AP Macroeconomics Question 33: Answer and Explanation

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Question: 33

7. Assume Astobia and Bonavia are countries that exercise free trade. If the real interest rate in Astobia decreases in comparison to Bonavia's real interest rate, then for Bonavia which of the following would be true of capital flow, the value of its currency, and its exports?

Capital Flow     Currency     Exports

  • A. (A) outflow     appreciation     decrease
  • B. (B) outflow     appreciation     increase
  • C. (C) inflow     depreciation     decrease
  • D. (D) inflow     depreciation     decrease
  • E. (E) inflow     appreciation     decrease

Correct Answer: E

Explanation:

E Because Astobia's interest rate is now lower than Bonavia's, it would be more profitable for investors to invest in Bonavia's economy. Therefore, there would be an inflow of capital as more money comes into the country. This will cause Bonavia's currency to appreciate, which will increase the demand for Bonavia's currency. However, as Bonavia's currency appreciates, it will be more expensive for people from other countries to buy products from Bonavia, and therefore their exports will decrease. The answer is (E).