shift just right, the current account may be
unchanged, as shown in Fig. 5.8. In any event, the world real interest
rate increases, and saving and investment in both countries decline.
(Graph is drawn in tutorials)
Week 7
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