Chapter 4 – The Economic Environment

 

Multiple Choice Questions

 

WHAT ARE THE KEY ECONOMIC FORCES AFFECTING BUSINESS OPERATIONS?

 

1.      Economic forces include all of the following issues EXCEPT:

a.      political stability of the country (moderate, page 106)

b.      economic stability

c.       the existence and influence of capital markets

d.      factor endowments

 

2.      Key economic indicators include all of the following EXCEPT:

a.       inflation

b.      public policy (moderate, page 106)

c.       surpluses

d.      deficits

 

3.      Which of the following is NOT considered an economic force?

a.       general economic framework of a country

b.      size of the market

c.       political system in a country  (moderate, page 106)

d.      availability of a good economic infrastructure

 

4.      Essential inputs to the production process, such as human resources, physical resources, etc., are known as:

a.    market conditions.

b.   demand conditions.

c.    location-specific conditions.

d.               factor conditions. (moderate, page 106-107)

 

CONTRAST WAYS OF COMPARING COUNTRIES BY INCOME.

 

5.      Which of the following statements regarding gross national income (GNI) is FALSE?

a.       Gross national income refers to size of demand.

b.      Gross national income was formerly referred to as gross national product.

c.       The key dimension used to distinguish one country from another is the size of demand.

d.      Gross national income and gross domestic product can be used interchangeably. (moderate, page 107)

 

6.      Per capita GNI is determined by ______________ the size of GNI of a nation by its total population.

a.      dividing  (moderate, page 107)

b.      multiplying

c.       adding

d.      subtracting


 

7.      ____________ is the value of production that takes place within a nation’s border, without regard to whether the production is done by domestic or foreign factors of production.

a.       Gross national product

b.      Gross domestic product  (moderate, page 107)

c.       Gross national income

d.      Gross domestic expense

 

WHAT ARE MEANT BY THE QUALITY OF DEMAND AND THE QUANTITY OF DEMAND?

 

8.      The composition of demand is also known as which of the following?

a.       quantity of demand

b.      size of demand

c.       quality of demand (moderate, page 107)

d.      structure of demand

 

9.      The size of demand is also known as which of the following?

a.       quality of demand

b.      size of demand

c.       structure of demand

d.      quantity of demand (moderate, page 107)

 

10.    Demand conditions, also known as market potential, include all of the following dimensions EXCEPT:

a.      the composition of host country demand (moderate, page 107)

b.      the composition of home demand

c.       the size and pattern of growth of home demand

d.      the internationalization of demand

 

WHAT ARE THE FUNCTIONS OF THE WORLD BANK?

 

11.    _______________ is comprised of 181 countries, and its major objective is to provide development assistance to countries, especially the poorest of the poor.

a.       The United Nations

b.      The World Bank (moderate, page 107)

c.       The International Development Association

d.      The International Finance Corporation

 

12.    All of the following are examples of programs provided by the World Bank EXCEPT:

a.       investing in people, particularly through basic health and education

b.      supporting and encouraging private business development

c.       protecting government officials (difficult, page 107)

d.      promoting reforms to create a stable macroeconomic environment, conducive to investment and long-term planning

 

13.    The World Bank classifies economies into each of the following categories according to per-capita GNI EXCEPT:

a.       low-income

b.      middle-income

c.       high-income

d.      low-low income (moderate, page 107)

 

 

 

 

 

 

14.    The World Bank refers to the low- and middle-income countries as which of the following?

a.      developing countries (moderate, page 107)

b.      underdeveloped countries

c.       developed countries

d.      under industrial countries

 

COMPARE THE RELATIVE WEALTH AND POPULATION OF LOW, MIDDLE, AND HIGH INCOME COUNTRIES.

 

15.    Developing countries are also known as _______________, a term also used in describing the capital markets in those countries as different from capital markets in the more advanced countries.

a.       underdeveloped countries

b.      emerging countries (moderate, page 109)

c.       developed countries

d.      under industrial countries

 

16.    High-income countries are also called which of the following?

a.       underdeveloped countries

b.      emerging countries

c.       industrial countries (moderate, page 109)

d.      under industrial countries

 

17.    The developing countries include a variety of different types of countries that include all of the following EXCEPT:

a.       India

b.      Guyana

c.       Vietnam

d.      The United Kingdom (moderate, page 109)

 

18.    _______________ countries generate nearly 80% of the world’s GNI, but they represent a relatively small number of countries and populations.

a.      High-income (moderate, page 109)

b.      Below average income

c.       Low-income

d.      Middle-income

 

19.    Economic control refers to:

a.       who owns the resources engaged in economic activity.

b.      public ownership of resources.

c.       private ownership of resources.

d.      whether resources are allocated and controlled by the public or the private sector

   (moderate, page 113).

 

WHAT FACTORS ARE CONSIDERED WHEN DETERMINING HOW ECONOMICALLY FREE A COUNTRY IS?

 

20.    Factors that determine economic freedom include all of the following EXCEPT:

a.       trade policy

b.      natural resources (moderate, page 114)

c.       taxation

d.      monetary policy

 

 


 

21.    The 2002 index of economic freedom published by the Heritage Foundation and the Wall Street Journal classify countries into each of the following categories EXCEPT:

a.       free

b.      mostly free

c.       mostly unfree

d.      poor (moderate, page 114)

 

22.    There is _______________ between economic freedom and economic growth.

a.       a negative correlation

b.      no relationship effect

c.       negative demand exchanges

d.      a positive correlation (moderate, page 114)

 

23.    Countries that are high in economic freedom have more control in the _______________ than the _______________ sector.

a.      private; public (easy, page 114)

b.      public; private

c.       public; commercial

d.      commercial; public

 

CONTRAST MARKET, COMMAND, AND MIXED ECONOMIES

 

22.    Which of the following economies best describes the following example? The price of gasoline rises during holidays because of the excess of demand over supply. Rising prices bring supply and demand into balance.

a.       command economy

b.      market economy (moderate, page 114)

c.       centrally planned economy

d.      theocratic economy

 

23.    A _______________ is one in which resources are primarily owned and controlled by the private sector, not the public sector.

a.       command economy

b.      centrally planned economy

c.       market economy (moderate, page 114)

d.      social economy

 

24.    In a _______________, all dimensions of economic activity, including pricing and production decisions, are determined by a central government plan.

a.       market economy

b.      mixed economy

c.       democracy

d.      command economy (moderate, page 115)

 

25.    In which of the following types of economies does the government consider itself a better judge of resource allocations than its businesses or citizens?

a.      command economy (moderate, page 115)

b.      market economy

c.       mixed economy

d.      democracy

 


WHAT ARE THE KEY MACROECONOMIC CONDITIONS AFFECTING INTERNATIONAL BUSINESS STRATEGY?

           

26.    Which of the following best reflects global economic growth? 

a.       The Asian Financial Crisis was devastating for firms in Asia, but U.S. firms were largely unaffected.

b.      Even though the collapse of the dot-com sector hurt U.S. firms in calendar 2001, strong economic growth in Europe and Japan offset the U.S. economic collapse.

c.       Global economic growth has been strong since the start of the new century due to relative peace and stability.

d.      One economic challenge after another has resulted in global economic stagnation since the beginning of the 21st century.  (easy, page 118)

 

27.    Which region in the world showed the greatest percentage growth in GDP per capita in the 1990s? 

a.       North America

b.      Africa

c.       East and South Asia  (moderate, page 118)

d.      The former Soviet Union

 

WHAT ARE THE ADVERSE AFFECTS OF INFLATION ON INTERNATIONAL BUSINESS?

 

28.    _______________ occurs because aggregate demand is growing faster than aggregate supply.

a.      Inflation (moderate, page 119)

b.      Deflation

c.       Expansion

d.      Retention

 

29.    Inflation affects all of the following EXCEPT:

a.       interest rates

b.      a person’s culture (moderate, page 119)

c.       exchange rates

d.      the cost of living

 

30.    In general, the higher the inflation in a country, the more likely:

a.       that country’s currency will rise.

b.      people’s culture will change.

c.       that country’s currency will fall. (moderate, page 119)

d.      the currency will not be affected.

 

31.    If inflation in one country is going up relative to that of its trading partners, but the exchange rate is staying the same, which of the following is most likely to occur?

a.       the products will gradually become less expensive in export markets

b.      product quality will deteriorate in export markets

c.       product quality will improve in export markets

d.      the products will gradually become more expensive in export markets (moderate, page 119)

 

WHAT IS A BALANCE OF PAYMENTS, AND WHAT ARE ITS MAJOR COMPONENTS?

 

32.    The _______________ records a country’s international transactions.

a.      balance of payments (moderate, page 122)

b.      surplus of payments

c.       deficit of payments

d.      payments in arrears


 

33.    The _______________ is comprised of trade in goods and services and income from assets abroad.

a.       capital account

b.      current account (moderate, page 122)

c.       payment account

d.      deficit account

 

34.       The component of the current account balance in the balance of payments  which includes transactions such as travel, passenger fares, and other transportation, and royalties and fees on licensing agreements with foreign customers is the:

a.       unilateral transfers balance.

b.      merchandise balance.

c.       services balance(moderate, page 122).

d.      bilateral transfers balance.

 

35.     The _______________ shows transactions in real or financial assets between countries. For example, when the Turtle Bay Hilton Hotel on the North Shore of Oahu, Hawaii, was sold to Japanese investors, the transaction was recorded as an inflow of capital to the United States.

a.       payment account

b.      current account

c.       deficit account

d.      capital account (moderate, page 122)

 

WHY DO COMPANIES MONITOR COUNTRIES’ BALANCE OF PAYMENTS?

 

36.    _______________ can be measured in two ways—the total amount of the debt and debt as a percentage of GDP.

a.      External debt (moderate, page 124)

b.      Internal debt

c.       Universal debt

d.      Bilateral debt

 

37.    Which of the following countries suffered the largest default ($155 billion in external debt) by any country in history?

a.       Brazil

b.      Argentina  (moderate, page 124)

c.       China

d.      Colombia

 

38.    The amount of money borrowed from foreign public or private sector banks is/are:

a.       internal deficits.

b.      privatization.

c.       external debt (easy, page 124).

d.      balance on current account.

 

39.    The sale of state-owned enterprises to the domestic or foreign sector is:

a.       internalization.

b.      externalization.

c.       privatization (easy, page 125)

d.      domestication.


 

40.    Government internal deficits can occur for any of the following reasons EXCEPT:

a.       the tax system is so poorly run that the government cannot collect all the revenues it wants to

b.      government programs such as defense and welfare are too big for revenues to cover

c.       too much privatization is occurring in the country (difficult, page 124)

d.      state-owned enterprises run huge deficits

 

MOST FORMERLY COMMAND ECONOMIES ARE GOING THROUGH ECONOMIC TRANSITION.  WHAT IS MEANT BY ECONOMIC TRANSITION?

 

41.    As countries in transition from command to market economy move to control expenditures and reduce their budget deficits, one important strategy to pursue is which of the following?

a.       nationalization of private-owned enterprises

b.      commercialization of state-owned enterprises

c.       industrialization of state-owned enterprises

d.      privatization of state-owned enterprises (moderate, page 125)

 

42.    In general, transition implies all of the following EXCEPT:

a.       increasing government subsidies to protect locally owned and operated enterprises (moderate, page 125)

b.      liberalizing economic activity, prices, and market operations

c.       developing indirect, market-oriented instruments for macroeconomic stabilization

d.      achieving effective enterprise management and economic efficiency

 

43.    Which of the following reflects economic transition experienced by Russia?

a.       Political and economic transition occurred at different times instead of all at once.

b.      Initial transition steps resulted in steep economic increases.

c.       Subsidies and other government-supporting activities were immediately stopped.

d.      Privatization has not been altogether effective. (difficult, page 127)

 

44.    Which of the following reflects economic transition experienced by China?

a.   Chinese growth has been far stronger than for other countries in transition. (moderate, page 127)

b.    Political and economic transition occurred at the same time.

c.                Privatization of state-owned enterprises has been very successful.

d.    The economic transition has been enhanced by a quick move to democracy.

 

WHAT IS PRIVATIZATION?

 

45.    _______________ reduces debt by removing the need of the government to subsidize the state-owned enterprises.

a.       Commercialization

b.      Privatization (moderate, page 125)

c.       Universalism

d.      Communism

 

46.    The key to successful privatization is the availability of which of the following?

a.       unskilled labor

b.      physical resources

c.       capital (moderate, page 125)

d.      skilled labor


 

47.    In general, transition implies all of the following EXCEPT:

a.       liberalizing economic activity, prices, and market operations, along with reallocating resources to their most efficient use

b.      developing indirect, market-oriented instruments for macroeconomic stabilization

c.       achieving effective enterprise management and economic efficiency, usually through privatization

d.      imposing soft budget constraints, which provides incentives to improve efficiency (difficult, page 125)

 

Essay Questions

 

48.    List the issues related to economic forces in the international arena.

 

         Answer

         Economic forces include such issues as the general economic framework of a country, economic stability, the existence and influence of capital markets, factor endowments, the size of the market, and the availability of a good economic infrastructure, such as transportation and communications.

         (easy, page 106)

 

49.    What are the key economic forces affecting business operations?

        

Answer

         Economic forces include such issues as the general economic framework of a country, economic stability, the existence and influence of capital markets, factor endowments, the size of the market, and the availability of good economic infrastructure, such as transportation and communications.  Managers need to understand the nature of the world’s economies if they are going to make wise investment decisions.

         (easy, page 106)

 

50.    In a short essay, discuss the importance of factor conditions and demand conditions on international business.

 

         Answer

a.    Factor conditions include essential inputs to the production process such as human resources, physical resources, knowledge resources, capital resources, and infrastructure. Physical resources include weather, the existence of waterways to get goods to and from market, and the availability of crucial minerals and agricultural products. Knowledge resources are best represented by research and development conducted by companies and governments. Capital resources include the availability of debt and equity capital that firms can use to expand. Infrastructure includes roads, port facilities, energy, and communications.

b.    Demand conditions, also known as market potential, include three dimensions: the composition of home demand, the size and pattern of growth of home demand, and the internationalization of demand. The composition of demand is known as the quality of demand, and size is known as the quantity of demand. Factor conditions are especially crucial for investments made for the production of goods, but demand conditions are crucial for market-seeking investments. The combination of factor and demand conditions, along with other qualities, make up the location-specific advantage that a country has to offer domestic and foreign investors.

      (moderate, page 106)

 

51.    What are meant by the quality of demand and the quantity of demand?

        

Answer

         Demand conditions include three dimensions:  the composition of home demand, the size and pattern of growth, and the internalization of demand.  The composition of demand is known as the quality of demand, and the size is known as the quantity of demand.

         (moderate, page 106)

 

52.    Contrast ways of comparing countries by income.

        

Answer

         The key dimension used to distinguish one country from another is the size of demand, or the gross national income (GNI), formerly referred to as Gross National Product.  In particular, countries are classified according to per capita GNI, or the size of GNI of a nation divided by its total population.  Those countries with high populations and high per capita GNI are most desirable in terms of market potential.  Those with low per capita GNI and low populations are least desirable, and the other countries fit somewhere in between.

         (moderate, page 107)

 

53.    In a short essay, define GNI and its effect on international business.

 

         Answer

         Gross National Income is the broadest measure of economic activity. It is the market value of final goods and services newly produced by domestically owned factors of production. For example, the value of a Ford car manufactured in the United States and the portion of the value of a Ford manufactured in Mexico using U.S. capital and management counts in U.S. GNI. However, the portion of the value of a Japanese Toyota manufactured in the United States using Japanese capital and management would not be counted in U.S. GNI, but it would be counted in Japanese GNI. Countries are classified according to per-capita GNI, or the size of GNI of a nation divided by its total population. Those countries with high populations and high per-capita GNI are most desirable in terms of market potential. Those with low per-capita GNI and low populations are least desirable, and the other countries fit somewhere in between.

         (moderate, page 107)

 

54.    In a short essay, describe the World Bank and list the various programs used by the World Bank to assist underdeveloped countries.

 

         Answer

The World Bank is a multilateral lending agency that uses per-capita GNI as a basis for its lending policies. The World Bank Group was founded in 1944 by the United Nations. It consists of five closely held institutions: the International Bank for Reconstruction and Development, the International Development Association, the International Finance Corporation, the Multilateral Guarantee Agency, and the International Center for Settlement of Investment Disputes. The World Bank’s major objective is to provide development assistance to countries, especially the poorest of the poor.

 

         The programs of the World Bank include:

a.      investing in people, particularly through basic health and education.

b.     protecting the environment.

c.      supporting and encouraging private business development.

d.     strengthening the ability of the governments to deliver quality services, efficiently and transparently.

e.      promoting reforms to create a stable macroeconomic environment, conducive to investment and long-term planning.

f.      focusing on social development, inclusion, governance, and institution building as key elements of poverty reduction.

(difficult, page 107)

 

55.    What are the functions of the World Bank?

 

         Answer

The activities of the World Bank are important to MNEs, because they build infrastructure and promote economic growth and stability, improving the quality and quantity of demand.  In particular, the World Bank is most interested in eliminating poverty and its demand-reducing influences.

(easy, page 107)

 

56.   The World Bank classifies economies into several specific categories according to per-capita GNI. In a short essay, discuss these categories relating them to specific levels of country development.

 

         Answer

         The classification of economies based on per-capita GNI is as follows:

a.       low income: $725 or less in 1997

b.      middle income: $786-$9,655

·         lower middle income: $786-$3,125

·         upper middle income: $3,126-$9,655

c.       high income: $9,656 or more

 

The World Bank refers to the low- and middle-income countries as developing countries, even though it recognizes that not all developing countries are alike nor are they all developing. Developing countries are also known as emerging countries, a term also used in describing the capital markets in those countries as different from capital markets in the more advanced countries. High-income countries are also sometimes called developed countries or industrial countries. The developing countries include a variety of different types of countries, some with large populations, such as China and India, and other with small populations, such as Guyana. It also includes countries in economic transition to a market economy, such as China, Poland, Russia, and Vietnam. The high-income countries are a natural place to do business because of the quality and quantity of demand, but the developing countries exhibit tremendous potential because of the sheer size of the population.

(moderate, page 108)

 

57.    A useful way to classify countries is by economic system. In a short essay, describe and discuss the three ways economies can be categorized based on ownership and control.

 

         Answer

Ownership means those who own the resources engaged in economic activity—the public sector, the private sector, or both. Public sector ownership of economic activity refers to the existence of state-owned enterprises. A good example would be China prior to the reforms initiated in 1978 by Chinese leader Deng Xiaoping. At that time, all enterprises in the country were owned by the state. Hong Kong and the United States are examples of the absence of state ownership in major economic activity. The degree varies, but most countries with significant state-owned enterprises are moving toward less, not more, ownership of enterprises. This is known as the process of privatization. Control of economic activity means whether resources are allocated and controlled by the public or the private sector.

a.       Market economy – A market economy is one in which resources are primarily owned and controlled by the private sector, not the public sector. The key factors that make the market economy work are consumer sovereignty and freedom of companies to operate in the market. Prices are determined by supply and demand.

b.      Command economy – In a command economy, also known as a centrally planned economy, all dimensions of economic activity, including pricing and production decisions, are determined by a central government plan. The government owns and controls all resources. The government sets goals for every business enterprise in the country—how much they produce and for whom. In this type of economy, the government considers itself a better judge of resource allocation than its businesses or citizens.

c.       Mixed economy – In actuality, no economy is purely market or completely command. Most market economies have some degree of government ownership and control, while most command economies are moving toward a market economy and away from command concepts.

         (moderate, page 113)


 

58.    What factors are considered when determining how economically free a country is?

 

         Answer

There are 10 factors that are considered when determining how economically free a country is.  These factors include trade policy, fiscal burden of government, government intervention in the economy, monetary policy, capital flows and investment, banking and finance, wages and prices, property rights, regulation, and black markets.

(moderate, page 114)

 

59.    Each year, the Heritage Foundation and the Wall Street Journal publish an index of economic freedom in which they rate countries according to 50 variables organized into 10 economic factors. In a short essay, list and discuss the economic factors on which this index is based, and describe the 2002 index country classifications.

 

         Answer

a.       The economic factors on which the index of economic freedom is based are trade policy, taxation, government intervention in the economy, monetary policy, capital flows and investment, banking, wage and price controls, property rights, regulation, and black markets. The study is helpful in that it identifies ways that governments control economic activity and the degree to which they do so.

b.      The 2002 index classified countries as free, mostly free, mostly unfree, and repressed. Examples of free countries include Hong Kong, Singapore, and the United States, while repressed countries include Iraq, Cuba, and North Korea. Mostly free countries include the Czech Republic, Japan, Canada and mostly unfree countries include Zambia, Mexico, and Brazil. Countries at the top of the index (free countries) also have a high degree of political freedom, whereas the countries at the bottom of the index (repressed countries) have no political freedom.

         (moderate, page 114)

 

60.    Contrast market, command, and mixed economies.

 

         Answer

         A market economy is one in which resources are primarily owned and controlled by the private sector, not the public sector. The key factors that make the market economy work are consumer sovereignty and freedom for companies to operate in the market.

         In a command economy, all dimensions of economic activity, including pricing and production decisions, are determined by a central government plan.  The government owns and controls all resources.

         In actuality, no economy is purely market or completely command. Most market economies have some degree of government ownership and control, while most command economies are moving toward a market economy and away from command concepts.

         (moderate, page 114)

 

61.    What are the key macroeconomic conditions affecting international business strategy?

 

         Answer

         The three key macroeconomic conditions affecting international business strategy are economic growth, inflation, and surpluses and deficits.

         (easy, page 116)


 

62.    An economic factor that management needs to consider is inflation. In a short essay, define inflation and discuss the effects of inflation on international business.

 

         Answer

         Inflation means that prices are going up. The inflation rate is the percentage increase in the change in prices from one period to the next, usually a year. Economists use different types of indices to measure inflation, but the one they use the most is the consumer price index. The CPI measures a fixed basket of goods and compares their prices from one period to the next. A rise in the index results in inflation. The demand can occur because of government spending where spending is rising faster than the tax revenues to fund the spending or because of increases in the money supply. Inflation affects interest rates, exchange rates, the cost of living, and the general confidence in a country’s political and economic system. High inflation often results in an increase in interest rates for two reasons. The first reason is that interest rates must be higher than inflation so that they can generate a real return on interest-bearing assets. Second, monetary authorities such as the Federal Reserve Bank in the United States use high interest rates to bring down inflation. When interest rates rise, companies are hesitant to borrow money, which tends to slow down economic growth. In addition, consumers are hesitant to incur consumer debt because of the higher cost of repayment. As demand falls, prices should stabilize or fall. Inflation is also the most significant factor that influences exchange rates. Basically, the higher the inflation in a country, the more likely that a country’s currency will fall. Countries with low inflation should have stable or relatively strong currencies. Inflation also affects the cost of living. As prices rise, consumers find it more difficult to purchase goods and services unless their income rises the same as or faster than inflation. High inflation also creates problems for companies that deal in exports. If inflation is going up but the exchange rate is staying the same, the products will gradually become more expensive in export markets.

         (moderate, page 119)

 

63.    What are the adverse effects of inflation on international business?

 

         Answer

         Inflation affects interest rates, exchange rates, the cost of living, and the general confidence in a country’s political and economic system.  High inflation often results in an increase in interest rates for two reasons.  The first reason is that interest rates must be higher than inflation so that they can generate a real return on interest-bearing assets.  Second, monetary authorities such as the Federal Reserve Bank in the United States or the European Central Bank use high interest rates to bring down inflation. When interest rates rise, companies are more hesitant to borrow money, which tends to slow down economic growth.

         (moderate, page 119)

 

64.    External and internal surpluses and deficits are other measures of a country’s economic stability. In a short essay, discuss external and internal surpluses and deficits and the balance of payments as it relates to international business.

 

         Answer

An external deficit refers to the excess of a country’s cash outflows over its inflows. An internal deficit refers to the excess of government expenditures over government revenues. The balance of payment records a country’s international transactions. These can be transactions between companies, governments, or individuals. The balance of payments is divided into the current account and the capital account.

a.       The current account is comprised of trade in goods and services and income from assets abroad. Part of the current account is merchandise trade balance, which measures the country’s trade deficit or surplus. The second component of the current account is services, which includes transactions such as travel, passenger fares, and other transportation, and royalties and fees on licensing agreements with foreign customers. The third component of the current account is income receipts/payment on assets. This includes items such as receipts from foreign direct investments abroad. A final category, unilateral transfers, is typically not a significant component of the current account balance, but it includes government and private relief grants and income transferred abroad by guest workers, such as Turkish workers in Germany sending money back to their families in Turkey. The current account balance is an important long run and comprehensive measure of a country’s transactions with the rest of the world.

b.      The capital account shows transactions in real or financial assets between countries. Examples of capital account transactions include foreign direct investments, the purchase and sale of securities, and the purchase of U.S. treasury bonds by a Japanese investor. Also measured in financial assets are changes in the official reserve assets of a country, such as gold, special drawing rights, and foreign currencies.

(moderate, page 122)

 

65.    What is a balance of payments, and what are its major components?

 

         Answer

         The balance of payments records a country’s international transactions.  These can be transactions between companies, governments, or individuals.  The balance of payments is divided into the current account and the capital and financial account.  The current account is comprised of trade in goods and services and income from assets abroad and payments on foreign-owned assets in the country.  The capital account shows transactions in real or financial assets between countries.

         (moderate, page 122)

 

66.    What is privatization?

 

         Answer

         As countries move to control expenditures and reduce their budget deficits, one important strategy to pursue is the privatization of state-owned enterprises.  Privatization reduces debt by removing the need of the government to subsidize the state-owned enterprise.  When the government owns enterprises, it often feels an obligation to keep the enterprises afloat to preserve jobs.  Once it is free from ownership, the enterprises can succeed or fail on their own merits.

         (moderate, page 125

 

67.    Most command economies are in the process of transition to a market economy. In a short essay, discuss the meaning of transition, and also discuss the related factors that can make an economic transition more successful.

 

         Answer

In general, transition to a market economy implies all of the following:

a.       liberalizing economic activity, prices, and market operations, along with reallocating resources to their most efficient use.

b.      developing indirect, market-oriented instruments for macroeconomic stabilization.

c.       achieving effective enterprise management and economic efficiency, usually through privatization.

d.      imposing hard budget constraints, which provides incentives to improve efficiency.

e.       establishing an institutional and legal framework to secure property rights, the rule of law, and transparent market-entry regulations.

A study of countries in transition has shown that the following factors must be implemented for a successful economic transition:

a.       Sustained macroeconomic stabilization (inflation control) is essential.

b.      No pain, no gain. Delayed reforms may defer the pain, but they defer sustained recovery and increase the risk that growth will be reversed.

c.       There is no royal road to reform. There is no one key to growth; countries have to implement all the different components of reform.

d.      Developing an appropriate legal structure is indispensable.

(moderate, page 125)