Principles of Economics

1.    How would the following transactions affect U.S. exports, imports, and net exports?
a.    An American art professor spends the summer €¨touring museums in Europe.
b.    Students in Paris flock to see the latest movie from €¨Hollywood.
c.    Your uncle buys a new Volvo.
d.    The student bookstore at Oxford University in €¨England sells a copy of this textbook.
e.    A Canadian citizen shops at a store in northern €¨Vermont to avoid Canadian sales taxes.
2.    Would each of the following transactions be included in net exports or net capital outflow? Be sure to say whether it would represent an increase or a decrease in that variable.
a.    An American buys a Sony TV.
b.    An American buys a share of Sony stock.
c.    The Sony pension fund buys a bond from the U.S. €¨Treasury.
d.    A worker at a Sony plant in Japan buys some €¨Georgia peaches from an American farmer.
3.    Describe the difference between foreign direct investment and foreign portfolio investment. Who is more likely to engage in foreign direct investment€”a corporation or an individual investor? Who is more likely to engage in foreign portfolio investment?
4.    How would the following transactions affect U.S. net capital outflow? Also, state whether each involves direct investment or portfolio investment.
a.    An American cellular phone company establishes €¨an office in the Czech Republic.
b.    Harrods of London sells stock to the General €¨Electric pension fund.
c.    Honda expands its factory in Marysville, Ohio.
d.    A Fidelity mutual fund sells its Volkswagen stock €¨to a French investor.
5.    Would each of the following groups be happy or unhappy if the U.S. dollar appreciated? Explain.
a.    Dutch pension funds holding U.S. government €¨bonds
b.    U.S. manufacturing industries
c.    Australian tourists planning a trip to the United €¨States
d.    An American firm trying to purchase property €¨overseas
6. What is happening to the U.S. real exchange rate in each of the following situations? Explain.
a.    The U.S. nominal exchange rate is unchanged, but €¨prices rise faster in the United States than abroad.
b.    The U.S. nominal exchange rate is unchanged, but €¨prices rise faster abroad than in the United States.
c.    The U.S. nominal exchange rate declines, and prices €¨are unchanged in the United States and abroad.
d.    The U.S. nominal exchange rate declines, and €¨prices rise faster abroad than in the United States.
7. A can of soda costs $0.75 in the United States۬and 12 pesos in Mexico. What is the peso-dollar exchange rate if purchasing-power parity holds?۬If a monetary expansion caused all prices in Mexico to double, so that soda rose to 24 pesos, what would happen to the peso-dollar exchange rate?
8. Assume that American rice sells for $100 per bushel, Japanese rice sells for 16,000 yen per bushel, and the nominal exchange rate is 80 yen per dollar.
a.    Explain how you could make a profit from this €¨situation. What would be your profit per bushel€¨of rice? If other people were to exploit the same opportunity, what would happen to the price of rice in Japan and the price of rice in the United States?
b.    Suppose that rice is the only commodity in the world. What would happen to the real exchange rate between the United States and Japan?

9. A case study in the chapter analyzed purchasing- power parity for several countries using the price of Big Macs. Here are data for a few more countries:
Country Price of a Big Mac       Predicted Exchange Rate       Actual Exchange Rate
Chile            2,050 pesos                ____ pesos/$                                      472 pesos/$
Hungry        830 forints                 ____ forints/$                                    217 forints/$
Czech         70 korunas                  ____korunas/$                                    18.9 korunas/$
Brazil          11.25 real                   ____ real/$                                          1.99 real/$
Canada        5.41 C$                      ____ C$/$                                            1.00 C$/$

a. For each country, compute the predicted exchange rate of the local currency per U.S. dollar. (Recall that the U.S. price of a Big Mac was $4.37.)
b. According to purchasing-power parity, what is the predicted exchange rate between the Hungarian forint and the Canadian dollar? What is the actual exchange rate?
c. How well does the theory of purchasing-power parity explain exchange rates?
10. Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only commodity is Spam.
a.    In2000acanofSpamcosts2dollarsinEcteniaand €¨6 pesos in Wiknam. What is the exchange rate €¨between Ectenian dollars and Wiknamian pesos?
b.    Overthenext20years, inflationis3.5percentper €¨year in Ectenia and 7 percent per year in Wiknam. What will happen over this period to the price of Spam and the exchange rate? (Hint: Recall the rule of 70 from Chapter 27.)
c.    Which of these two nations will likely have a higher nominal interest rate? Why?
d. A friend of yours suggests a get-rich-quick scheme: Borrow from the nation with the lower nominal interest rate, invest in the nation with the higher nominal interest rate, and profit from the interest- rate differential. Do you see any potential problems with this idea? Explain.