Open and Closed Economy Quiz

True or False. Write TRUE if the statement is correct, otherwise write FALSE. If the
statement is FALSE, underline the item/statement which made it false and write below
the number the correct item/statement.(2pts each)

1. In a three-sector economy, the government levies taxes on household and firms,

purchase goods and services from firms, and receive factors of production from
the household sector.
2. The Government must increase its expenditure to increase the aggregate
demand, purchasing power, and money supply in an economy necessary to
combat deficiency.
3. Trade and capital flows have a major impact on the country’s economy and affect
economic process such as economic growth, exchange rates, and interest rates.
4. Limited interdependence with the external sector also increases the contagion
effect.
5. The percentage nominal appreciation equals the percentage real appreciation
plus the difference between domestic and foreign inflation.

Provide a brief explanation/discussion on the following items:

1. Differentiate Capital and Current account. (2pts)

2. How does the domestic economy relate to the external sector? (5pts)
3. Cite one example of a country closely associated with closed economy. (2pts)
4. Explain the process of the Circular Flow for a Three Sector Economy (4pts)
5. What are the implications of Purchasing Power Parity? Explain. (2pts)

Problem Solving: (10pts)

Given:
Y = 5,000,
G = 1,000,
T = 1,000,
C = 250 + 0.75(Y −T),
I = 1,000 − 50r, NX = 500 − 500e,
r = r* = 5.

a. In this economy, solve for national saving, investment, the trade balance, and the
equilibrium exchange rate. (4.5pts)
b. Suppose now that G rises to 1,250. Solve for national saving, investment, the trade
balance, and the equilibrium exchange rate. Explain what you find. (4.5pts)
c. Now suppose that the world interest rate rises from 5 to 10 percent. (G is again
1,000.) (1pt)