EC410 Spring 2019 Final Exam 1. (6 points) Define or explain ALL THREE terms on this page. The quality and accuracy of your answers matter! Exchange rate band Dollarization Currency manipulation 2. (6 points) State how the appreciation of the U.S. dollar against other world currencies affects the following: Whirlpool, a U.S.-based manufacturer and exporter of home appliances is _____________________ (better off, worse off, not affected) A real estate developer in Miami, selling elite condos to wealthy foreigners is _____________________ (better off, worse off, not affected) An agency selling to Americans adventure tours to Nepal and Tanzania is ________________________ (better off, worse off, not affected) The amount of tariffs the U.S. government collects from imported products _______________________ (increases, decreases, is not affected) 2 EC410 Spring 2019 Final Exam 3. (2.5 pts) The lecture and the textbook discussed the limitation known as “the trilemma” each country involved in international economic activities has to face. Put check marks next to the conditions from the following list that are part of the trilemma. ____ Free trade in goods and services ____ Fixed exchange rate ____ International mobility of capital ____ International mobility of labor ____ Ability to conduct independent economic policies (1.5 pts) Out of the conditions you checked, how many can be satisfied simultaneously? a) none b) one c) two d) three 4. (10 points total) At 4:15pm on Monday, the Federal Reserve will publish last week’s exchange rates. After 4:15pm (Eastern time, I assume) on Monday, go to http://www.federalreserve.gov/releases/h10/current and answer the following questions using the information for May 3, 2019. a. (4 pts) Look up May 3rd , 2019 spot exchange rates between the U.S. dollar and the Japanese yen, and between the U.S. dollar and the British pound and state them below in the following formats. In all cases, use at least three meaningful digits (so, for example, 0.000136, not 0.0001): EJPY/USD = EUSD/JPY = EGBP/USD = EUSD/GBP = b. (4 pts) Use Internet sources of your choice and look up the “historical” exchange rate between the U.S. dollar and the Japanese yen for May 3, 2018. State it below, using one of the two formats provided in part a. Provide the link to the source you used: What happened to the value of the Japanese yen relative to the U.S. dollar over the course of the year that passed between the two dates? The Japanese yen has ____________________ against the US dollar by approximately ________ %. (appreciated, depreciated) (no less than two digits) c. (2 pts) Use the information from part a to determine the most recent (May 3, 2019) Japanese-yen-to-Britishpound spot exchange rate. Show your work. EJPY/NZD = 3 EC410 Spring 2019 Final Exam 5. (8 points total) Two neighboring countries, Zambonia and Farmia, can fish or make quilts. Both production processes use labor as the only factor. It takes a Zambonian four hours to catch a bucket of fish (enough to feed a family) and twenty hours to make a quilt. For a Farmian, it takes six hours to catch a bucket of fish and ninety hours to make a quilt. Use your knowledge of the Ricardian model of trade to answer the following questions. a. True/False questions (1.5 pts each, no explanation required). T F – The autarkic price ratio in Farmia is 1 quilt = 15 buckets of fish. T F – The autarkic price ratio in Zambonia is 1 bucket of fish = 5 quilts. T F – Zambonia has an absolute advantage in both goods. T F – Zambonia has a comparative advantage in both goods. b. (2 pts) If the two countries decide to trade, the production of which of the two goods should Farmia specialize in and why? 6.a. (4 pts) Write two versions of the interest parity condition, the exact one and the approximate one. In class, we used the US dollar and the euro. Please use British pounds in place of the euro. (1+ iUS) = ------------------------ iUS = + ----------------------------- b. (4 pts) Using the dollar-to-euro exchange rate from the most recent foreign exchange table and one of the formulas above, answer the following question: If twelve-month certificates of deposit (CD) issued by British banks currently yield 3% annually while dollardenominated twelve-month CDs issued by U.S. banks yield 1.5%, what 12-month forward exchange rate between the euro and the dollar is required for the interest parity condition to hold? Show your work. c. (2 pts) Does the market expect the British pound to appreciate or depreciate? 4 EC410 Spring 2019 5 Final Exam EC410 Spring 2019 Final Exam 7. Multiple choice questions. Each question is worth 1.5 points. 7.1. Virtually all the coffee consumed in the United States is imported. On the world scale, the U.S. is a large consumer of coffee. Which of the following is the most accurate description of what would happen in the U.S. market for coffee if the U.S. government imposes a tariff on imported coffee? a) A decrease in demand for coffee. b) An increase in demand for coffee. c) An increase in supply of coffee. d) A decrease in supply of coffee. 7.2. Virtually all the coffee consumed in the United States is imported. On the world scale, the U.S. is a large consumer of coffee. If the U.S. government imposes a tariff on imported coffee, what would be the effect on the U.S. terms of trade? a) The U.S. terms of trade will improve. b) The U.S. terms of trade will worsen. c) The direction of the effect will depend on the size of the countries with which the U.S. is trading. d) The U.S. terms of trade will remain unchanged. 7.3. Virtually all the coffee consumed in the United States is imported. On the world scale, the U.S. is a large consumer of coffee. What will be the effect of the U.S. tariff on imported coffee, on the overall economic welfare of the United States? a) The U.S. economic welfare will improve. b) The U.S. economic welfare will decrease. c) The U.S. economic welfare will not be affected. d) The effect on the U.S. economic welfare may be positive or negative. 7.4. Which of the following statements is correct? a) A quota raises the price of imported goods in the recipient country while a tariff does not. b) A tariff raises the price of imported goods in the recipient country while a quota does not. c) Neither a tariff nor a quota affects the price of imported goods in the recipient country. d) Both a quota and a tariff raise the price of imported goods in the recipient country. 7.5. Foreign direct investment involves several types of risks. Hedging is the most effective in protecting against which type of risks? a) Political risks. b) Foreign exchange risks. c) Risk of commercial losses. d) Risk of expropriation. 7.6. Three countries enter into an agreement to remove all tariffs and trade barriers between them. They also agree on a common trade policy with regard to non-members. Faced with political backlash, the countries stop short of allowing mobility of factors of production such as labor and capital. Which of the following terms best describes this arrangement? a) Customs union b) Economic union c) Political union d) Common market e) Free trade area 7.7. The practice of selling goods in a foreign market at a lower price than that in the originating country is called a) offshoring. b) dumping. c) countervailing. d) insourcing. e) subsidizing. 6 EC410 Spring 2019 Final Exam 7.8. Earlier this year, U.S. federal prosecutors opened a criminal investigation of China’s Huawei Technologies Co, for a) using components purchased from North Korea. b) selling their products in the U.S. at unfairly low prices. c) stealing commercial secrets from U.S. companies. d) selling their products in the U.S. at unfairly high prices. 7.9. The reason for the 25% tariffs on Chinese imports imposed by the U.S. earlier this year was stated to be... a) to compensate US for intellectual property theft by China. b) to make a statement to Canada and Mexico. c) to punish China for their currency manipulation. d) to incentivize US consumers to “buy North American”. 7.10. As was uncovered in the last trivia, trade negotiations are currently going on between Japan and the US. Japan requested that the US removes tariffs on Japanese steel and aluminum, in returns for the U.S.’ request to do what? a) ease the rules for patenting American inventions in Japan. b) maintain a favorable exchange rate between the dollar and the yen. c) open Japanese market for American agricultural goods. d) reduce the price for Japanese electronics sold in the U.S. 7.11. Another trade deal currently negotiated is between the U.S and the European Union. One item on the agenda is the elimination of tariffs on industrial goods. Which of the following most accurately describes the attitude towards that proposal among the EU countries? a) Italy was the most in favor of it, Greece voted against it. b) Denmark was the most in favor of it, Belgium voted against it. c) Poland was the most in favor of it, Spain voted against it. d) Germany was the most in favor of it, France voted against it. 7.12. In the course of these negotiations, the EU also voiced its objections to the US government subsidies to... a) Boeing. b) Microsoft. c) dairy farmers. d) agriculture in general. 8. (9 points) True or False? For each of the following statements, circle “T” if you think the statement is true and “F” if you think the statement is false. No explanation is required. Each statement is worth 1.5 points. T F – A tariff is more likely to improve the importing country’s well-being when that country is small. T F – The appreciation of the U.S. dollar would help the U.S. keep its manufacturing jobs. T F – Exchange rates are more volatile than prices of goods and services. T F – According to the Ricardian model, technologically advanced countries gain from trade whereas underdeveloped countries are hurt by trade. T F – Depreciation of the national currency makes imports into that country more expensive. T F – In year 2018, the volume of international investment flows between the U.S. and China was smaller than in year 2016. 7 EC410 Spring 2019 Final Exam 9. (4 pts) Explain the differences between a customs union and a monetary union. Which of the two represents the higher degree of economic integration among countries? 10. (7 points) a. Carefully explain whether strengthening of the U.S. dollar is more likely to increase the U.S. trade deficit or to decrease it, and why. b. Which of the world countries had the largest trade surplus in year 2018? c. Which of the world countries had the largest trade deficit in 2018? 8 EC410 Spring 2019 Final Exam 11. (7 points) As you may know, many Hollywood actors are in fact Canadian-born. A lobby group in the Canadian Parliament is pushing forward the idea of a “Keep Talent At Home” campaign. The essence of their proposal is to develop a proper movie industry in Canada. They argue that doing so would keep talented actors in their home country and create jobs. Due to the obvious presence of economies of scale in movie-making, the Canadian industry would need some time – approximately ten or fifteen years – to grow before it can really compete with Hollywood, but after that it would create steady jobs for Canada and produce better movies than Hollywood does, and at a lower cost, making the entire world better off. The group argues that until the industry reaches that critical size, it needs to be protected from international competition. The group is therefore asking for subsidies to the developing movie industry and a tax on non-Canadian movies shown and distributed in Canada. 7.1. This argumentation follows the pattern typical of the a) optimal tariff argument b) infant industry protection argument c) preferential trade agreement d) foreign direct investment argument e) anti-dumping legislation 7.2. You were asked to help the Canadian free-trade group build the argument against granting protection to the Canadian movie industry. Briefly list the points you are going to use in your argumentation. Use full sentences! Feel free to use more space if you need to. 9 EC410 Spring 2019 Economists believe that the Fed will raise rates and the ECB will continue to cut. Final Exam 12. (20 points total) The quote on your left was taken from an April 26, 2016 Wall Street Journal article entitled “An African Tale of Two Currencies”. Of course, “the Fed” here stands for the “U.S. Federal Reserve”, “the ECB” for “the European Central Bank”, and “rates” refer to benchmark interest rates. a. (2 pts) If the majority of market players share the beliefs outlined in the quote, what effect will they have on the forward dollar-to-euro exchange rate? Be brief. b. (4 pts) Use the diagram below to graphically illustrate the effect of the aforementioned expectations (and ONLY expectations!) on the current dollar-to-euro exchange rate. iUS Rate of return US EU (M/P)US U.S. money market E$/euro Foreign exchange market c. (5 pts) Next, let’s go back to the original quote. Suppose the prediction turns out to be true on both accounts: 1) the US Fed raises the rates, and 2) the ECB lowers the rates. Show how these two events affect the two graphs below. If you make any shifts, mark them “1” and “2” accordingly. iUS Rate of return US EU (M/P)US U.S. money market E$/euro Foreign exchange market d. (2 pts) Your overall conclusion: These events will cause the U.S. dollar to ____________________ against the euro. (appreciate, depreciate) 10 EC410 Spring 2019 e. (3 pts) The same article mentioned on the previous page goes on to say…. (see the insert) → The CFA franc used by Ivory Coast is pegged to the euro whereas the Nigerian currency, the naira, is pegged to the U.S. dollar. So far, the central banks of both countries are able to successfully maintain the peg. Given the exchange rate dynamics you have forecasted on the previous page, and assuming everything else equal, which country’s economy (Nigeria or Ivory Coast) do you expect to perform better? Explain your opinion. Final Exam Many African businesses are waiting to see what the central banks will do this year. The success of Jean-Louis Menudier’s business in Ivory Coast is tied to the European Central Bank, but for Funsho Peters in Nigeria, the U.S. Federal Reserve is key. Many African countries are affected by the monetary policy of central banks thousands of miles away because their currencies are pegged to either the euro or the dollar. f. (4 pts) Why would Ivory Coast or Nigeria want to use a currency peg rather than let their currencies float freely? 13. (4 points) Abundastan is a relatively labor abundant country. Which group – capital owners or workers – in that country do you expect to favor international trade more? Carefully explain why. 11
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