Economics 2150A/B Study Guide - Quiz Guide: Currency Crisis, Excess Supply, Capital Flight

1.

In an open economy with global capital markets and mobile capital:

A) a country has control over both its domestic money supply and exchange rate.

B) a country has control of either its domestic money supply or exchange, but not both.

C) a country only has control over its domestic money supply.

D) a country only has control over its exchange rate.

2.

An overvalued fixed exchange rate can be maintained only as long as:

A) the country's central bank reserves are available to support currency intervention in the foreign exchange market.

B) the country's central bank can increase the domestic money supply.

C) the country's government increases debt financing.

D) none of the above.

3.

The decrease in demand faced by McDonald's during 2001-2002 can be attributed to:

A) decrease in consumer preference for high-fat content food.

B) increase in lawsuits.

C) increase in competitive pressures.

D) all of the above.

Assume the central bank engages in aggressive open market purchases in an effort to stimulate the domestic economy. The nation has flexible exchange rates and the central bank does not intervene in the foreign exchange markets.

a) The change in R causes foreign money to flow (into or out of) the nation. This causes the domestic currency to (appreciate or depreciate).

b) The combined effect of changes in R, PI and RGDP causes the domestic currency to (appreciate or depreciate).

c) The depreciation of the domestic currency will tend to (increase or decrease) exports and NE but the changes in PI and RGDP will (increase or decrease) NE. The net result will be an (increase or decrease) in NE.

d) NE will tend to (support or oppose) the goal of stimulating the nation’s economy.

Just as with the price of a good, the price, or exchange rate, of a currency is determined by supply and demand. However, rather than using a traditional supply and demand analysis as shown in Marthinsen, currency traders often consider whether foreign funds will flow into or out of a country as a result of a particular economic circumstance. If foreigners wish to make domestic purchases or investments, the foreign currency must first be exchanged for the domestic currency. Thus, foreign funds flowing into a country increase the demand for the domestic currency and it appreciates. Funds flowing out reverse this process leading to depreciation of the domestic currency. In the table, place an X to indicate whether each economic condition will cause foreign funds to flow in or out of the country and whether the domestic currency will appreciate or depreciate.