Chapter 13. The Open Economy Revisited, The Mundell-Fleming Model and the Exchange-Rate Regime

Chapter 13. The Open Economy Revisited, The Mundell-Fleming Model and the Exchange-Rate Regime 1.Compared to a closed economy, an open economy is one that: A) allows the exchange rate to float. B) fixes the exchange rate. C) trades with other countries. D) does not trade with other countries. 2.The Mundell–Fleming model assumes that: A) prices are flexible, whereas the IS–LM model assumes that prices are fixed. B) prices are fixed, whereas the IS–LM model assumes that prices are flexible. C) as in the IS–LM model, prices are fixed. D) as in the IS–LM model, prices are flexible. 3.The Mundell–Fleming model is a model for a open economy. A) short-run; small B) short-run; large C) long-run; large D) long-run; small 4.In the Mundell–Fleming model: A) the exchange rate system must have a floating exchange rate. B) the exchange rate system must have a fixed exchange rate. C) it makes no difference whether the exchange rate system has a floating or a fixed exchange rate. D) the behavior of the economy depends on whether the exchange rate system has a floating or fixed exchange rate. 5.In the Mundell–Fleming model, the domestic interest rate is determined by the: A) intersection of the LM and IS curves. B) domestic rate of inflation. C) world rate of inflation. D) world interest rate. 6.In a small open economy with perfect capital mobility, if the domestic interest rate were to rise above the world interest rate, then would drive the domestic interest rate back to the level of the world interest rate. A) capital inflow B) capital outflow C) the central bank D) a decline in domestic saving 7.Assuming there is perfect capital mobility, compared to a large open economy, a small open economy is one in which the: A) exchange rate is fixed. B) exchange rate is floating. C) domestic interest rate equals the world interest rate. D) domestic interest rate is not equal to the world interest rate. 8.In a small open economy a decrease in the exchange rate will net exports and shift the curve. A) increase; IS B) decrease; IS C) increase; LM D) decrease; LM 9.If short-run equilibrium in the Mundell–Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the IS* curve: A) slopes downward and to the right because the higher the exchange rate, the lower the level of net exports and, therefore, of short-run equilibrium income in the goods market. B) is vertical because there is only one investment level that is consistent with the world interest rate. C) is vertical because the exchange rate does not enter into the IS* equation. D) slopes downward and to the right because the higher the exchange rate, the higher the level of net exports and, therefore, of short-run equilibrium income in the goods market. 10.In the Mundell–Fleming model on a Y – e graph, the curves labeled IS* and LM* are labeled that way as a reminder that: A) the price level is held constant at the world price level p*. B) the interest rate is held constant at the world interest rate r*. C) the exchange rate is held constant at the world exchange rate e*. D) output is held constant at the full employment level. 11.If short-run equilibrium in the Mundell–Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the LM* curve: A) slopes upward and to the right because at a higher income a higher interest rate is needed to increase velocity. B) is vertical because monetary velocity is independent of the interest rate. C) is vertical because the exchange rate does not enter into the LM* equation. D) slopes upward and to the right because a higher exchange rate leads to a higher income. 12.In the Mundell–Fleming model, the exogenous variables are the: A) world interest rate, the price level, and the exchange rate. B) level of government spending, taxes, and income. C) exchange rate and level of income. D) price level, world interest rate, monetary policy, and fiscal policy. 13.The intersection of the IS* and LM* curves shows the and the at which both the goods market and the money market are in equilibrium. A) interest rate; price level B) price level; exchange rate C) level of output; exchange rate D) level of output; price level 14.Under a floating system, the exchange rate: A) fluctuates in response to changing economic conditions. B) is maintained at a predetermined level by the central bank. C) is changed at regular intervals by the central bank. D) fluctuates in response to changes in the price of gold. 15.In a small open economy with a floating exchange rate, an effective policy to increase equilibrium output is to: A) increase government spending. B) increase taxes. C) increase the money supply. D) decrease the money supply. 16.In a small open economy with a floating exchange rate, an effective policy to decrease equilibrium output is to: A) decrease government spending. B) decrease taxes. C) increase the money supply. D) decrease the money supply. 17.In a small open economy with a floating exchange rate, the exchange rate will appreciate if: A) the money supply is increased. B) the money supply is decreased. C) government spending is decreased. D) taxes are increased. 18.In a small open economy with a floating exchange rate, the exchange rate will depreciate if: A) the money supply is decreased. B) import quotas are imposed. C) government spending is increased. D) taxes are decreased. 19.In a small open economy with a floating exchange rate, if the government adopts an expansionary fiscal policy, in the new short-run equilibrium: A) income and the exchange rate will both rise. B) the exchange rate will rise, but income will remain unchanged. C) income will rise, but the exchange rate will remain unchanged. D) both income and the interest rate will rise. 20.In a small open economy with a floating exchange rate, a rise in government spending in the new short-run equilibrium: A) chokes off investment, but not by as much as the new government spending. B) chokes off an amount of investment just equal to the new government spending. C) attracts foreign capital, thus raising the exchange rate and reducing net exports, but not by as much as the new government spending. D) attracts foreign capital, thus raising the exchange rate and reducing net exports by an amount just equal to the new government spending. 21.In a small open economy with a floating exchange rate, the supply of real money balances is fixed and a rise in government spending: A) raises the interest rate, so that income must rise to maintain equilibrium in the money market. B) raises the interest rate so that net exports must fall to maintain equilibrium in the goods market. C) cannot change the interest rate so that net exports must fall to maintain equilibrium in the goods market. D) cannot change the interest rate so income must rise to maintain equilibrium in the money market. Use the following to answer questions 22-23: Exhibit: IS*–LM* 22.(Exhibit: IS*–LM*) A small open economy with a floating exchange rate is initially at equilibrium A with IS*1, LM*1, equilibrium exchange rate e2, and equilibrium output Y1. If there is an increase in government spending to IS*2, the new equilibrium will be at , holding everything else constant. A) A B) B C) C D) D 23.(Exhibit: IS*–LM*) A small open economy with a floating exchange rate is initially at equilibrium A with IS* , LM * , 1 equilibrium exchange rate e2, and equilibrium output Y1. * If there is a monetary expansion to everything else constant. A) A B) B C) C D) D LM 2 , the new equilibrium will be at , holding 24.In a small open economy with a floating exchange rate, if the government decreases the money supply, then in the new short-run equilibrium: A) income falls and the exchange rate rises. B) the exchange rate falls and income rises. C) income remains unchanged but the exchange rate rises. D) the exchange rate remains unchanged but income falls. 25.In a small open economy with a floating exchange rate, if the government increases the money supply, then in the new short-run equilibrium the: A) interest rate falls and the level of investment rises. B) exchange rate falls and net exports increase. C) interest rate falls but the level of investment does not rise. D) exchange rate falls but net exports do not increase. 26.According to the Mundell–Fleming model for a small open economy with flexible exchange rates, if the Federal Reserve cannot alter domestic interest rates, changes in the money supply could still influence aggregate income through changes in the: A) exchange rate. B) price level. C) level of government spending. D) tax rates. 27.In a small open economy with a floating exchange rate, if the government imposes an import quota, then in the new short-run equilibrium the IS* curve shifts to the right, raising the exchange rate: A) but not raising net exports or income. B) and net exports but not income. C) and income but not net exports. D) net exports and income. 28.In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, then in the new short-run equilibrium: A) imports will decrease while exports remain constant, leading to a rise in net exports. B) imports will decrease and exports will increase, leading to a rise in net exports. C) imports will decrease and exports will decrease by an equal amount. D) both imports and exports will remain unchanged. Use the following to answer questions 29-30: Exhibit: Shifting IS* and LM* 29.(Exhibit: Shifting IS* and LM*) A small open economy with a floating exchange rate is initially in equilibrium at A with IS* , LM *. 1 Holding all else constant, if the government imposes a tariff on imports in order to protect domestic jobs, then the curve will shift to . A) LM *; 1 B) LM *; C) IS *; LM * LM 3 * 1 D) IS *; IS2 IS* 30.(Exhibit: Shifting IS* and LM*) A small open economy with a floating exchange rate is initially in equilibrium at A with IS* , LM *. 1 Holding all else constant, if domestic consumers develop greater preferences for imported goods, then the curve will shift to . A) LM *; B) LM *; C) IS *; LM 2 LM 3 * 1 D) IS *;