Open Economy MacroeconomicsClass 12 Introductory Macroeconomics Case Study Questions
10 Questions
Generated by KedovoAI
Case 1 of 10
Case Study7 marks
Linkages in an Open Economy
An open economy is one which interacts with other countries through various channels. In reality, most modern economies are open. There are three ways in which these linkages are established.
- Output Market: An economy can trade in goods and services with other countries. This widens choice in the sense that consumers and producers can choose between domestic and foreign goods.
- Financial Market: Most often an economy can buy financial assets from other countries. This gives investors the opportunity to choose between domestic and foreign assets.
- Labour Market: Firms can choose where to locate production and workers to choose where to work. There are various immigration laws which restrict the movement of labour between countries. Movement of goods has traditionally been seen as a substitute for the movement of labour. We focus on the first two linkages. Foreign trade influences Indian aggregate demand in two ways. First, when Indians buy foreign goods, this spending escapes as a leakage from the circular flow of income decreasing aggregate demand. Second, our exports to foreigners enter as an injection into the circular flow, increasing aggregate demand for goods produced within the domestic economy.
Questions on this case
1(1 mark)MCQ
According to the passage, an open economy primarily trades with other nations in:
2(1 mark)
Identify the three market linkages through which an open economy interacts with other countries.
3(1 mark)MCQ
How do exports to foreigners affect the aggregate demand of a country?
4(2 marks)
Explain how the purchase of foreign goods acts as a 'leakage' from the circular flow of income.
5(2 marks)
The passage states that the movement of goods is seen as a substitute for the movement of labour. Why might this be the case, considering the restrictions on the labour market?
Case Study7 marks
Components of the Current Account
Current Account is the record of trade in goods and services and transfer payments. Trade in goods includes exports and imports of goods. Trade in services includes factor income and non-factor income transactions. Transfer payments are the receipts which the residents of a country get for 'free', without having to provide any goods or services in return. They consist of gifts, remittances and grants. They could be given by the government or by private citizens living abroad. A surplus current account means that the nation is a lender to other countries and a deficit current account means that the nation is a borrower from other countries. Balance on Current Account has two components: Balance of Trade or Trade Balance, and Balance on Invisibles. Balance of Trade (BOT) is the difference between the value of exports and value of imports of goods of a country in a given period of time. Net Invisibles is the difference between the value of exports and value of imports of invisibles, which include services, transfers, and flows of income.
Questions on this case
1(1 mark)MCQ
Which of the following is an example of a transfer payment?
2(1 mark)
What does a deficit on the current account signify about a nation?
3(2 marks)
What is the key difference between the Balance of Trade (BOT) and the Balance on Current Account?
4(1 mark)MCQ
'Trade in services' is a component of:
5(2 marks)
Explain with an example how a transaction can be part of 'factor income' within the trade in services.
Case Study7 marks
The Capital Account and BoP Financing
Capital Account records all international transactions of assets. An asset is any one of the forms in which wealth can be held, for example: money, stocks, bonds, Government debt, etc. Purchase of assets is a debit item on the capital account. If an Indian buys a UK Car Company, it enters capital account transactions as a debit item (as foreign exchange is flowing out of India). On the other hand, sale of assets like sale of share of an Indian company to a Chinese customer is a credit item on the capital account. These items are Foreign Direct Investments (FDIs), Foreign Institutional Investments (FIIs), external borrowings and assistance. Surplus in capital account arises when capital inflows are greater than capital outflows. A country that has a deficit in its current account (spending more than it receives from sales to the rest of the world) must finance it by selling assets or by borrowing abroad. Thus, any current account deficit must be financed by a capital account surplus, that is, a net capital inflow.
Questions on this case
1(1 mark)MCQ
A sale of shares of an Indian company to a Chinese customer is recorded as a:
2(1 mark)
What does a surplus in the capital account indicate?
3(2 marks)
Why is the purchase of a foreign company by an Indian resident considered a debit item on the capital account?
4(1 mark)MCQ
Which of the following is a component of the Capital Account?
5(2 marks)
Explain the relationship between the current account and the capital account as described in the passage.