AP Macro Quiz: Open Economy Models & Capital Flows

📚 Quick Study Guide

• 🌍 An open economy interacts with other countries through trade in goods & services and financial flows (buying & selling assets).
• ⚖️ The balance of payments records all international transactions. It's composed of the current account and the financial account.
• 💰 The current account (CA) measures trade in goods and services, net income, and net transfers: $CA = Exports - Imports$.
• 📈 The financial account (FA) measures the purchase and sale of assets: $FA = Capital Inflow - Capital Outflow$.
• 🔑 In an open economy, national saving equals domestic investment plus net capital outflow: $S = I + NCO$.
• 💸 Net capital outflow (NCO) is the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.
• 💱 The real exchange rate is the rate at which goods and services of one country trade for the goods and services of another: $Real Exchange Rate = (Nominal Exchange Rate * Domestic Price) / Foreign Price$.
• 💡 A trade surplus (Exports > Imports) implies a positive net capital outflow. A trade deficit (Imports < Exports) implies a negative net capital outflow.

🤔 Practice Quiz

1. Which of the following is included in the financial account?
   1. A) Purchase of U.S. government bonds by a Japanese investor
   2. B) Sale of wheat to China
   3. C) Dividends received from a foreign stock investment
   4. D) A U.S. tourist's expenses in Europe
2. If a country has a trade surplus, what must be true?
   1. A) Its net capital outflow is negative.
   2. B) Its net capital outflow is positive.
   3. C) Its net capital outflow is zero.
   4. D) Its saving is less than its domestic investment.
3. Suppose the nominal exchange rate is 120 Japanese yen per U.S. dollar. A Big Mac costs $5 in the U.S. and 600 yen in Japan. What is the real exchange rate?
   1. A) 0.25 Big Macs
   2. B) 0.5 Big Macs
   3. C) 2 Big Macs
   4. D) 4 Big Macs
4. Which of the following would increase U.S. net capital outflow?
   1. A) An increase in U.S. interest rates
   2. B) A decrease in foreign interest rates
   3. C) Increased confidence in the U.S. economy by foreign investors
   4. D) A government budget surplus
5. If national saving is greater than domestic investment, then:
   1. A) There is a trade deficit.
   2. B) There is a trade surplus.
   3. C) Net capital outflow is negative.
   4. D) The economy is closed.
6. What effect does an increase in the real exchange rate have on net exports, all other things equal?
   1. A) Increases net exports
   2. B) Decreases net exports
   3. C) No effect on net exports
   4. D) Initially increases, then decreases net exports
7. A country experiences a large capital inflow. What is the likely effect on the domestic interest rate and exchange rate?
   1. A) Interest rate increases, exchange rate appreciates
   2. B) Interest rate decreases, exchange rate appreciates
   3. C) Interest rate increases, exchange rate depreciates
   4. D) Interest rate decreases, exchange rate depreciates