doubts../Amit sir plz help..

[Target MA]

Q1-The average rate of inflation in USA and Japan between the years 1960-73 is 3.2% and 6.1%
respectively, then the growth rate of
a) No definite conclusion can be made c) Japan will be more
b) USA will be more d) Japan will be less

Q2-Which of the following would likely have the least direct influence on a country’s current
account?
a) inflation c) exchange rates
b) national income d) a tax on income earned from foreign stock

[Sumit]

Q1.I think it's C)Japan will be more.
Why so?
Sol.As we know the Formula: % Change in NER=% Change in RER+(P*-P) where NER=Nominal exchange rate, RER=Real exchange rate, P*=Inflation rate in foreign country n P=Inflation rate in domestic country...
Let Assume US as domestic country.
Now, At P*=P, RER=NER due to PPP which say S(yen/$)=Price in Japan/Price in US where S(yen/$) is spot exchange rate.....

So, As question say P=3.2 & P*=6.1...
So due to high inflation in japan NER i.e S(yen/$) increase which means dollar appreciate and yen depreciate....This result can also be verified by Relative form of PPP which say  S(yen/$)=Inflation rate in japan minus Inflation rate in US..

Now, Due to Appreciation of Dollar the Import of US increase and export decrease this mean Balance of trade will be worsen off of US n better off of Japan..n due to less export and more Import then before domestic US producer will produce less Bcoz demand for there goods from japan has fallen...Now due to less production GDP of US will Fall..n due to this Growth rate also fall...n similarly we will see due to yen depreciation growth of Japan will increase....
So, In this case answer will be...C) Japan will be more..

Note: Assumptions in above Case: 1)In the above case  I initial assume that there is no inflation in both the country.Also before inflation growth rate in both the country is same...
2)There Is only bilateral trade....i.e US only trade with Japan & Japan only with US....

Also If we relax these two assumption then the answer will be a) No definite conclusion can be made...



Q2.
I think its b)National Income.

Sol: We know that CA=(X-IM)+NY+NCT Wheere CA is the current account, X and IM the export and import of goods and services respectively, NY the net income from abroad, and NCT the net current transfers.
So,by Using above CA formula n the Formula  which say % Change in NER=% Change in RER+(P*-P) we can infer that a change in a)inflation will influence NER...which in turn Influence export n import....n Export n Import will influence CA....
Similar Argument for B) exchange rates ...change in exchange rate will influence IM n Export which in turn Influence CA...
d) a tax on income earned from foreign stock: As we know tax on income earned from foreign stock will lower NY from abroad...this means imposition of tax will lower the balance of CA...

Now, b) national income: suppose there is increase in domestic income Is this mean NY(=Income from abroad minus income to abroad) will fall n due to this CA????..NOT always coz increase of income doesn't implied that income to abroad will defiantly increase..


PS: This is my point of view.