International Macroeconomics 4th

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1. In theory, financially open economies can:
A) manipulate their trade accounts to avoid imbalances.
B) avoid all economic shocks or downturns.
C) lower the unemployment rate but cannot control inflation.
D) use access to the international financial markets to keep investment and
consumption stable.

2. When a disaster destroys a family's home, the family can make use of all the following
solutions, EXCEPT:
A) accept gifts or donations from friends.
B) accept gifts or donations from charitable organizations.
C) apply for a loan or seek insurance payouts.
D) take over the next undamaged property in the vicinity.

3. When disaster strikes a country and destroys infrastructure and businesses, it is likely
that:
A) savings will decline and the current account will move into a surplus.
B) the current account will move into a deficit.
C) investment will decline.
D) savings will decline and the current account will move into a deficit.

4. For the three years after a severe economic shock such as that caused by a hurricane,
typically:
A) nations enjoy higher consumption.
B) creditors become impatient for debtors to begin their payback.
C) investment rises and saving falls; the current account deficit rises, financed by
financial inflows.
D) domestic financial markets are able to handle the situation without a decrease in
consumption.

5. A nation's use of international capital markets enables it to do all of the following,

EXCEPT:
A) provide for a higher level of national defense.
B) smooth consumption over time.
C) build a productive national capital stock.
D) reduce risk through diversification.

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 6. Continually rolling the interest on a loan over into the principal is called:
A) a budget surplus.
B) a Ponzi game.
C) the intertemporal approach.
D) macroeconomics.

7. The notion that a country must live within its means, thus determining the amount a
country can borrow, is known as the:
A) short-run trade-off.
B) resource allocation rule.
C) long-run budget constraint.
D) law of reciprocity.

8. There is a limit to a nation's ability to use international financial markets to supplement

domestic consumption or investment. Why?
A) Lenders like a diversified group of borrowers.
B) International lenders require collateral.
C) Communication is difficult because of language and differences in legal systems.
D) At some point, a nation will not be able to service the rising level of external debt.

9. If a country has a $100 million debt and the interest rate on the debt is 5% and the debt
is serviced each year, this would result in:
A) an interest payment of $5 million and a reduction in the debt amount by $10
million each year.
B) an interest payment of $15 million and a reduction in the debt amount by $10
million each year.
C) an interest payment of $5 million and no change in the debt amount.
D) an interest payment of $1 million and an increase in the debt amount by $10
million each year.

10. If a country has $100 million of debt, the interest rate on the debt is 10%, and the
country does not make any payments on the debt, then at the end of year 3, the debt
amount would be:
A) $121 million.
B) $110 million.
C) $133.1 million.
D) $100 million.

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11. A country has $50 million of debt at the rate of 10%. It does not make any payments in
year 1 and manages to renegotiate the interest rate to 5% at the end of year 1. The
interest payment in year 2 for this country would be:
A) $57.75 million.
B) $7.75 million.
C) $5 million.
D) $2.75 million.

12. Which of the following is NOT an assumption belonging to the long-run budget
constraint model?
A) The government has a balanced budget.
B) Prices are perfectly flexible.
C) The economy is a price taker, small, and open.
D) The economy can borrow or lend unlimited amounts at the world real interest rate.

13. International borrowing and lending involve changes in:

A) the price level.
B) the interest rate.
C) the levels of external wealth.
D) the stock of gold owned by a nation at a particular time.

14. The change in external wealth from period N – 1 to N is equal to:

A) the balance on the current account minus the balance on the financial account (FA).
B) the trade balance (deficit or surplus) plus interest (earned or paid) on external debt
or wealth.
C) a nation's domestic income plus net foreign factor income.
D) the balance on the current account plus the balance on the capital account.

15. A nation's net income from interest is:

A) the domestic interest rate minus the world interest rate.
B) the world interest rate times external assets.
C) the world interest rate times external liabilities.
D) the world interest rate times external wealth.

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16. Which of the following is the value of a country's external wealth at the end of 2016 if
its external wealth was $1 billion at the end of 2015 and its trade balance was $500
million in 2016? Assume the world interest rate is 10% per annum.
A) $1.5 billion
B) $1.6 billion
C) $0.5 billion
D) $0.6 billion

17. Which of the following is the value of a country's external wealth at the end of 2016 if
its external wealth was –$1 billion at the end of 2015 and its trade balance was $500
million in 2016? Assume the world interest rate is 10% per annum.
A) –$1.5 billion
B) –$1.6 billion
C) –$0.6 billion
D) –$0.4 billion

18. Suppose that a country has external wealth of $1 billion in 2014. What is the future
value of this external wealth at the end of 2016, assuming a world interest rate of 10%
per annum and no additions or subtractions to external wealth from trade balance
surpluses or deficits during the period?
A) $1.1 billion
B) $1.2 billion
C) $1.21 billion
D) $0.812 billion

19. In a two-period case, a country's present value of _____ from year 1 should be equal to
the present value of _______.
A) trade balance; trade balances of the next two years
B) wealth; trade balances for the next four years
C) wealth; trade balances for the next two years
D) trade balance; wealth for the next two years

20. If a nation has a balanced current account and its net external wealth is positive:
A) it is a net debtor and payment flows are negative.
B) it is a net creditor and payment flows are positive.
C) it is in balance and its payment flows are zero.
D) it has liabilities greater than assets.

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21. The two-period budget constraint tells us:
A) a creditor country can afford future deficits "on average."
B) a creditor country cannot afford future deficits "on average."
C) a debtor country cannot afford future deficits "on average."
D) a debtor country can afford future deficits "on average."

22. If the United States is currently a net international debtor, then:

A) it has negative net international wealth.
B) it has positive net international wealth.
C) it must run trade deficits to eliminate its net international debt.
D) it must borrow internationally to eliminate its net international debt.

23. What happens if the trade balance is in surplus by more than a nation's service payments
on its external debt?
A) The nation's net external wealth declines.
B) The nation's net external wealth increases.
C) The nation's net external wealth is constant.
D) The nation must run a trade deficit during the subsequent period.

24. What is the present value of a nation's net external wealth?

A) It is gold, plus outstanding currency, plus foreign currency reserves in the nation.
B) It is the present and future real GDP discounted to present value.
C) It is the average real income per capita times the average work span times the rate
of economic growth.
D) It is the sum (discounted to the present) of future trade deficits or surpluses.

25. The long-run budget constraint for a nation is:

A) GDP minus taxes to run the government.
B) equal to GDP divided by the population.
C) the level of external debt, offset by the sum of the present value of future trade
surpluses taken to infinity.
D) determined by its ability to lure international investment and capital inflows.

26. The long-run budget constraint indicates that, in the long run, a country's initial external
wealth must be offset by (i.e., equal to):
A) the present value of its future trade balances.
B) the future value of its future trade balances.
C) the current value of its future trade balances.
D) the present value of its future external wealth.

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27. The long-run budget constraint dictates that:
A) the present value of trade balances is zero taken to infinity.
B) the present value of wealth is equal to zero taken to infinity.
C) the present value of wealth is exactly offset by the present value of trade balances.
D) if the present value of wealth is positive, the nation cannot afford future trade
deficits on average.

28. The present value of a perpetual loan, for which only outstanding interest is paid (no
principal), is equal to:
A) the principal.
B) the sum of future interest payments, which is infinity.
C) zero.
D) It depends on the rate of interest, which is also the rate of discount.

29. What is the present value of annual payments of $1,000 received in perpetuity (i.e.,
forever) if the world interest rate is 6%?
A) $16,667
B) $1,060
C) $6,000
D) $60

30. The present value of an infinite stream of payments (X) at an interest rate of r% (r*) is
calculated as:
A) X – r*.
B) X + r*.
C) X × r*.
D) X ÷ r*.

31. If you are scheduled to receive a $10,000 payment in two years and the interest rate is
10%, then the present value of this payment is:
A) $9,000.
B) $8,264.
C) $12,000.
D) $5,000.

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32. The present discounted value of an infinite stream of payments of $1 per year when the
interest rate is 10% is:
A) 0.909.
B) 1.
C) 1.1.
D) 10.

33. Suppose that the present discounted value of a stream of payments is $1,000. If the
yearly payment is $50, what is the interest rate?
A) 50%
B) 20%
C) 5%
D) 0.5%

34. The present discounted value of an infinite stream of payments of $5 per year when the
interest rate is 20% is:
A) 1.
B) 5.
C) 25.
D) 100.

35. Suppose that the present discounted value of a stream of payments is $200. If the yearly
payment is $10, what is the interest rate?
A) 50%
B) 20%
C) 5%
D) 0.5%

36. Suppose that the present discounted value of a stream of payments is $1,000. If the
interest rate is 10%, what is the constant payment per year?
A) 100
B) 10
C) 1
D) 1,000

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37. The United States has been experiencing trade deficits on the order of $600 billion to
$800 billion during the past several years. Which of the following is an implication of
these trade deficits?
A) U.S. GDP has been larger than U.S. GNE.
B) U.S. GDP has been smaller than U.S. GNE.
C) U.S. net external wealth has been increasing.
D) U.S. exports are greater than U.S. imports.

38. If a nation's yearly trade balance exactly offsets the interest due on its net external
wealth, what is the effect on its net external wealth?
A) It remains the same.
B) It explodes.
C) It declines at first and then rises dramatically.
D) It rises gradually because of interest compounding.

39. Because the trade balance is the difference between GDP and GNE, the long-run budget
constraint for a nation becomes:
A) its initial wealth minus depreciation plus investment.
B) the present value of: the sum of its GDP, minus its GNE, plus its initial external
wealth (or minus its initial debt).
C) the value of real assets plus foreign currency reserves plus new investment.
D) the present value of domestic production of capital goods plus exports.

40. The long-run budget constraint says that:

A) a country will be able to borrow in perpetuity.
B) a country will have to always balance its budget in the short-run.
C) a country's expenditure must equal its production.
D) a country's expenditure can be higher than its production.

41. The exorbitant privilege for the United States implies that:
A) the United States can lend money to people at low interest rates.
B) U.S. investments abroad often earn very low interest rates.
C) foreigners' investments in the United States earn them less income than the U.S.
investments abroad.
D) foreigners' investments in the United States earn them more income than the U.S.
investments abroad.

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42. The United States has experienced a favorable situation in world financial markets.
What is it?
A) The United States has huge net external wealth and is able to control many foreign
corporations, banks, and governments as a result.
B) Even though the United States has huge net external debt, it has benefited from a
1.5% gain in interest differential and an additional 2% capital gain on its net
debt/wealth.
C) Other nations deposit their funds in U.S. banks, making them available for U.S.
borrowers.
D) Politically the United States is very powerful, and most international financial
organizations want good relationships with it, making financial dealings more
favorable to the United States.

43. In the case of the United States, the long-run budget constraint is eased somewhat by:
A) increasing debt and increasing wealth at the same time.
B) figuring in the capital gain differential and an interest rate differential on external
assets and liabilities.
C) the surprising shrinking trade deficit of the United States.
D) the shrinkage of the U.S. national debt.

44. Most experts believe that the favorable U.S. situation in world financial markets:
A) could be transferred to other nations if they could get their economies in order.
B) is actually even better than it appears because of the robust nature of the U.S.
economy.
C) may be exaggerated because of faulty statistics, and the U.S. net external debt may
be even larger.
D) is a direct result of the expertise of the Federal Reserve and the U.S. Treasury.

45. The intertemporal model is NOT used in determining which of the following?
A) how yearly international imbalances affect the long-run wealth or debt of a nation
B) how a nation must borrow each year the difference between payments to the rest of
the world and income from the rest of the world
C) how a nation's external debt can grow to unsustainable levels as a result of
persistent imbalances
D) how a nation must save each year the amount equal to the difference between
payments to the rest of the world and income from the rest of the world

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46. In low-income nations, the budget constraint is usually:
A) more lenient because creditor nations are interested in helping poor countries grow.
B) more stringent because poor nations have low credit ratings and pay higher rates of
interest.
C) ignored by international financial markets.
D) good for these nations because they should not get into debt they are unable to
repay.

47. What is a sudden stop?

A) a situation in which a nation runs out of labor resources
B) a situation in which a nation's prime minister has to call a new election
C) a situation in which a nation's financial markets collapse and investors lose
everything
D) a situation in which a nation's creditors decide to cease new lending

48. An assumption of the intertemporal model that is often not met in low-income nations
is:
A) that the economy is always at full employment.
B) that prices are flexible.
C) that a nation can borrow or lend any amount in international markets at the
prevailing world real rate of interest.
D) that the government of the nation has a balanced budget.

49. The risk premium associated with a government loan:

A) rises with national debt.
B) is independent of national debt.
C) falls with national debt.
D) is unrelated to government bond ratings.

50. The key lesson from the LRBC model is:

A) nations can safely run trade deficits as long as they can cover the interest each year.
B) nations must balance their current account year by year.
C) nations must maintain a balance between the present value of deficits and the
present value of surpluses that satisfy the LRBC.
D) nations may lend externally but it is dangerous to borrow.

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51. Economists say the United States has a favorable interest differential because:
A) interest that the U.S. government pays on Treasury debt is unusually low.
B) returns on foreign portfolio investment in the United States are low.
C) returns on foreign portfolio investment in the United States are high.
D) returns on U.S. international investments are unusually high.

52. The assumption of a nation's ability to borrow or lend any amount it chooses is:
A) always true.
B) never true.
C) true only for nations with advanced industrial economies and good credit ratings.
D) true for emerging economies due to their high returns on investment.

53. A sudden stop in credit availability:

A) is usually manageable if the nation has sufficient reserves to cover imports.
B) is usually very disruptive and necessitates major cuts in expenditures.
C) affects large industrial nations primarily.
D) is very unlikely to happen in practice.

54. Assuming investment (I) and government purchases (G) are zero, then the basic model
of an open economy (where C = consumer spending; S = saving; T = taxes; X – M =
exports – imports; and Q = GDP) is:
A) C + I + G = Q.
B) I = S.
C) I + S = G + T.
D) Q – C = X – M.

55. In the absence of consumption smoothing, the following are possible:

A) income and consumption are balanced yearly, and consumption does not fluctuate
with income.
B) consumption fluctuates with income.
C) consumption does not have to change as income changes.
D) income and consumption are balanced yearly, and consumption fluctuates with
income.

56. The effect on a country's consumption as a result of a permanent shock is:

A) that consumption smoothing is not possible.
B) a temporary change in consumption.
C) a permanent change in consumption.
D) that consumption smoothing is not possible and there is a permanent change in
consumption.

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57. If you prefer to smooth consumption, which of the following would you prefer?
A) $100 of consumption today and $50 of consumption tomorrow
B) $75 of consumption today and $75 of consumption tomorrow
C) $50 of consumption today and $100 of consumption tomorrow
D) You would be indifferent between all of these.

58. The long-run budget constraint will be met as long as:

A) a nation limits its borrowing to half the outstanding debt.
B) the present value of GDP is the same as the present value of yearly consumption.
C) a nation's productivity grows along with its population.
D) the government is stable and external shocks are minimal.

59. The LRBC dictates that if initial wealth equals zero:

A) present value of GDP (Q) = present value of C (GNE).
B) present value of GDP (Q) = present value of TB.
C) present value of TB = present value of C (GNE).
D) present value of TB = 0 = present value of GDP (Q) – present value of C (GNE).

60. The present value of GDP:

A) equals GNE.
B) equals GNE only when the country begins with positive initial wealth.
C) equals GNE only when the country begins with negative initial wealth.
D) plus the present value of initial wealth must equal the present value of GNE.

61. If an economy is closed and has no internal shocks, its consumption will:
A) be perfectly smooth.
B) be erratic depending on consumer tastes.
C) be constrained because households have no means to borrow for large purchases.
D) decline as equipment and machinery depreciate.

62. In a closed economy, what happens to the present value of GDP (discounted at 5%)
following an output shock (decline) of 21% recovered the following year?
A) There is a permanent drop of 1% in the present value of GDP.
B) There is no long-run effect on present value.
C) There is a 1-year drop of 1% in GDP the first year followed by full recovery.
D) There is a downward spiral in real GDP resulting in a permanent drop of 21%.

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63. An open economy has:
A) greater ability to smooth its consumption because of the absence of domestic
shocks.
B) greater ability to smooth its consumption because of the ability to borrow
internationally.
C) less ability to smooth its consumption because of the lower marginal product of
capital.
D) less ability to smooth its consumption to weak links present in the financial system.

64. If, in an open economy with a real world interest rate of 5%, an output shock (decline)
of 21% occurs followed by a recovery the next year:
A) no consumption smoothing is possible.
B) the nation can borrow 20% of GDP in the first year and repay 1% of GDP each
year in perpetuity resulting in consumption smoothing.
C) then no borrowing is possible because of the possibility of exceeding the long-run
budget constraint.
D) the economy would have to forswear all international trade and financial flows.

65. If a nation experiences an output shock and wishes to borrow to smooth consumption,
how much of the loss is the nation able to borrow and still maintain the long-run budget
constraint?
A) 100% of the output shock
B) 20% of the output shock
C) a percentage of the shock to GDP equal to 1/(1 + r*), where r* is the world long-run
real interest rate
D) A nation in such a position is better off not to borrow because it might get into
financial trouble.

66. If a nation experiences an output shock and wishes to borrow to smooth consumption,
how much of consumer spending must it forgo each year to achieve consumption
smoothing and maintain the long-run budget constraint?
A) an amount equal to r*/(1 + r*) of the output shock
B) an amount equal to 20% of its output shock
C) 95% of the output shock
D) an amount equal to r* as a percent of the former level of GDP

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67. In an open economy, as long as the long-run budget constraint is upheld, a nation may:
A) run a trade deficit during temporary shocks and run a trade surplus during
temporary gains in output, keeping consumption stable.
B) save during temporary shocks and borrow during temporary gains.
C) forgo borrowing to maintain financial stability, allowing consumption to fluctuate.
D) save even if it is just a little during each period.

68. When there is a temporary shock to output (positive or negative), what happens to
consumption in an open economy?
A) It is unchanged.
B) It changes by exactly the same amount as output.
C) It changes by more than the temporary output gain or loss by a factor of (1 + r*) /
r*.
D) It changes by less than the temporary output gain or loss by a factor of r* / (1 + r*).

69. Consumption smoothing is possible as long as the output shock is:

A) temporary.
B) permanent.
C) less than 10%.
D) more than the rate of interest.

70. In an open economy, in the long run, permanent shocks to GDP:

A) are always contentious during an election year.
B) are rare, but cannot be ignored.
C) must be dealt with by permanent changes in consumption.
D) indicate that taxes need to be raised.

71. If the United States were a closed instead of an open economy, the economic effects of
the Iraq War would be felt:
A) more by U.S. consumers.
B) by trading partners with the United States.
C) less by U.S. consumers.
D) by the world.

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72. Events such as wars not financed by increases in taxes, such as the U.S. Afghanistan and
Iraq wars:
A) usually involve international borrowing and an increase in external debt.
B) can be paid for by transfers and gifts from sympathetic allies.
C) can be financed by increasing discount operations, thereby avoiding tax increases.
D) add to the instability of the international economy and create large spikes in GDP
growth.

73. If the percentage of change in total spending (C + G) is lower than the percentage
change in income, an economy has some degree of:
A) financial autonomy.
B) consumption smoothing.
C) imminent recession.
D) prosperity.

74. Which of the following statements is NOT correct?

A) Many poor nations have backward financial markets, giving the public no access to
foreign investments.
B) Financial markets offer little security and government regulation in poor nations.
C) In many poor nations, few people are rich enough to save, and there is capital
flight.
D) Poor nations benefit greatly from globalization through the use of foreign
investments.

75. A nation that engages in precautionary savings is:

A) putting away money for the children of baby boomers who will enter college in the
next decade.
B) storing foreign currency reserves, bonds, or deposits to use in case of persistent
deficits.
C) forgetting that saving cannot save an economy from poverty—it takes investment.
D) holding back pay of top government officials to make them accountable for their
actions.

76. International firms have begun to offer a new product based on the need for nations to
put their savings into productive and high-return assets. It is called:
A) external wealth funds.
B) sovereign wealth funds.
C) automatic withdrawals.
D) sovereign debt accounts.

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77. Which of the following methods can a country use to accumulate precautionary savings?
A) an increase in taxes
B) a reduction of government expenses
C) an accumulation of foreign exchange reserves by central banks
D) a reduction in unemployment benefits

78. Sovereign wealth funds are created for all of the following reasons, EXCEPT:
A) to get a better return on their assets.
B) to save the windfall from natural resource exports.
C) to discourage foreign investment in the domestic economy.
D) to invest bank reserves and state revenue/savings.

79. Low-income nations with poor credit ratings are often dependent on commodity sales as
a major portion of income. To insure against the effects of a fall in the prices of
commodities, the nation could:
A) borrow internationally.
B) save as a precaution and purchase sovereign wealth funds with that money.
C) ask for debt reduction and forgiveness.
D) enter into a cartel to boost the prices of commodities.

80. If low-income nations purchase sovereign wealth funds, in effect they are:
A) providing scarce investment funds to other nations, causing a transfer from poor to
rich.
B) increasing the risk of default.
C) just delaying the inevitable drop in consumption.
D) treating corporations as tools of government policy.

81. Sovereign wealth funds are __________that invest the savings of nations into
productive and high-return assets.
A) privately owned firms
B) state-owned firms
C) family-owned firms
D) U.S.–based firms

82. Sovereign wealth funds are created:

A) to get a better return on their assets.
B) to allocate the windfall from natural resource exports.
C) to discourage foreign investment in the domestic economy.
D) to distribute bank reserves and state revenue/savings.

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83. To insure against the effects of a fall in the prices of commodities, _______ countries
could save as a precaution and purchase sovereign wealth funds with that money.
A) low-income
B) middle-income
C) high-income
D) all

84. The events that transpired in Chile from 2000–07 provide an example of how sovereign
wealth funds can be used to:
A) provide scarce investment funds to other nations, causing a transfer from poor to
rich.
B) manage output volatility.
C) ensure consistently high output.
D) encourage corporations to accept government policy.

85. Full consumption smoothing occurs when:

A) the ratio of income volatility to output volatility is zero.
B) the ratio of consumption volatility to output volatility is exactly 1.
C) the ratio of consumption volatility to output volatility is zero.
D) the ratio of output volatility to expenditure volatility is zero.

86. Testing evidence from consumption volatility, researchers have found that until high
levels of liberalization are reached:
A) financial globalization does not deliver any consumption smoothing benefits.
B) financial globalization delivers a large measure of consumption smoothing
benefits.
C) financial globalization intensifies problems in nations with backward financial
systems.
D) financial globalization results in less government debt and a higher standard of
living.

87. Some nations use external financial assets as a buffer and a precautionary measure to:
A) allow their net external balance to average to zero over time.
B) ensure that if they must default on debt, foreigners cannot confiscate assets.
C) reduce or eliminate the need to go into debt to smooth consumption.
D) find new investment opportunities in the domestic market.

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88. Some emerging market national governments accumulate _____ for them to serve as a
buffer for output shocks.
A) inventories of grain
B) foreign (currency) reserves
C) bonds denominated in their own currency
D) insurance policies

89. International investments purchased by a nation's government are known as:

A) surety bonds.
B) sovereign wealth funds.
C) repurchase agreements.
D) preferred stock.

90. Rather than cut consumption during any year to make a productive investment, an
open-economy nation that chooses to finance investment and preserve consumption
during the first year:
A) is always worse off.
B) is better off if the return is greater than the rate of interest.
C) must repay the investment 10 times over because of compounding.
D) is subject to criticism for policies that favor rich investors.

91. Countries such as Norway are turning toward investing in private companies:
A) because of the increased risk of treasury bills.
B) to gain influence in the Western economies.
C) to increase their rates of return on investments.
D) so that they can be more dependent on market fluctuations.

92. Rather than cut consumption during any year to make a productive investment,
___________ nation that chooses to finance investment and preserve consumption
during the first year_______________.
A) an open-economy; is always worse off.
B) a closed-economy; is better off if the return is greater than the rate of interest.
C) an open-economy; is better off if the return is greater than the rate of interest.
D) a closed-economy; is subject to criticism for policies that favor rich investors.

93. The discovery of oil in Norway in the 1970s:

A) led to a permanent increase in the amount of labor.
B) led to an increase in Norway's influence in the Western economies.
C) led to an increase in their rates of return on investments.
D) led to a permanent increase in capital stock.

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94. Investment will occur in an open economy more often than in a closed economy
because:
A) investment decisions have fewer constraints because investors and borrowers will
compare the marginal product of capital in any nation with the world real interest
rate.
B) without information, investors often make poor investment decisions.
C) governments like to subsidize overseas investment for domestic firms.
D) international financial organizations prefer to lend for international investments
rather than domestic ones.

95. Investment spending will occur as long as the marginal product of capital:
A) is rising.
B) is falling.
C) is greater than the real rate of interest.
D) is greater than the increase in consumer spending.

96. The decision rule for making an investment is to do so as long as:

A) the marginal product of capital is positive (Q/K > 0).
B) the marginal product of labor is positive (Q/L > 0).
C) the marginal product of capital is greater or equal to the world real interest rate
(Q/K  r*).
D) the initial level of wealth is equal to zero.

97. A closed economy that considers an investment opportunity capable of raising

production in future years will:
A) raise consumption in the present but not in the future.
B) have to rely on funding by government.
C) need to cut consumption by the amount of the investment in the first year to
achieve greater consumption in the future.
D) need to cut back on other profitable investment opportunities.

98. In an open economy, investment can be funded externally, possibly leading to:
A) very unstable consumer spending, which may lead to recession.
B) unsustainable debt.
C) foreign control of domestic corporations.
D) a simultaneous increase in income and smooth consumption, with adherence to the
long-run budget constraint.

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 99. If the long-run budget constraint is upheld, an investment expenditure will increase the
present value of consumption only if:
A) the present value of debt is equal to zero.
B) the present value of output is greater than the present value of the investment
expenditure.
C) the present value of exports is greater than the present value of imports.
D) output is increasing faster than the growth of population.

100. In a country where output equals consumption and I and G are zero, a new investment
holds the prospect of permanently increasing output and, thus, consumption. Based on
this information, which of the following statements is correct?
A) If it is a closed economy, then there is a better prospect for investment and
consumption smoothing than in an open economy.
B) If it is an open economy, then it is better for the economy to borrow externally to
pay for the investment.
C) If it is a closed economy, then the increase in investment can be achieved without
sacrificing consumption.
D) If it is an open economy, then it will result in more fluctuations in output and
consumption.

101. Which of the following statements about a closed economy is NOT correct?
A) Investment and consumption are to be satisfied with the same output.
B) Investment and consumption are at odds with each other.
C) A closed economy has to be self-sufficient.
D) Consumption smoothing and an increase in investment can be achieved
simultaneously.

102. Using Norway's oil industry as an example, it is possible to finance large and profitable
investment without:
A) risk to investors.
B) government interference.
C) large initial consumption sacrifices.
D) service payments on debt or repayment of principal.

103. When Norway began producing oil, which of the following events did NOT occur?
A) There was an increase in Norway's capital stock.
B) There was an increase in foreign investment in Norway.
C) There was a decline in consumption to finance the investment.
D) There was a current accounts deficit in Norway.

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104. It is not surprising that financially open economies are able to:
A) enjoy higher levels of consumer spending.
B) recycle investment funds by repaying interest with increased income from
production.
C) delink savings and investment, thus increasing consumption smoothing.
D) get lower rates of interest on borrowing.

105. Which group of nations has the least correlation between savings and domestic
investment?
A) developed countries across the world
B) the European Union
C) emerging economies
D) All nations have the same correlation.

106. If there are diminishing marginal returns to capital, such as postulated in economic
production models, what is the marginal product of capital for low-income nations?
A) Their marginal products of capital are lower than in high-income nations.
B) Their marginal products of capital are higher than in high-income nations.
C) Their marginal products of capital are equal to their marginal products of labor.
D) Their marginal products of labor are increasing, causing labor migration.

107. If capital flows freely throughout the world, one would expect it would flow:
A) from the rich nations, where it is abundant and cheap, to the poor nations, where it
is scarce and dear.
B) from the poor nations, where it has less value, to the rich nations, where it has more
value.
C) from the savers to financial institutions.
D) from international lenders to international borrowers.

108. In the Cobb–Douglas production function, one of the conclusions reached is that the
lower the level of income, the higher is the MPK. This is possible because of which of
the following?
A) There are increasing returns.
B) The productivity levels are different.
C) There are diminishing returns.
D) There are constant returns.

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109. If production functions are identical, low-income nations have a ____ capital per worker
than high-income nations, _____ labor productivity, and a ____ marginal product of
capital.
A) lower; lower; higher
B) lower; higher; higher
C) lower; lower; lower
D) higher; higher; lower

110. If Mexico has 8% of capital per labor of the U.S. level, it is likely that under the simple
model,
A) capital will flow into the United States because it has more capital.
B) Mexico will never achieve the capital–labor ratio of the United States.
C) U.S. capital per labor will decline to the level of Mexico.
D) capital will flow into Mexico because the MPK of capital is higher in Mexico.

111. With free movement of capital internationally, the principle of convergence postulates
that:
A) at some future time, external debt and external wealth will cancel each other out.
B) poor nations will finally adopt capitalism and free markets.
C) when the baby-boom generation retires, the investment rate will rise to
compensate.
D) rates of return on capital investment will be equalized worldwide as investors seek
the highest return.

112. The production function model showed that capital flows to poorer regions, because the
marginal product of capital is higher in the poorer regions. Robert Lucas's paper showed
that that was NOT true. The reason was that:
A) investors were forced to abandon higher returns in poorer countries.
B) it was assumed that production functions were the same in all countries.
C) it was assumed that production functions were different for rich and poor countries.
D) rich countries offered higher interest rates.

113. If the production functions of rich and poor nations are NOT identical, resulting in
lower marginal products of capital for poor nations, then:
A) capital markets are basically dysfunctional.
B) it must mean the labor productivity for poor nations is higher.
C) capital markets cannot be relied on to bring about convergence.
D) capital markets may be functioning efficiently and correctly after all.

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114. If two nations have identical production functions, as indicated by free flows of
information, what happens when the marginal product of labor (MPL) in one nation is
lower than the MPL in the other?
A) The MPK must be lower.
B) The MPK must be higher.
C) The MPL will continue to decline while the other continues to rise.
D) The marginal product of both labor and capital will be equal.

115. Allowing for productivity differences between rich and poor countries results in:
A) poor countries reaching the levels of capital per worker of rich countries.
B) poor countries reaching the levels of output per worker of rich countries.
C) poor countries not reaching the levels of capital per worker of rich countries.
D) rich country capital per worker decreasing to the level of poor countries.

116. Recently, economists have attributed the level of A, in the standard production function
q = Ak, to reflect all of the following except:
A) social efficiency.
B) quality of institutions.
C) education policies.
D) technical efficiency.

117. What might explain why in some lower-income nations, such as Mexico, there are low
levels of capital inflows?
A) the reluctance of the government to allow higher levels of capital inflows
B) the low return on capital
C) the existence of different production functions, which would indicate a lower
marginal product of capital
D) identical production functions but other constraints on capital transfers

118. When poor nations cannot compete with rich nations to attract capital because of their
lower overall productivity, it creates:
A) convergence.
B) long-run divergence.
C) externalities.
D) opportunities for cross-border investment.

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119. The production function may have the same marginal products, yet the production
constant term, A, may differ. Today, most economists believe this is caused by:
A) differences in technology.
B) differences in social efficiency of production (factors affecting production, such as
policies, work ethic, education, institutional infrastructure, or cultural differences).
C) corruption and a poor regulatory climate.
D) gender bias.

120. What implications for the effectiveness of foreign aid would there be if low-income
nations have lower marginal products of capital?
A) Foreign aid would probably be more effective.
B) Foreign aid would be preferable to private investment.
C) Foreign aid would suffer the same problems as private investment and possibly be
ineffective in increasing productivity.
D) To be effective, foreign aid provided by governments would have to be managed
by private concerns.

121. What is the primary role of the World Bank?

A) to pay a high return on investments
B) to provide loans for technical development
C) to provide loans for stabilizing exchange rates
D) to provide free checking to poor people

122. If the productivity of capital in low-income nations is substantially lower than

productivity in high-income nations, then:
A) output per worker will never catch up to the rich nations, even with access to
capital markets.
B) productivity of capital can be improved by better training of workers and more
foreign investment.
C) output per worker will grow more slowly, but at some point there will be
convergence.
D) the low-income nations will lose their ability to borrow in international markets.

123. Economists are increasingly convinced that institutions, public policies, or culture may
influence a nation's productivity more than technology acquisition. This impact is
known as:
A) technical efficiency.
B) cultural norms.
C) welfare economics.
D) social efficiency.

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124. A major factor affecting investment opportunities in rich versus poor nations, aside from
the productivity of capital is:
A) population growth.
B) risk factors that threaten investment.
C) government meddling in the affairs of business.
D) tax burdens on wealthy individuals.

125. Poor nations are often poorly equipped to provide social capital, and compared with rich
nations:
A) the cost of labor is very high.
B) the cost of producing social capital is higher in poor nations.
C) there is too much social legislation.
D) they have meager tariff revenues and so cannot afford basic necessities.

126. Nations can lower risk via asset diversification. How do nations engage in
diversification?
A) by investors relying on mutual funds instead of choosing their own stocks
B) by directing some investment activities abroad and some domestically
C) by buying private insurance against devaluation
D) by restricting all investment toward domestic capital

127. If a nation diversifies its capital portfolio so that it owns some foreign capital and
foreigners own a percentage of the nation's capital, then:
A) domestic returns will be lower.
B) domestic returns will be higher.
C) domestic returns will equal international returns.
D) the nation will earn an average return, and its consumption will remain stable in the
event of output shocks.

128. As long as at least some output shocks are asymmetric, it is possible to:
A) avoid all risk.
B) lower the volatility of income by international diversification of capital assets.
C) lower the risk of default.
D) avoid any consumption declines as a result of the shocks.

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129. Whenever economic shocks are asymmetric, affecting only one nation among all the
nations that are mutual investors, asset diversification:
A) will have substantial benefits in lessening the shocks and smoothing consumption.
B) will have no measurable benefits in lessening shocks.
C) will probably backfire as one nation gains while the other loses.
D) creates a tense atmosphere in which profits take precedence over human welfare.

130. It is better to invest in a country whose shocks:

A) are positively correlated with yours.
B) are independent of yours.
C) are negatively correlated with yours.
D) are common to yours.

131. Two nations each own 50% of the capital of the other nation (diversification). What is
the situation when labor composes more than 50% of available resources?
A) In order to achieve perfect diversification, labor must move from one nation to the
other.
B) No gain will occur from the diversification.
C) The risk from economic shock will be eliminated by the diversification of assets.
D) Some risk from economic shocks can be eliminated, but not all.

132. It has been shown that although investors could lower volatility and earn a higher
average return on a diversified portfolio:
A) there seems to be a home bias factor, which reveals that investors favor domestic
investments.
B) there are downside risks not recognized by the market.
C) most governments limit international investment.
D) investors prefer focusing on overseas investments.

133. Explanations for behavior seeming to favor domestic investments over international
investments might include:
A) the provincial nature of investors.
B) the fact that many domestic corporations already incorporate international assets
and foreign operations.
C) globalization has not caught on in the financial markets.
D) language and cultural barriers.

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134. Risk sharing through asset trade internationally is limited because:
A) not all capital assets can be traded internationally, and the number of assets is
comparatively small.
B) laws prohibit many kinds of international investment.
C) returns on international assets are usually lower.
D) there is a larger risk of currency devaluation.

135. How would one explain the seemingly contradictory situation that exists for the United
States: How does the United States, despite a large external debt, enjoy being a net
recipient of interest payments?

136. In addition to the other problems of low-income nations is the relative disadvantage they
face in the international capital markets. What are some issues related to low-income
nations, and what effect do they have on their ability to access international capital
markets?

137. To analyze the long-run constraint on international borrowing, we make simplifying

assumptions to calculate changes in a nation's external wealth. Discuss these
assumptions and tell why they are important to the model.

138. Give an intuitive explanation for the long-run budget constraint.

139. What is a “sudden stop” and what are the consequences?

140. Explain the concept of consumption smoothing in your own words.

141. Assume a nation has an output level of 150. Suppose there is a sudden temporary drop
in GDP by 16%. How will the trade balance evolve if this country has access to global
financial markets with an interest rate of 5%?

142. Assume a nation has an output level of 150 units per year, and that consumption is also
150. Suppose there is a sudden temporary drop in GDP by 16%. What does the long-run
consumption path look like if this country has access to global financial markets with an
interest rate of 5%?

Page 27
143. Chile's finance minister earn a reputation for being "stingy," but shortly thereafter he
was hailed for his economic insight. How do you explain that?

144. Assume a nation has an output level of 100 units per year, and that consumption is also
100. If a nation has an opportunity to make a productive investment that costs 16 units
of production that raises yearly output by 5%, how might a nation undertake the
investment and smooth consumption during the entire period?

145. Explain what is meant by “efficient” investment.

146. What is the Lucas paradox?

147. Even with the numerous problems faced by low-income nations, there are further issues
that limit capital inflows and perpetuate poverty. Describe some of these issues in the
context of the factors that lower the marginal product of capital.

148. In theory, there are three primary benefits to financial globalization. Briefly explain
each.

149. The lack of institutional infrastructure hinders the development of poor nations, and it
may render capital less productive. As a result, some say that foreign aid is ineffective
in stimulating economic development. Explain.

150. What is the difference between technical efficiency and social efficiency?

151. Explain the similarities between diversification and consumption smoothing.

152. Why does ownership of locally owned multinational firms mitigate the home bias?

153. What is the home bias?

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Answer Key
1. D
2. D
3. D
4. C
5. A
6. B
7. C
8. D
9. C
10. C
11. D
12. A
13. C
14. B
15. D
16. B
17. C
18. C
19. C
20. B
21. A
22. A
23. B
24. D
25. C
26. A
27. C
28. A
29. A
30. D
31. B
32. D
33. C
34. C
35. C
36. A
37. B
38. A
39. B
40. C
41. C
42. B
43. B
44. C

Page 29
45. D
46. B
47. D
48. C
49. A
50. C
51. B
52. C
53. B
54. D
55. D
56. D
57. B
58. B
59. D
60. D
61. A
62. A
63. B
64. B
65. C
66. A
67. A
68. D
69. A
70. C
71. A
72. A
73. B
74. D
75. B
76. B
77. C
78. C
79. B
80. A
81. B
82. A
83. A
84. A
85. C
86. A
87. C
88. B
89. B
90. B

Page 30
 91. C
92. C
93. C
94. A
95. C
96. C
97. C
98. D
99. B
100. B
101. D
102. C
103. C
104. C
105. B
106. B
107. A
108. C
109. A
110. D
111. D
112. B
113. D
114. B
115. C
116. D
117. C
118. B
119. B
120. C
121. B
122. A
123. D
124. B
125. B
126. B
127. D
128. B
129. A
130. C
131. D
132. A
133. B
134. A
135.
136.

Page 31
137.
138.
139.
140.
141.
142.
143.
144.
145.
146.
147.
148.
149.
150.
151.
152.
153.

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