AP_Krugman_Textbook

Module 42

Check Your Understanding

1. a.The increased purchase of Mexican oil would cause U.S.
   individuals (and firms) to increase their demand for the
   peso. To purchase pesos, individuals would increase their
   supply of U.S. dollars to the foreign exchange market,
   causing a rightward shift in the supply curve of U.S. dol-
   lars. This would cause the peso price of the dollar to fall
   (the amount of pesos per dollar would fall). The peso
   would appreciate and the U.S. dollar would depreciate as
   a result.
   b.With the appreciation of the peso it would take more U.S.
   dollars to obtain the same quantity of Mexican pesos. If
   we assume that the price level (measured in Mexican
   pesos) of other Mexican goods and services would not
   change, other Mexican goods and services would become
   more expensive to U.S. households and firms. The dollar
   cost of other Mexican goods and services would rise as the
   peso appreciated. So Mexican exports of goods and ser -
   vices other than oil would fall.
   c.U.S. goods and services would become cheaper in terms
   of pesos, so Mexican imports of goods and services would
   rise.


2. a.The real exchange rate equals pesos per U.S. dollar ×
   aggregate price level in the U.S./aggregate price level in
   Mexico. Today, the aggregate price level in both countries
   is 100. The real exchange rate today is: 10 ×(100/100) =
   10. The aggregate price level in five years in the U.S. will
   be 100 ×(120/100) =120, and in Mexico it will be 100
   × (1,200/800) =150. Thus, the real exchange rate in five
   years, assuming the nominal exchange rate does not
   change, will be 10 ×(120/150) =8.
   b.Today, a basket of goods and services that costs $100
   costs 800 pesos, so the purchasing power parity is 8 pesos
   per U.S. dollar. In five years, a basket that costs $120 will
   cost 1,200 pesos, so the purchasing power parity will be
   10 pesos per U.S. dollar.
   Tackle the Test:
   Multiple-Choice Questions


3. d


4. d


5. d


6. b


7. b
   Tackle the Test:
   Free-Response Questions


8. In order to purchase more imports from Europe, U.S.
   consumers must supply more dollars in exchange for
   euros. As shown in the diagram, the increase in the sup-
   ply of dollars shifts the dollar supply curve to the right
   and decreases the exchange rate from XR 1 to XR 2.

Module 41

Check Your Understanding

1. a.The sale of the new airplane to China represents an
   export of a good to China and so enters the current
   account.
   b.The sale of Boeing stock to Chinese investors is a sale of a
   U.S. asset and so enters the financial account.
   c.Even though the plane already exists, when it is shipped
   to China it is an export of a good from the United States.
   So the sale of the plane enters the current account.
   d.Because the plane stays in the United States, the Chinese
   investor is buying a U.S. asset. So this is identical to the
   answer in part b: the sale of the jet enters the financial
   account.

Tackle the Test:

Multiple-Choice Questions

1. e


2. a


3. b


4. a


5. a

Tackle the Test:

Free-Response Questions

4%

0

SUS

DUS

International

equilibrium

interest rate

Equilibrium

interest rate

in the U.S.

Equilibrium

interest rate

in China

Quantity of

loanable funds

Interest

rate

EUS

(a) United States

(b) China

0

SC

DC

Quantity of

loanable funds

Interest

rate

EC

Capital inflow to

the United States

Capital outflow

from China

4%

S-24 SOLUTIONS TO AP REVIEW QUESTIONS