Problem Set #7
Economics 100b; Spring 1996; Brad DeLong
1. In a closed economy, national savings must be equal to national
investment. Does the same hold true in an open economy, with
international trade. Why or why not?
2. Suppose that a TV set in the US costs $300, and sells for 6000
yuan in China. What would purchasing-power-parity suggest should be
the equilibrium exchange rate between dollars and yuan?
3. In a small open economy, what effect does an increase in
government purchases have? How about a closed economy? How about a
large open economy?
4. Suppose that the government enacts an investment tax credit that
boosts investment as a function of the interest rate, and offsets the
effect of the credit on overall taxes by raising income taxes enough
to replace the lost revenue. What effect does such an ITC have in a
large open economy?
5. Why might purchasing-power-parity fail to hold? That is, why might
there be systematic differences between the nominal exchange rate and
the relative price levels in two countries?
6. The U.S. savings rate is low relative to other industrial
countries. If the U.S. was a closed economy, would its rate of
investment as a share of GDP be higher or lower than that of other
industrial countries? Why?
7. When Francois Mitterand was first elected president in France in
1981, many investors feared that the socialist president would bring
higher inflation and renewed instability. French citizens increased
their lending outside the country, and their purchases of foreign
assets. Foreigners became less willing to lend to the French. How
would you analyze such a shift in investors' preferences for assets
in one country relative to the rest of the world? What would you
expect happened to the French economy (a small open economy) in the
wake of Mitterand's election?
8. Canada's nominal interest rates are four percentage points per
year above U.S.nominal interest rates. Assuming that investments in
Canada and the U.S. are equally risky, what does this differential
tell you about investors' expectations of the future course of the
Canada-US exchange rate?