Jim Whitney Economics 311

Problem Set 5

1. Based on the political economy of trade protection, account for each of the following in a sentence or two:
a. Why surveys indicate that the majority of the U.S. public favors increased protectionism even though the costs to U.S. consumers of the country's protectionist policies exceed $30 billion per year.
b. Why politicians tend to prefer trade protection to production subsidies even when production subsidies cause a smaller national welfare loss than trade protection. (Use a diagram to support your answer to this question.)
c. Why the costs of protection may be closer to the entire consumer costs of the protection rather than just the conventional efficiency losses.
 
2. Consider the attached worksheet, Examples of International Transactions.
a. Calculate the missing international transactions subtotals and balances.
b. Which countries, if any, experienced net lending with respect to the rest of the world during the reported year? How can you tell?
 
3. Consider the following exchange rate information:
Foreign currency per dollar
EU Euro Japanese Yen
April 1, 2004 0.81301 104.400
April 1, 2005 0.77155 107.230
a. Over the period indicated, did the U.S. dollar appreciate or depreciate against the EU euro? Against the Japanese yen? How did you decide?
b. Did the euro appreciate or depreciate against the Japanese yen over the same period? How did you decide?
 
4. Suppose the US and Japan (J) produce, consume and trade cars and personal computers (PCs). US and Japanese cars are imperfect substitutes for each other, as are US and Japanese PCs. On balance, the US is a net exporter of PCs and a net importer of cars.
a. Assuming that the present exchange rate is 100 yen per dollar, complete the following table:
  Price of US goods... Price of Japanese goods...
  in dollars in yen in yen in dollars
Cars $10,000   1,000,000 yen  
PCs 2,000   200,000 yen  
b. Now suppose that the value of the dollar rises to 125 yen, with no other changes. Re-compute prices to complete the following table:
  Price of US goods... Price of Japanese goods...
  in dollars in yen in yen in dollars
Cars $10,000   1,000,000 yen  
PCs 2,000   200,000 yen  
c. What has happened to the international competitiveness of US auto producers? US PC producers?
 

 

5.  a.  Complete the Comparing domestic and foreign returns worksheet <faculty.oxy.edu/whitney/classes/ec311/handouts/d32_h1_ipc_tru_evid.htm>.
b.  Rank the covered interest arbitrage earnings for U.S. savers from high to low.
c.  For each country, indicate whether covered interest arbitrage or uncovered interest arbitrage was the more profitable option for U.S. savers.
 
6. Consider the following information about the economies of Mexico and the U.S.:
1. 2004 2005 %D, 2004-5
2. Exchange rate, end of period (pesos per dollar) 11.286 10.898 -3.4%
3. Mexico: Consumer price index (2000=100): 122.3 127.1 4.0%
4. US: Consumer price index (2000=100): 109.7 113.4 3.4%
5. Interest rate on deposits:
6.    US 3.51%
7.    Mexico 3.46%
For each of the following, be sure to show your work, or at least any key formulas you used:
a. In nominal terms, did the dollar depreciate or appreciate against the Mexican peso in 2005? How did you decide?
b. Based on purchasing power parity, should the dollar have appreciated or depreciated against the Mexican peso in 2005? By what percent? Support your answer.
c. In real terms, did the dollar depreciate or appreciate against the Mexican peso in 2005? By what percent? Support your answer.
d. If you had deposited your savings in Mexico from the end of 2004 to the end of 2005, what overall rate of return would you have earned? Support your answer.
 
7. a. What would cause a country's currency to depreciate...
(1) according to the purchasing-power approach to exchange rate determination?
(2) according to the asset-market approach to exchange rate determination?
b. Which approach helps to explain why the real exchange rate tends to deviate from its purchasing power parity (PPP) level over short-run time periods? Explain briefly how this happens.
 

 

Jim Whitney Economics 311 
Examples of international transactions
(Figures are in billions of U.S. dollars)
Line   United States China Argentina
1 Year 2005 2005 2005
2 Currency units Bill US$ Bill. US$ Bill. US$
3 Goods: Exports 898.46 762.5 40.1
4 Goods: Imports -1,677.40 -628.3 -27.3
5 Services: Credit (receipts) 376.79 74.4 6.2
6 Services: Debit (payments) -314.58 -83.8 -7.6
7 Income: Credit (Domestic income earned abroad) 474.65 39.0 4.1
8 Income: Debit (Foreign income earned within) -463.35 -28.3 -10.3
9 Current Transfers: Credit (received) 15.78 27.7 1.2
10 Current Transfers: Debit (paid) -101.85 -2.3 -0.6
11 Private capital account transactions, net 767.0 62.9 1.6
12 Reserves and Related Items 14.10 -207.3 -7.6
13 Net Errors and Omissions 10.41 -16.5 0.2
       
International transactions subtotals:      
14 Trade balance (sum lines 3-4) -778.94    
15 Services balance (sum lines 5-6) +62.21    
16 Net factor income (sum lines 7-8) +11.29    
17 Net transfers (sum lines 9-10) -86.07    
18. Current account balance (sum lines 14-17) -791.51