This exam consists of 21 multiple choice questions and 2 problems. Each multiple choice question is worth 2 points for a total of 42 points in this section. Answer each multiple choice question by picking the best option. The point value of the problems are written next to them. The problems are together worth 18 points. Concentrate and think your answers through.

By the way, I enjoyed teaching this class. Hope you enjoyed taking it. Have a good summer. All the very best to all of you.

In aswering the essay problems, try to make your answer as complete as possible. Even if you are not sure of the exact answer, try to demonstrate as much of your knowledge as possible.

1. The effective rate of protection is

a. Always higher than the nominal rate of protection

b. Always lower than the nominal rate of protection

c. Always equal to the nominal rate of protection

d. None of the above

Answer:

Unit Labor Requirement

			Coffee		Apples


Colombia		4		10


Brazil			8		16

Note: This is a constant cost model

2. Brazil has absolute advantage in

a. Coffee

b. Apples

c. Both goods

d. Neither goods

Answer:

3. According to Adam Smith’s principle of Absolute Advantage, when the two countries move from autarky to free trade,

a. Colombia will export coffee and Brazil will export apples

b. Colombia will export apples and Brazil will export coffee

c. Colombia will export both apples and coffee

d. Brazil will export both apples and coffee

Answer:

4. What is the quantity of coffee produced in Colombia in autarky?

a. 5

b. 10

c. 25

d. Not enough information to calculate autarky production

Answer:

5. Based on the information above we can say that

a. Colombia has comparative advantage in coffee

b. Colombia has comparative advantage in apples

c. Brazil has comparative advantage in coffee

d. Brazil has absolute advantage in apples

Answer

6. If the two countries engage in free trade according to comparative advantage then the amount of coffee produced by Colombia in free trade is

a. 25

b. 0

c. 12

d. Not enough information to calculate Brazil’s coffee production

Answer:

7. In the Ricardian Model of trade, in autarky equilibrium

a. Production is determined by comparative advantage

b. Relative prices are determined by technology

c. Countries tend to specialize in the producton of a sisngle good

d. None of the above

Assume that Colombia is capital abundant, Brazil is labor abundant, the calculator industry is capital intensive and the airplane industry is labor intensive. Labor is mobile between the two industries within each country, but capital is immobile in the short run.

8. What is the effect of moving from autarky to free trade (in the short run) on capital owners in the calculator industry in Colombia?

a. The real return increases

b. The real return decreases

c. There is an ambiguous effect

d. There is no effect

Answer:

9. What is the effect of autarky to free trade (in the short run) on the capital owners in the airplane industry in Colombia?

a. The real return increases

b. The real return decreases

c. There is an ambiguous effect

d. There is no effect

Answer:

10. What is the effect of moving from autarky to free trade (in the short run) on capital owners in the calculator industry in Brazil?

a. The real return increases

b. The real return decreases

c. There is an ambiguous effect

d. There is no effect

Answer:

11. What is the effect of autarky to free trade (in the short run) on the capital owners in the airplane industry in Brazil?

a. The real return increases

b. The real return decreases

c. There is an ambiguous effect

d. There is no effect

Answer:

The following table summarizes two hypothetical situations in the US market for whiskey.

The first column depicts the situation in the presence of a $5 tariff per bottle on imported whiskey. The Second column represents the situation in the absence of the tariff (i.e. under free trade). You may assume that transportation costs are zero and that demand and supply curves are linear.

				With $5 tariff	Free Trade

World price of whiskey		$10		$10

Tariff per unit			$5		$0

Price of whiskey in the US	$15		$10

Quantity of whiskey bought 	100		130
in the US per year

Quantity of whiskey produced 	75		60
in the US per year

12. What is the quantity of imports in free trade?

a. 70

b. 25

c. 15

d. Not enough infomation provided

Answer:

13. What is the quantity of imports after the imposition of the tariff?

a. 70

b. 25

c. 15

d. Not enough information provided

Answer:

14. What is the CHANGE in consumer surplus due to the imposition of the tariff?

a. -500

b. -150

c. -575

d. Not enough information provided

Answer:

15. What is the value of the total deadweight loss due to the imposition of the tariff?

a. 112.5

b. 75

c. 150

d. Not enough information provided

Answer:

16. What is the CHANGE in producer surplus due to the imposition of the tariff?

a. +375.5

b. +337.5

c. -337.5

d. +347.5

Answer:

17. The tariff revenue raised by the governement is

a. 500

b. 150

c. 125

d. None of the above

Answer:

18. Suppose that the dollar-pound spot rate is 2 dollars to a pound, the dollar-yen spot rate is 2 dollars to an yen, and suppose the pound-yen spot rate is 2 pounds to an yen.

Starting with $100, to make a profit

a. Sell the dollars for yen, then sell the yen for pounds and then sell the pounds for dollars

b. Sell the dollars for pounds, then sell the pounds for yen and then sell the yen for dollars

c. Because markets are efficient, there can never be positive profits from arbitrage

d. None of the above

Answer:

19. Suppose the exchange rates described in question 18 are the exchange rates you face.

When all the gains from arbitrage are exhausted, the dollar price of the yen (on the spot market)

a. Will be lower

b. Will be higher

c. Will be unchanged (since markets are efficient, arbitrage guarantees exchange rates are always consistent)

d. None of the above

Answer:

20.) If the United States runs a balance of payments deficit vis-a-vis England then the US dollar (in a flexible exchange rate regime)

a. will depreciate with respect to the pound

b. will appreciate with respect to the pound

c. will not be affected because the Federal Reserve will increase money supply

d. None of the above

Answer:

21.) Assume that the interest rate on dollar denominated deposits in 1 year is 15%. The interest rate on German deutchemark denominated deposits is 3%. The current spot exchange rate between the dollar and mark is $1=DM1. The current 1 year forward exchange rate is $1.5 for 1DM. You have $1000 to invest.To maximize your returns, you should

a. invest the $1000 in dollar denominated deposits

b. invest the $1000 in DM denominated deposits

c. be indifferent between the two

d. none of the above

Problem 1: This question carries 12 points

This question asks you to examine the experience of the European Monetary System. As part of the system assume that the exchange rate between the French Franc and German Mark is fixed at FF 3= DM1. Also assume that exchange rate corresponds to the equilibrium in the two currency markets. Draw a diagram for either the market for francs or marks (or both). Suitably define the exchange rate for the two markets. Make sure you fix the idea that the market(s) is (are) in equilibrium in your mind.

Starting from this situation suppose (1) the French government follows policies which put downward pressure on French interest rates and (2) German government follows policies which put upward pressure on interest rates.

(1) Tell me what you expect to happen in the two markets for francs and marks in terms of the demand for these currencies.

(2) If the exchange rate was FLEXIBLE and could freely adjust, what would you expect to happen to the franc and the mark?

(3) If the French government was committed to maintaining the exchange rate at FF3=DM1, the what actions would the French Central Bank would have to take?

Problem 2: This question carries 6 points

What is foreign exhange market intervention? How is intervention related to the state of the balance of payments under a fixed exchange rate regime? Why is foreign exchange intervention unnecessary under a perfectly flexible exchange rate regime?