In a Small Open Economy with a Floating Exchange Rate

question 21

Multiple Choice

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.

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Definitions:

Fixed Cost Financing

A financing strategy where the costs remain constant regardless of the level of production or sales.

Future Cash Flows

Expected cash receipts and payments a business anticipates receiving or paying out over a future period.

Bias

A preconception or inclination towards something, potentially leading to unfair judgments or decisions in various contexts.

Incremental Overhead

The additional indirect costs incurred due to a change in business activities, such as an increase in production volume.