Macroeconomics Canadian 7th Edition Abel Test Bank 1

Macroeconomics, 7Ce
Chapter 5: Saving and Investment in the Open Economy
Test Bank for Macroeconomics Canadian 7th

Edition Abel Bernanke Croushore Kneebone
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Chapter 5 Saving and Investment in the Open Economy
5.1 Multiple-Choice Questions
1) Canada's balance of payment accounts

A) are a record of all Canadian international transactions.
B) are part of the national income accounting.
C) show a flow of funds into Canada as credit and the flow of funds out of Canada as debit.
D) all of the above.
Answer: D
Diff: 1 Type: MC Page Ref: 132
2) The merchandise trade balance is a country's

A) exports of goods.
B) net exports of goods.
C) exports of goods and services.
D) net exports of goods and services.
Answer: B
3) If a country's merchandise exports exceed its merchandise imports

A) it has a trade surplus.
B) it has a trade deficit.
C) it has a current account surplus.
Copyright © 2016 Pearson Canada Inc. 5-81
Macroeconomics, 7Ce
D) it has a current account deficit.

Answer: A
4) If France has a trade deficit, then

A) imports into France exceed exports from France.
B) exports from France exceed imports into France.
C) imports into Canada from France exceed exports from Canada into France.
D) imports into France from Canada exceed exports from France into Canada.
Answer: A
5) If all international factor payment flows are investment income, then net investment income
from abroad equals
A) net exports.
B) the current account balance.
C) the trade balance.
D) net factor payments from abroad.
Answer: D

Macroeconomics, 7Ce
6) If Canada donates footballs to Japan, how is the transaction recorded on the Canadian balance
of payments accounts?
A) debit: merchandise trade; credit: capital account
B) debit: capital account; credit: merchandise trade
C) debit: net unilateral transfers; credit: merchandise trade
D) debit: merchandise trade; credit: net unilateral transfers
Answer: C
7) The current account balance consists of

A) the trade balance plus the services balance.
B) net exports of goods and services, minus net unilateral transfers.
C) net exports of goods and services, plus investment income from abroad, plus net unilateral
transfers.
D) net exports of goods and services, plus investment income from abroad, plus net unilateral
transfers, minus the capital account balance.
Answer: C
8) If a Canadian firm buys stereos from a Japanese firm and the Japanese firm uses the dollars it
gets to buy Canadian Treasury bonds, what items are recorded in the Canadian balance of
payments accounts?
A) credit the trade account; credit the capital account
B) credit the trade account; debit the capital account
C) debit the trade account; debit the capital account
D) debit the trade account; credit the capital account
Answer: D
9) Suppose a wealthy Saudi Arabian prince donates 2000 camels to the San Diego Zoo. The
Canadian trade balance ________ and the current account balance ________.
A) falls; rises
B) rises; rises
C) is unchanged; is unchanged
D) falls; is unchanged
Answer: C
10) If a Canadian company imports 10 Toyotas from Japan at $15,000 each, and the Japanese
company buys airline tickets on a Canadian airline with the money, how does this affect the
Canadian balance of payments accounts?
A) debit: merchandise trade; credit: capital account
B) debit: capital account; credit: merchandise trade
C) debit: merchandise trade; credit: services
D) debit: services; credit: merchandise trade
Answer: C

Macroeconomics, 7Ce
11) If a French company sells 1000 gallons of Perrier to a Canadian company at 25 francs per
gallon and uses the money to buy stock in a Spanish cork company, how does this affect the
French balance of payments accounts?
A) debit: capital account; credit: merchandise trade
B) debit: merchandise trade; credit: capital account
C) debit: net investment income from abroad; credit: capital account
D) debit: merchandise trade; credit: net investment income from abroad
Answer: A
12) Which of the following would be part of the nation's current account?
A) an old house purchased by a Canadian in Croatia
B) the purchase of a Canadian Treasury bond by a foreigner
C) the interest a Canadian earns on a British bond
D) a factory built by the Japanese in Canada
Answer: C
13) Which of the following would be part of the nation's capital account?
A) a nightclub show seen by a Canadian in Mexico City
B) a dividend from a British equity owned by a Canadian
C) a payment to the Philippine government for the use of military bases in their country
D) one hundred shares of British Petroleum stock purchased by a Canadian
Answer: D
14) The difference between the current account balance and net exports is
A) the capital account.
B) net unilateral transfers plus net factor payments from abroad.
C) adjustments in net foreign assets.
D) income receipts from foreign assets.
Answer: B
15) Which of the following statements is true?

A) The world as a whole has a current account surplus.
B) The world as a whole has a current account balance.
C) The world as a whole has a balance of payment surplus.
D) The world as a whole has a current account deficit.
Answer: D

Macroeconomics, 7Ce
16) The world as a whole has a current account deficit because

A) some countries export less than they import.
B) There are statistical discrepancies.
C) The United States and China have current account deficit.
D) Income from assets held abroad is misreported.
Answer: D
17) The official settlements balance equals

A) the sum of the current account and the capital account.
B) the current account minus net unilateral transfers.
C) net investment income from abroad.
D) the net increase in a country's official reserve assets.
Answer: D
18) If the Bank of Canada buys $3 billion worth of Japanese yen, $4 billion of German marks,
and $2 billion of French francs, and sells $5 billion of British pounds, how does this affect the
official settlements balance?
A) falls by $4 billion
B) rises by $4 billion
C) rises by $9 billion
D) falls by $5 billion
Answer: B
19) Suppose the current account shows debits of $4.7 billion and credits of $5.3 billion. The
current account balance is ________, and the capital account balance is ________.
A) +$0.6 billion; -$0.6 billion
B) +$0.6 billion; +$0.6 billion
C) -$0.6 billion; -$0.6 billion
D) -$0.6 billion; +$0.6 billion
Answer: A
20) A capital account surplus necessarily implies

A) a balance of payments surplus.
B) a current account surplus.
C) a current account deficit.
D) an increase in the nation's official reserve assets.
Answer: C

Macroeconomics, 7Ce
21) If Canada acquired net foreign assets of $50 billion in one year, this would be the equivalent
of
A) net imports of $50 billion.
B) net foreign borrowing of $50 billion.
C) a capital account deficit of $50 billion.
D) a current account deficit of $50 billion.
Answer: C
22) You just read that forecasters predict Canada will run a current account deficit in 2004. From
this you would infer that Canada will also
A) run a capital account deficit in 2004.
B) decrease its official reserve assets.
C) run a balance of payments surplus.
D) decrease its holding of net foreign assets.
Answer: D
23) Which of the following statement is true?

A) In each period, except for measurement errors, the current account balance and the capital
account balance must sum to zero.
B) In each period, except for measurement errors, the sum of the current account balance and the
capital account balance must be positive.
C) In each period, except for measurement errors, the sum of the current account balance and the
capital account balance must be negative.
D) In each period, except for measurement errors, the sum of the current account balance and the
capital account balance may be positive or negative.
Answer: A
24) If there are no factor payments from abroad and no unilateral transfers, net exports of $10
billion is the same as
A) a current account deficit of $10 billion.
B) a capital account surplus of $10 billion.
C) net acquisition of foreign assets of $10 billion.
D) net foreign borrowing of $10 billion.
Answer: C

Macroeconomics, 7Ce
25) A friend claims that Canada is a net international debtor. The best way of testing this claim is
to
A) see whether Canadian foreign liabilities exceeded Canadian foreign income.
B) see whether Canadian receipts from foreign assets exceeded Canadian payments to foreign
owners of Canadian assets.
C) see whether Canadian official reserve assets were positive or negative.
D) see whether Canada ran a balance of payments surplus or deficit last year.
Answer: B
26) When a current account has a surplus of $5 billion, it means that

A) the capital account must have a deficit of $5 billion.
B) next exports must be negative.
C) net foreign lending is negative.
D) net acquisition of foreign assets is negative.
Answer: A
27) In goods market equilibrium in an open economy

A) the desired amount of exports must equal the desired amount of imports.
B) the desired amount of exports must equal the desired amount of imports less the amount lent
abroad.
C) the desired amount of national saving must equal the desired amount of domestic investment.
D) the desired amount of national saving must equal the desired amount of domestic investment
plus the amount lent abroad.
Answer: D
28) In goods market equilibrium in an open economy

A) the desired amount of exports must equal the desired amount of imports.
B) the desired amount of exports must equal the desired amount of imports less the amount lent
abroad.
C) the desired amount of national saving must equal the desired amount of domestic investment.
D) the desired amount of national saving must equal the desired amount of domestic investment
plus the current account balance.
Answer: D
29) Absorption refers to

A) the total amount of imports purchased by a country.
B) the net amount of imports purchased by a country.
C) total spending by domestic residents, businesses, and governments.
D) GDP less desired consumption, desired investment, and government purchases.
Answer: C

Macroeconomics, 7Ce
30) Suppose output is $35 billion, government purchases are $10 billion, desired consumption is
$15 billion, and desired investment is $6 billion. Net foreign lending would be equal to
A) -$4 billion.
B) -$2 billion.
C) $2 billion.
D) $4 billion.
Answer: D
31) An economy in which output exceeds absorption

A) will send goods abroad and have a current account surplus.
B) is a net importer with a current account deficit.
C) is a net borrower in the international market.
D) will have a capital account deficit.
Answer: A
32) Sweetland economy's GDP is $2000 billion, desired consumption spending $1200 billion,
desired investment spending $500 billion, and government purchases $400 billion. The
Sweetland economy's absorption is
A) $2000 billion.
B) $1200 billion.
C) $2100 billion.
D) -$100 billion.
Answer: D
33) Which of the following statements about the Canadian balance of payment is true?
A) Historically, Canada has for the most part had a current account surplus.
B) Canada has always had a capital account deficit.
C) Canadians' ownership of foreign assets has always been greater than foreigners' ownership of
Canadian assets.
D) Canada has always maintained a current account balance.
Answer: A
$15 billion, and desired investment is $6 billion. Desired savings is equal to
A) $2 billion.
B) $10 billion.
C) $14 billion.
D) $16 billion.
Answer: B

Macroeconomics, 7Ce
$15 billion, and desired investment is $6 billion. Absorption is equal to
A) $25 billion.
B) $31 billion.
C) $35 billion.
D) $39 billion.
Answer: B
36) A small open economy is an economy that

A) has a small government.
B) has a very low net exports.
C) is too small to affect the world real interest rate.
D) has a negative balance of payments.
Answer: C
37) For a small open economy, an increase in the world real interest rate would necessarily
A) increase net foreign lending.
B) decrease net exports.
C) decrease the current account balance.
D) worsen the balance of payments.
Answer: A
38) A small open economy has a current account balance of zero. A rise in the world real interest
rate causes
A) a current account surplus.
B) a capital account surplus.
C) net borrowing from abroad.
D) absorption to exceed income.
Answer: A
39) A small open economy has a current account balance of zero. A rise in its investment
demand causes
A) a current account surplus.
B) a capital account deficit.
C) income to exceed absorption.
D) net borrowing from abroad.
Answer: D

Macroeconomics, 7Ce
40) A small open economy increases its investment demand. This causes the world real interest
rate to ________ and the country's current account balance to ________.
A) rise; fall
B) remain unchanged; rise
C) rise; rise
D) remain unchanged; fall
Answer: D
41) A small open economy increases its desired saving. This causes the world real interest rate to
________ and the country's current account balance to ________.
A) fall; fall
C) fall; rise
Answer: B
42) When a temporary adverse supply shock hits a small open economy, it causes the current
account to ________ and investment to ________.
A) fall; fall
B) rise; remain unchanged
C) fall; remain unchanged
D) rise; fall
Answer: C
43) When future labour income falls in a small open economy, it causes the current account to
________ and investment to ________.
A) fall; rise
D) rise; rise
Answer: B
44) If there is an increase in the future marginal product of capital in a small open economy, it
causes the current account to ________ and saving to ________.
A) fall; rise
D) rise; rise
Answer: C

Macroeconomics, 7Ce
45) If there is an increase in taxes on business firms in a small open economy, it causes the
current account to ________ and saving ________.
A) fall; fall
D) rise; fall
Answer: B
46) You have just read in the newspaper that a hurricane has destroyed Guatemala's coffee crop
for this year. Guatemala is a small open economy. Based on this information alone, you would
expect that
A) desired investment would fall in Guatemala.
B) desired investment would increase in Guatemala.
C) net foreign lending by Guatemala would increase.
D) net foreign lending by Guatemala would decrease.
Answer: D
47) The best weather in a decade has given Australia a bumper wheat crop. Australia is a small
open economy. Based on this information alone, you would expect that
A) desired investment would decrease.
B) desired investment would increase.
C) the current account would increase.
D) the current account would decrease.
Answer: C
48) An innovation will enable Haitian sugar cane farmers to harvest the sugar cane twice as
efficiently in the future. Haiti is a small open economy. Based on this information alone, you
would expect that
A) desired saving would increase.
B) net foreign borrowing would increase.
C) net exports would increase.
D) the current account balance would go further into surplus.
Answer: B
49) When there are two large open economies, the world real interest rate will be such that
A) desired international lending by one country equals desired international borrowing by the
other country.
B) desired international lending will be the same in both countries.
C) desired international borrowing will be the same in both countries.
D) desired international lending and borrowing will be zero in both countries.
Answer: A

Macroeconomics, 7Ce
50) A large open economy is an economy

A) that has a large government sector.
B) that has a positive net exports.
C) that is large enough to affect the world real interest rate.
D) that has a positive balance of payments.
Answer: C
51) The main difference between the small open economy and the large open economy is that
A) the former faces a fixed international real interest rate, but the latter can influence it.
B) the former can influence the international real interest rate, but the latter cannot.
C) the former cannot maintain a large current account deficit, but the latter can.
D) the former can maintain a large current account deficit, but the latter cannot.
Answer: A
52) When there are two large open economies, if desired international lending by the domestic
country exceeds desired international borrowing by the foreign country, then
A) domestic saving must rise.
B) domestic saving must fall.
C) the world real interest rate must fall.
D) the world real interest rate must rise.
Answer: C
53) When there are two large open economies, if desired international borrowing by the domestic
country exceeds desired international lending by the foreign country, then
A) domestic investment must fall.
B) domestic investment must rise.
C) the world real interest rate must fall.
D) the world real interest rate must rise.
Answer: D
54) A large open economy increases its investment demand. This causes the world real interest
rate to ________ and the country's current account balance to ________.
A) rise; fall
C) rise; rise
Answer: A

Macroeconomics, 7Ce
55) A large open economy increases its desired saving. This causes the world real interest rate to
________ and the country's current account balance to ________.
A) fall; fall
C) fall; rise
Answer: C
56) When a temporary adverse supply shock hits a large open economy, it causes the current
account to ________ and investment to ________.
A) fall; fall
D) rise; fall
Answer: A
57) When future labour income falls in a large open economy, it causes the current account to
________ and investment to ________.
A) fall; rise
D) rise; rise
Answer: D
58) If there is an increase in the future marginal product of capital in a large open economy, it
causes the current account to ________ and saving to ________.
A) fall; rise
D) rise; rise
Answer: A
59) If business taxes rise in a large open economy, it causes the current account to ________ and
saving to ________.
A) fall; fall
D) rise; fall
Answer: D

Macroeconomics, 7Ce
60) Real domestic interest rates would increase in a large open economy if
A) there were a temporary negative domestic supply shock.
B) the government imposed capital controls and the capital account had been in deficit.
C) foreigners were more willing to save.
D) there were a temporary negative supply shock abroad in a small open economy.
Answer: A
61) Assuming no change in the effective tax rate on capital, an increase in the government
budget deficit will raise the current account deficit if and only if the increase in the budget deficit
A) reduces desired national saving.
B) increases desired national saving.
C) reduces desired national investment.
D) increases desired national investment.
Answer: A
62) Assume that an increase in Costa Rica's government budget deficit reduced desired national
saving by 10 million colon. Assuming Costa Rica is a small open economy, you would expect
the government's action to
A) increase the current account balance by exactly 10 million colon.
B) increase the current account balance by less than 10 million colon.
C) reduce the current account balance by exactly 10 million colon.
D) reduce the current account balance by more than 10 million colon.
Answer: C
63) Assume that Costa Rica, a small open economy, has increased the government budget deficit
by 10 million colon, reducing the current account balance in the process. All else being equal,
you would expect this action to cause
A) an increase in desired saving in Costa Rica.
B) an increase in the real world interest rate.
C) an increase in exports by Costa Rica.
D) an increase in Costa Rica's absorption.
Answer: D
64) In a large open economy like the United States, an increased government budget deficit that
reduces national saving
A) reduces investment and improves the current account balance.
B) reduces investment and reduces the current account balance.
C) has no effect on investment, but reduces the current account balance.
D) has no effect on either investment or the current account balance.
Answer: B

Macroeconomics, 7Ce
65) If Ricardian equivalence proposition is true, a budget deficit resulting from a tax cut will
have
A) no effect on government expenditures.
B) no effect on current account because it does not affect national saving.
C) no effect on current account because people expect to pay lower taxes in the future.
D) no effect on current account because people expect to increase their consumption.
Answer: B
66) The term "twin deficits" refers to a situation in which there exists
A) a budget deficit as well as a current account deficit.
B) a budget deficit as well as a capital account deficit.
C) a budget deficit as well as a balance of payment deficit.
D) a current account deficit as well as a capital account deficit.
Answer: A
67) Justin spends his holidays in Mexico, where he spends $2500. This will
A) reduce the Canadian current account by $2500.
B) increase the Canadian current account by $2500.
C) have no change in the Canadian current account.
D) increase Canadian exports by $2500.
Answer: A
68) A group of Japanese tourists visits Banff National Park in Alberta and spends $20,000 on
goods and services in Canada. This will
A) reduce the Canadian current account by $20,000.
B) increase the Canadian current account by $20,000.
C) have no change in the Canadian current account.
D) increase Canadian imports.
Answer: B
69) An increase in the number of international students in Canada

A) has no effect on the Canadian current account.
B) decreases the Canadian current account.
C) decreases Canadian imports
D) increases the Canadian current account.
Answer: D

Macroeconomics, 7Ce
70) Suppose desired consumption is $10 billion and desired investment is $3 billion. If GDP is
$25 billion and government purchases are $2 billion, the desired national saving is
A) $12 billion.
B) $15 billion.
C) $14 billion.
D) $13 billion.
Answer: D
71) Suppose desired consumption is $10 billion and desired investment is $3 billion. If GDP is
$25 billion and government purchases are $2 billion, the desired foreign lending is
A) $10 billion.
B) $12 billion.
C) $13 billion.
D) $15 billion.
Answer: A
5.2 Essay Questions
1) Suppose a country has the following balance of payments data:
Merchandise exports 100

Merchandise imports 130
Service exports 60
Service Imports 50
Investment income receipts 75
Investment income payments 100
Transfers to other countries 15
Increase in home country assets abroad 130
Increase in foreign assets in home country 190
a. Calculate the current account balance.

b. Calculate the capital account balance.
c. Calculate the trade balance.
d. Calculate net factor payments.
Answer:
a. -60
b. 60
c. -30
d. -25
Diff: 2 Type: ES Page Ref: Sec. 5.1

Macroeconomics, 7Ce
2) Show where each of the following transactions belongs on the Canadian balance of payments
table, using an exchange rate of 100 Japanese yen per Canadian dollar.
a. A Japanese firm spends 5 billion yen to buy personal computers from IBM (a Canadian
firm).
b. A wealthy Japanese businessman gives $100 thousand to the San Diego Zoo.
c. A Canadian firm buys 1 million Sony Walkmans at 6000 yen each (Sony is a Japanese firm).
d. A Japanese investment banking firm buys 500 million dollars worth of newly issued
Canadian government Treasury bills.
e. Canadian steel firms send 2000 executives to Japan to take courses in the Japanese method of
steel production and Japanese management techniques, paying 2 million yen per executive.
f. Repeat parts a. - e. for the balance of payments table of Japan.
Answer:
a. Credit: $50 million exports of merchandise
b. Credit: $100 thousand net unilateral transfers
c. Debit $60 million imports of merchandise
d. Credit: $500 million increase in foreign-owned assets in Canada
e. Debit: $40 million imports of services
f. Debit: 5 billion yen imports of merchandise
Debit: 10 million yen net unilateral transfers
Credit: 6 billion yen exports of merchandise
Debit: 50 billion yen increase in Japanese-owned assets abroad
Credit: 4 billion yen exports of services
3) In a small open economy
Sd = $20 billion + ($100 billion) r%

Id = $30 billion - ($100 billion) r%
Y = $70 billion
G = $20 billion
rw = .04.
a. Calculate the current account balance.

b. Calculate net exports.
c. Calculate desired consumption.
d. Calculate absorption.
Answer:
a. -$2 billion
b. -$2 billion
c. $26 billion
d. $72 billion

Macroeconomics, 7Ce
4) Consider a small open economy with desired national saving of Sd = 20 + 200rw and desired
investment of Id = 30 - 200rw. Calculate national saving, investment, and the current account
balance in equilibrium when the real world interest rate is
a. rw = 0.025
b. rw = 0.05
c. rw = 0.0
d. Now suppose something causes desired national saving to increase by 10, so that it is now
Sd = 30 + 200rw. Repeat parts a, b, and c.
e. Suppose, with desired national saving at its original level of Sd = 20 + 200rw, something
causes desired investment to rise by 10, Id = 40 - 200rw. Repeat parts a, b, and c.
Answer:
a. S = 25, I = 25, CA = 0
b. S = 30, I = 20, CA = 10
c. S = 20, I = 30, CA = -10
d. rw = 0.025: S = 35, I = 25, CA = 10
rw = 0.050: S = 40, I = 20, CA = 20
rw = 0.000: S = 30, I = 30, CA = 0
e. rw = 0.025: S = 25, I = 35, CA = -10
rw = 0.050: S = 30, I = 30, CA = 0
rw = 0.000: S = 20, I = 40, CA = 20
S = 20, I = 40, CA = -20
5) Consider a small open economy in equilibrium with a zero current account balance. What
happens to national saving, investment, and the current account balance in equilibrium if
a. future income rises?

b. business taxes rise?
c. government expenditures decline temporarily?
d. the future marginal product of capital rises?
Answer:
a. Saving curve shifts left, so S falls, I is unchanged, CA falls.
b. Investment curve shifts left, so S is unchanged, I fails, CA rises.
c. Saving curve shifts right, so S rises, I is unchanged, CA rises.
d. Investment curve shifts right, so S is unchanged, I rises, CA falls.

Macroeconomics, 7Ce
6) A large open economy has desired national saving of Sd = 20 + 200 rw and desired national
investment of Id = 30 - 200rw. The foreign economy has desired national saving of Sd = 40 +
100rw and desired national investment of IdFor = 75 - 400rw.
a. Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor, and IFor.
b. Suppose Sd rises by 45, so that now Sd = 65 + 200 rw. Calculate the equilibrium values of rw
CA, CAFor, S, I, SFor, and IFor.
c. Suppose with Sd back to Sd = 20 + 200rw as in part a, that Id rises by 45, to Id = 75 - 400rw.
Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor and IFor.
Answer:
a. In equilibrium, Sd + SdFor = Id + IdFor, so that 60 + 300rw = 105 – 600rw, or 900rw = 45,
so rw= 0.05. Using this in the formulas, we get S = 30, I = 20, CA = 10, SFor = 45, IFor = 55,
and CAFor = -10.
b. Now 900 rw = 0, so rw = 0.0. Using this in the formulas, we get S = 65, I = 30, CA = 35,
SFor = 40, IFor = 75, and CAFor = 35.
c. Now 900 rw = 90, so rw = 0.10. Using this in the formulas, we get S = 40, I = 55, CA = -15,
SFor = 50, IFor = 35, and CAFor = 15. Notice that the current account may swing from positive
to negative, depending on the value of the real interest rate.
7) Consider a large open economy that has a zero current account balance. What are the effects
on the world real interest rate, national saving, investment, and the current account balance in
equilibrium if
a. future income rises?

b. business taxes decline?
c. government purchases decline?
d. the future marginal product of capital declines?
Answer:
a. rw rises, S falls, I falls, CA falls
b. rw rises, S rises, I rises. CA falls
c. rw falls, S rises, I rises, CA rises
d. rw falls, S falls, I falls, CA rises
8) Due to a change in the regulatory structure of a small open economy, the desired capital stock
becomes higher for both private investment and government investment. Increased government
investment spending is financed by borrowing, not by higher taxes. If both desired investment
and government spending rise at the same time, will there be "twin deficits"?
Answer: Desired saving shifts left, desired investment shifts right, so the current account
balance declines; there are twin deficits.

Macroeconomics, 7Ce
9) Suppose the government of a large open economy announces a major expansion of

government spending to dig a tunnel to the earth's core, to be financed entirely by borrowing.
What effect does this have on the world real interest rate, national saving, investment, and the
current account balance in equilibrium?
Answer: Desired national saving shifts left, causing the equilibrium world real interest rate to
rise, investment to fall, desired national saving to fall, and the current account balance to fall.
10) The government of a small open economy announces a tax cut of $100 this year, combined
with a tax increase of $110 next year, when the interest rate is 10%. What are the effects of this
change on the world real interest rate, national saving, investment, and the current account
balance in equilibrium when
a. Ricardian equivalence holds?

b. Ricardian equivalence does not hold?
Answer:
a. No effect on any of the variables.
b. Real world interest rate unchanged, national saving declines (private saving rises, but not as
much as government saving declines), investment is unchanged, and the current account balance
declines.
11) Briefly discuss the idea of "twin deficit." In your answer, include historical evidence, if any,
and explain why some economists do not agree with the idea. Is Ricardian equivalence
proposition consistent with the idea of twin deficit? Why?
Answer: The twin deficit idea is that the budget deficit is the primary cause of current deficit.
Therefore, if government runs a budget deficit, we should expect to see the current deficit as
well. The evidence on twin deficit is mixed. Although twin deficit can be observed in some
periods of the Canadian and the US budget deficit and current account data, it is not evident in
some other periods. In addition, the opposite has occurred in Japan. Therefore, some economists
doubt that there is a correlation between the two deficits. The Ricardian equivalence hypothesis
is not consistent with the twin deficit. According to the Ricardian equivalence hypothesis, a
deficit caused by a tax cut will lead to higher saving and, therefore, will not lead to any deficit in
the current account.
12) Consider an economy with GDP of $100 billion, desired investment of $20 billion, desired
consumption of $50 billion, and government purchases of $2 billion. Calculate the following:
a. Desired absorption
b. Desired national saving
c. Desired foreign lending
Answer:
a. $72 billion
b. $48 billion
c. $28 billion

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Macroeconomics, 7Ce

Chapter 5: Saving and Investment in the Open Economy

Test Bank for Macroeconomics Canadian 7th

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Chapter 5 Saving and Investment in the Open Economy

5.1 Multiple-Choice Questions

1) Canada's balance of payment accounts

2) The merchandise trade balance is a country's

3) If a country's merchandise exports exceed its merchandise imports

D) it has a current account deficit.

4) If France has a trade deficit, then

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7) The current account balance consists of

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15) Which of the following statements is true?

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16) The world as a whole has a current account deficit because

17) The official settlements balance equals

20) A capital account surplus necessarily implies

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23) Which of the following statement is true?

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26) When a current account has a surplus of $5 billion, it means that

27) In goods market equilibrium in an open economy

28) In goods market equilibrium in an open economy

29) Absorption refers to

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31) An economy in which output exceeds absorption

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36) A small open economy is an economy that

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50) A large open economy is an economy

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69) An increase in the number of international students in Canada

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5.2 Essay Questions

1) Suppose a country has the following balance of payments data:

Merchandise exports 100

a. Calculate the current account balance.

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3) In a small open economy

Sd = $20 billion + ($100 billion) r%

a. Calculate the current account balance.

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a. future income rises?

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a. future income rises?

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9) Suppose the government of a large open economy announces a major expansion of

a. Ricardian equivalence holds?

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