Chapter 15
1. Currency devaluation affects a country's trade balance via its impact on relative prices (elasticity approach), spending behavior (absorption approach), and the purchasing power of money balances (monetary approach).
2. See Question 1.
3. The Marshall-Lerner condition refers to the elasticities approach to devaluation. It suggests that devaluation works best at improving a country's trade balance when demand elasticities are high (i.e., the sum of the domestic demand elasticity for imports plus the foreign demand elasticity for exports exceeds one). Empirical studies suggest that demand elasticity for most countries are quite high.
4. The J-curve effect implies that due to time lags between the response of goods traded to relative price changes (e.g., recognition lags), currency devaluation will have a more pronounced effect on a country's trade balance over the longer run.
5. The extent to which changing currency values lead to changes in import and export prices is known as the pass-through relationship. Pass-through is important since buyers have incentives to alter their purchases of foreign goods only to the extent that the prices of these goods change in terms of their domestic currency following a change in the exchange rate.
6. The absorption approach concludes that currency devaluation best improves the trade balance when the country faces a trade deficit along with domestic unemployment.
7. The monetary approach suggests currency devaluation affects the domestic price level and the purchasing power of money balances, which lead to changes in domestic expenditures and the level of imports.
8. The 50 percent dollar appreciation results in a 50 percent increase in the firm's production cost in terms of the peso.
9. The 50 percent dollar appreciation results in a less-than 50 percent increase in the firm's production cost in terms of the peso.
10. a. Export quantity 1000, 1300, 1030
Import quantity 150, 120, 147
Export price $3000, $3000, $3000
Export receipts $3 million, $3.9 million, and $3.09 million
Import price $20,000, $22,000, $22,000
Import payments $3 million, $2.64 million, $3.234 million
Trade balance $0, $1.26 million, -$144,000
b. The dollar depreciation improves (worsens) the U.S. trade balance when the sum of the export-demand elasticity and the import-demand elasticity are greater (less) than 1.0.
c. Because the sum of the export-demand elasticity and the import-demand elasticity are less than 1.0, the U.S. trade balance will worsen.
Chapter 17
1. Internal balance consists of full employment with price stability. External balance consists of balance-of-payments equilibrium. Overall balance consists of internal balance plus external balance.
2. International economic policy makes use of expenditure-switching instruments (e.g., import tariffs) and expenditure-changing instruments (e.g., monetary policy).
3. An expenditure-changing policy refers to a government’s attempt to induce changes in aggregate demand, via fiscal policy (e.g., taxes, government expenditures) or monetary policy (e.g., open market operations, reserve requirements). An expenditure-switching policy attempts to divert expenditures away from foreign goods to domestic goods. Currency devaluation and import barriers are examples of expenditure-switching policies.
4. International economic policy formation faces political constraints such as society’s willingness to bear inflation or unemployment as part of the balance-of-payments adjustment process.
5. Currency devaluation (depreciation). Currency revaluation (appreciation).
6. Under a fixed exchange rate system, fiscal policy is successful in promoting internal balance while monetary policy is unsuccessful.
7. Under a floating exchange rate system, monetary policy is successful in promoting internal balance while fiscal policy is unsuccessful.
8. An expansionary monetary policy leads to a worsening in the home-country’s trade account and capital account, and thus deterioration in the overall balance-of-payments position. A concretionary monetary policy leads to an improvement in the home-country’s trade account and capital account, and thus an improvement in the overall balance-of-payments position.
9. An expansionary fiscal policy improves the nation’s balance-of-payments position if the resulting net-capital inflows more than offset the resulting trade-account deficit; if the trade-account deficit more than offsets the net-capital inflows, the overall balance-of-payments position deteriorates.
10. Policy agreement occurs when a given policy can improve two (or more) economic objectives at the same time. Policy conflict occurs when a given policy improves one objective while detracting from another objective; a dilemma thus exists concerning which objective to pursue.
11. Unemployment-with-BOP-surplus, policy agreement. Inflation-with-BOP-deficit, policy agreement. Unemployment-with-BOP-deficit, policy conflict. Inflation-with-BOP-surplus, policy conflict.
12. Examples of obstacles to successful international economic policy coordination include: (1) different national economic objectives, (2) different national institutions, (3) different national political climates, (4) different phases in the business cycle, and (5) lack of guarantee that governments can design and implement policies that are capable of achieving the intended results.
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