THE UNIVERSITY OF SYDNEY

Macroeconomic Theory: ECON5002

Week Eight

PRACTICE QUESTIONS

1) Which of the following events will cause the largest real depreciation for the
domestic economy?
A) a 2% increase in E and a 2% increase in P
B) a 6% increase in the domestic price level (P) and a 6% reduction in P*
C) a 3% increase in E
D) a 6% reduction in E and a 6% reduction in P*
E) a 6% reduction in E and a 6% increase in the foreign price level (P*)

2) If the price level in Japan is 3.0, the price level in the U.S. is 6.0, and it costs 100
Yen to buy one dollar, then the real exchange rate between the U.S. and Japan is:
A) 5.
B) 20.
C) 2.
D) 50.
E) 200.

3) When the U.S. has a current account surplus, we know that it is also:
A) lending to the rest of the world.
B) suffering from negative investment income.
C) running a balanced trade account.
D) borrowing from the rest of the world.
E) none of the above

4) Suppose you have one U.S. dollar with which you wish to purchase U.K. (one-
year) bonds in period t. Which of the following expressions represents the amount
of U.S. dollars you will receive in one year (i.e., period t+1) from purchasing U.K.
bonds in period t?
A) i
B) 1 + i*
C) (1 + i*)Et/Eet+1
D) (1 + i*)Eet+1/Et
E) none of the above

5) Which of the following best defines the real exchange rate?

A) the price of domestic currency in terms of foreign currency
B) the price of foreign currency in terms of domestic currency
C) the price of foreign bonds in terms of domestic bonds
D) the price of domestic goods in terms of foreign goods
E) none of the above

6) Assume the interest parity condition holds and that individuals expect the dollar
to appreciate by 5% during the coming year. Given this information, we know that:
A) i < i*.
B) i = i*.
C) the interest rate differential between the two countries is less than 5%.
D) individuals will only hold foreign bonds
E) none of the above

7) An increase in the real exchange rate indicates that:

A) domestic goods are now relatively cheaper.
B) domestic goods are now relatively more expensive.
C) foreign goods are now relatively cheaper.
D) both B and C

8) For this question, assume that the domestic interest rate is 6% and that the
foreign interest rate 4%. And finally, assume that the domestic currency is expected
to appreciate by 3% during the coming year. Given this information, we know that:
A) the interest parity condition holds.
B) individuals will only hold foreign bonds.
C) individuals will be indifferent about holding domestic or foreign bonds.
D) individuals will only hold domestic bonds.

9) Assume that the nominal exchange rate increases by 2%. If prices (both domestic
and foreign do not change), we know that:
A) domestic goods are now relatively cheaper.
B) foreign goods are now relatively cheaper.
C) domestic goods are now relatively more expensive.
D) both B and C