Free Response 2008

Scoring Guidelines 2008

Question 1 (a)

  • The effect of the decrease in consumption spending


Question 1 (e)

  • As a result of the increase in interest rate, the growth rate will fall.

  • The investment spending decreases and, as a result, capital formation will decrease.

Question 2 (a)

  • Current account record:

    • A United States resident buys chocolate from Belgium

    • A United States manufacturer buys computer equipment from Japan.

Question 2 (b)

  • Increase in income causes imports to increase, therefore the current account balance will decrease or move toward a deficit.

Question 2 (c)

  • The effect of an increase in United States firm's direct investment in India

    • X-axis: Quantity of US Dollars

    • Y-axis: Rupee per US Dollar


    The Demand and Supply Line-ups in Foreign Exchange Markets Demand
for the U.S. Dollar Comes from... A U.S. exporting firm that earned
foreign currency and is trying to pay U.S. -based expenses Foreign
tourists visiting the United States Foreign investors who wish to make
direct investments in the U.S. economy Foreign investors who wish to
make portfolio investments in the U.S. economy Supply of the U.S.
Dollar Comes from... A foreign firm that has sold imported goods in
the United States, earned U.S. dollars, and is trying to pay expenses
incurred in its home country U.S. tourists leaving to visit other
countries U.S. investors who want to make foreign direct investments
in other countries U.S. investors who want to make portfolio
investments in other countries

    When the U.S. government imposes a quota on the import of Japanese
cars, nothing happens in the market for loanable funds in panel (a) or
to net capital outflow in panel (b). The only effect is a rise in net
exports (exports minus imports) for any given real exchange rate. As a
result, the demand for dollars in the market for foreign-currency
exchange rises, as shown by the shift from DI to in panel (c). This
increase in the demand for dollars causes the value of the dollar to
appreciate from El to E2. This appreciation of the dollar tends to
reduce net exports, offsetting the direct effect of the import quota
on the trade balance. FIGURE 6 The Effects of an Import Quota Real
Interest Rate r, (a) The Market for Loanable Funds Supply Quantity of
Loanable Funds causes the real exchange rate to appreciate. (b) Net
Capital Outflow Real Interest Rate 3. Net exports, however, remain the
sa Real Exchange Rate Net Capital Outflow Supply n. An Import quota
increases the demand for ollars D, Quantity of Dollars (c) The Market
for Foreign-currency Exchange

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