Page 870 - Krugmans Economics for AP Text Book_Neat

S-24 SOLUTIONS TO AP REVIEW QUESTIONS

Module 41 Module 42
Check Your Understanding Check Your Understanding

1. a. The sale of the new airplane to China represents an 1. a. The increased purchase of Mexican oil would cause U.S.
export of a good to China and so enters the current individuals (and firms) to increase their demand for the
account. peso. To purchase pesos, individuals would increase their
b. The sale of Boeing stock to Chinese investors is a sale of a supply of U.S. dollars to the foreign exchange market,
U.S. asset and so enters the financial account. causing a rightward shift in the supply curve of U.S. dol-
c. Even though the plane already exists, when it is shipped lars. This would cause the peso price of the dollar to fall
to China it is an export of a good from the United States. (the amount of pesos per dollar would fall). The peso
So the sale of the plane enters the current account. would appreciate and the U.S. dollar would depreciate as
d. Because the plane stays in the United States, the Chinese a result.
investor is buying a U.S. asset. So this is identical to the b. With the appreciation of the peso it would take more U.S.
answer in part b: the sale of the jet enters the financial dollars to obtain the same quantity of Mexican pesos. If
account. we assume that the price level (measured in Mexican
Tackle the Test: pesos) of other Mexican goods and services would not
change, other Mexican goods and services would become
Multiple-Choice Questions more expensive to U.S. households and firms. The dollar
1. e cost of other Mexican goods and services would rise as the
2. a peso appreciated. So Mexican exports of goods and ser -
vices other than oil would fall.
3. b c. U.S. goods and services would become cheaper in terms
4. a of pesos, so Mexican imports of goods and services would
rise.
5. a 2. a. The real exchange rate equals pesos per U.S. dollar ×
Tackle the Test: aggregate price level in the U.S./aggregate price level in
Free-Response Questions Mexico. Today, the aggregate price level in both countries
is 100. The real exchange rate today is: 10 × (100/100) =
2. (a) United States 10. The aggregate price level in five years in the U.S. will

Interest be 100 × (120/100) = 120, and in Mexico it will be 100
rate S US × (1,200/800) = 150. Thus, the real exchange rate in five
Equilibrium years, assuming the nominal exchange rate does not
interest rate E change, will be 10 × (120/150) = 8.
in the U.S. US
4% b. Today, a basket of goods and services that costs $100
costs 800 pesos, so the purchasing power parity is 8 pesos
International per U.S. dollar. In five years, a basket that costs $120 will
equilibrium cost 1,200 pesos, so the purchasing power parity will be
interest rate
D US 10 pesos per U.S. dollar.
0 Quantity of Tackle the Test:
loanable funds
Capital inflow to Multiple-Choice Questions
the United States
1. d
2.
(b) China d
3.
Interest d
rate S C 4. b
5. b

Tackle the Test:
4%
Free-Response Questions
Equilibrium
interest rate E C 2.
in China In order to purchase more imports from Europe, U.S.
D
C consumers must supply more dollars in exchange for
0 Quantity of euros. As shown in the diagram, the increase in the sup-
loanable funds
Capital outflow ply of dollars shifts the dollar supply curve to the right
from China and decreases the exchange rate from XR to XR .
2
1