Exam 2: Practice exam

1.	Suppose that Australia is a small country in each of the situations below. Consider each case separately, use a domestic market diagram for each one, and start out from a situation of free trade in each case. Be sure to illustrate in your diagrams the relevant gains or losses which result from the dumping in each case.
	a.	Australia imports apparel. Will Australia's welfare rise, fall, remain the same, or change in an uncertain direction if exporters begin dumping their output on the world market?
	b.	Australia exports wheat. Will Australia's welfare rise, fall, remain the same, or change in an uncertain direction if other exporters begin dumping their output on the world market (assume that Australia still finds it better to export wheat than to import it at the new global price)?
	c.	Australia initially exports iron ore. Will Australia's welfare rise, fall, remain the same, or change in an uncertain direction if other exporters begin dumping their output on the world market at a price low enough to turn Australia into an importer of iron ore?

2.	In each of the following cases, indicate whether you think the current trade-restriction policy is a "first-best" policy option or not. If so, explain why. If not, propose a policy alternative that you think more directly and efficiently addresses the goal of the policymakers referred to each case.
	a.	The European Union has trade restrictions against bananas grown outside its former colony areas. The US has protested these restrictions, but EU policymakers argue that the restrictions provide economic assistance to their former colony countries.
	b.	The European Union restricts non-EU television broadcasts to no more than 49 percent of European air time. The US has protested these restrictions, but EU policymakers argue that their program producers can't afford the high cost of producing the more popular US-style programs, so they need the trade restrictions to promote European culture.
	c.	The European Union bans beef imports from the US because US beef is treated with growth hormones, which EU policymakers oppose for health reasons. The US has protested the ban, since no studies have shown any adverse health risks associated with growth hormones in beef, but EU policymakers have argued that their consumers are still skeptical and prefer not to eat hormone-treated beef.

3.	For each of the following events, indicate whether trade theory suggests that the event will make national welfare (1) rise, (2) fall, or (3) change in an uncertain direction. Explain your decision in each case--you do not need to draw any diagrams to receive full credit.
	a.	Mexico, a small-country importer of household appliances, unilaterally reduces its tariffs on appliances by 50%.
	b.	Japan, a large-country exporter of minivans, imposes an export tax on its minivan exports.
	c.	Brazil implements an export subsidy on coffee.
	d.	Chile signs a free-trade agreement with the European Union.
	e.	Peru, which lacks effective pollution controls for its high-cost petroleum-refining industry, begins importing refined petroleum products.

4.	a.	Answer each of the following questions as succinctly as you can (avoid complete sentences when possible):
		(1)	Indicate the expression for a country's net foreign investment (NFI), and use it to show the four ways a country can reduce its dependence on borrowing from abroad.
		(2)	In terms of international competitiveness, what pair of trade policies would have the same effect on a country as a 10% real depreciation of its currency?
		(3)	State the three components of the open-economy trilemma, and indicate the resulting policy implication.
	b.	Decide whether each of the following is true or false, and briefly explain your answer in each case:
		(1)	It would be surprising to observe the simultaneous occurrence of: (1) an appreciation of the yen relative to the mark, (2) a depreciation of the dollar relative to the mark, and (3) an appreciation of the dollar relative to the yen.
		(2)	The low elasticity of demand for OPEC oil is a necessary and sufficient condition to explain why OPEC countries experience a J-curve effect when their real exchange rate depreciates.
		(3)	The adjustment process related to the phenomenon of exchange-rate overshooting can account for the simultaneous occurrence of a deteriorating current account and a depreciating currency.

Use a foreign sector (NX/NFI) diagram to illustrate an initial balanced current account (NX=0) equilibrium.

Now suppose that interest rates rise abroad.

(1)

Depict the impact of this event in your diagram.

(2)

If the country has floating exchange rates, what will happen to the country's exchange rate? To its current account balance? Will the change in its current account balance tend to make domestic output rise or fall? Explain briefly.

(3)

If the country has fixed exchange rates, what will the country have to do to maintain its fixed rate? Will this policy response tend to make the country's domestic output rise or fall? Explain briefly.

At the start of the 1990s, several members of the European Union, including Germany, France, and the United Kingdom maintained fixed exchange rates with each other as part of the European Monetary System. In 1992, due in part to the costs of German reunification, interest rates in Germany rose. France decided to defend its exchange rate, while the United Kingdom did not. Consider the following unemployment-rate information:

Unemployment rates:	France	United Kingdom
1992	10.4%	10.1%
1996	12.5%	8.2%

In light of the analysis you have done in this problem, are you surprised by the changes in unemployment for France and the UK? Why or why not?

6.	The popular press often prints conflicting statements at different times about the consequences of macroeconomic events. For each of the following pairs of conflicting quotes, decide which one makes more economic sense, and explain your answer. (Note: you can receive full credit without drawing any graphs, and if you do draw graphs, you must still provide explanations as well.)
	a.	From 2 articles in the Los Angeles Times sometime prior to 1997:
		(1)	To bring the value of the dollar down, the U.S. will have to reduce its budget deficit.
		(2)	It is true that the elimination of the budget ...deficit would help strengthen the dollar.
	b.	From: "Euro's Continued Slide to Record Low Baffles Many Economists," Los Angeles Times, April 28, 2000:
		(1)	"[T]he euro's collapse coincides with a strengthening of the economies of the Western European countries that use it. Growth has been accelerating significantly since mid-1999 and is forecast to reach 3.4% this year."
		(2)	Increasingly wary, investors have been voting against the new European money, leading to an exodus of long-term capital. The net outflow of direct investment capital from the euro zone last year totaled $ 135 billion, slowing Europe's economic revival, according to the London-based Financial Times.
	c.	From 2 articles published in the Los Angeles Times on the same day, May 2, 2002:
		(1)	"Euro Signals Global Transition": The euro has risen against the dollar to more than 90 cents from about 85 cents in the last month. This reflects a decline in foreign investment in U.S. government and corporate securities, as investors have diversified into the euro, says Scott Weiner, managing principal of Payden & Rygel, a Los Angeles investment firm with operations in Europe.... [T]he huge shifts in the world economic scene...are likely to be positive for the U.S. economy.
		(2)	"Rift Opens Over U.S. Trade Deficit": "[T]he dollar continued its recent pullback [fall] against key currencies, including the euro and the yen" which could "drive the nation back into recession."