Page 477 - Krugmans Economics for AP Text Book_Neat

Module 43 AP Review

Solutions appear at the back of the book.
Check Your Understanding

1. Draw a diagram, similar to Figure 43.1, representing the foreign a. allowing the exchange rate to float more freely
exchange situation of China when it kept the exchange rate b. placing restrictions on foreigners who want to invest
fixed at a target rate of $0.121 per yuan and the market in China
equilibrium rate was higher than the target rate. Then show c. removing restrictions on Chinese who want to
with a diagram how each of the following policy changes might invest abroad
eliminate the disequilibrium in the market. d. imposing taxes on Chinese exports, such as clothing Section 8 The Open Economy: International Trade and Finance

Tackle the Test: Multiple-Choice Questions

1. Which of the following methods can be used to fix a country’s d. fixed, but managed
exchange rate at a predetermined level? e. floating within a target zone
I. using foreign exchange reserves to buy its own currency
4. Which of the following interventions would be required to
II. using monetary policy to change interest rates
keep a country’s exchange rate fixed if the equilibrium
III. implementing foreign exchange controls
exchange rate in the foreign exchange market were below
a. I only
the fixed exchange rate (measured as units of foreign
b. II only
currency per unit of domestic currency)? The government/
c. III only
central bank
d. I and II only
a. buys the domestic currency.
e. I, II, and III
b. sells the domestic currency.
2. Changes in exchange rates affect which of the following? c. buys the foreign currency.
a. the price of imports d. lowers domestic interest rates.
b. the price of exports e. removes foreign exchange controls.
c. aggregate demand
5. Which of the following is a benefit of a fixed exchange
d. aggregate output
rate regime?
e. all of the above
a. certainty about the value of domestic currency
3. The United States has which of the following exchange b. commitment to inflationary policies
rate regimes? c. no need for foreign exchange reserves
a. fixed d. allows unrestricted use of monetary policy
b. floating e. all of the above
c. fixed, but adjusted frequently

Tackle the Test: Free-Response Questions

1. Suppose the United States and India were the only two c. To bring the foreign exchange market back to an
countries in the world. equilibrium at the fixed exchange rate, would the U.S.
a. Draw a correctly labeled graph of the foreign exchange government need to buy or sell dollars? On your graph,
market for U.S. dollars showing the equilibrium in illustrate how the government’s buying or selling of dollars
the market. would bring the equilibrium exchange rate back to the
b. On your graph, indicate a fixed exchange rate set above the desired fixed rate.
equilibrium exchange rate. Does the fixed exchange rate lead
to a surplus or shortage of U.S. dollars? Explain and show
the amount of the surplus/shortage on your graph.

module 43 Exchange Rate Policy 435