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Econ 100B
Macroeconomic Analysis
Professor Steven Wood
Fall 2011
Problem Set #5
Due: November 22, 2011 (in class before 3:50:01 p.m.)
Place your completed problem set in the box near the entrance.
Please sign the following oath:
The answers on this problem set are entirely my own work. I neither copied from the work of others nor allowed
others to copy from my work.
_______________________________________
Signature
Any problem set turned in without a signature will be assigned a grade of zero.
Problem Set Instructions
1.
You MUST complete your problem set on this template.
2.
Graphs and equations MAY be drawn by hand. When drawing diagrams, clearly and accurately label all
axis, lines, curves, and equilibrium points.
3.
Explanations MUST be word-processed. Your explanations should be succinct and to the point.
Problem Set #5 (Fall 2011)
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A. Multiple Choice Questions (15 points). Circle the letter corresponding to the best answer (3 points each).
1.
Moral hazard arises because:
a.
b.
c.
d.
2.
The tyranny of collateral:
a.
b.
c.
d.
3.
A decrease in the prices of foreign goods.
An increase in the prices of foreign goods.
An increase in the prices of domestic goods.
An increase in the domestic rate of inflation.
In the short-run, an increase in the U.S. money supply would cause the value of the dollar to _____ and
U.S. net exports to _____ :
a.
b.
c.
d.
5.
Suggests that government tax rates are too high.
Generates problems of moral hazard and adverse selection.
Implies that when a person has very few assets it may be difficult to acquire financing.
Implies that government regulation can decrease moral hazard problems in the financial sector.
For a given real exchange rate, a nominal appreciation of the domestic currency will result from:
a.
b.
c.
d.
4.
Adverse selection exists.
Free-rider problems exist.
Of the law of diminishing marginal opportunity costs.
One party to an economic transaction possesses more information than another.
Increase; increase.
Increase; decrease.
Decrease; increase.
Decrease; decrease.
With a fixed exchange rate, what happens if a countrys currency is undervalued?
a.
b.
c.
d.
The currency appreciates.
The currency depreciates.
The central bank gains official reserve assets.
The central bank losses official reserve assets.
Problem Set #5 (Fall 2011)
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B. Analytical Question (35 points). Answer the following question based on the standard models of analysis
developed in class. The information in the various parts of the question is sequential and cumulative.
1.
Open Economy ADAS Model with the Foreign Exchange Market (35 points). Argentina (the
domestic economy) and Brazil (the foreign economy) are major trading partners that are initially in general
equilibrium with flexible exchange rates.
a.
Based only on this information, use an open economy ADAS model diagram for each country,
as well as a diagram of the foreign exchange market for the Argentine peso, to clearly and
accurately show each economys initial equilibrium position and equilibrium the in foreign
exchange market. These diagrams should be shown in BLACK.
Foreign Exchange Market
Problem Set #5 (Fall 2011)
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b.
Provide an economic explanation of what you have drawn in your diagrams above.
Argentina (the domestic economy) and Brazil (the foreign economy) are major trading partners that are initially
in general equilibrium with flexible exchange rates , which is at point E 0 on the Foreign Exchange Market
diagram.
c.
Now suppose that the Argentine central bank conducts a contractionary monetary policy. On your
diagrams above, clearly and accurately show what happens to economic output, inflation, and the Argentine
peso exchange rate. These changes should be drawn in RED.
d.
Provide an economic explanation of what you have drawn in your diagram above. Be sure to
discuss what happens to economic output, inflation, and the exchange rate and explain why these changes take
place.
Because the Argentine central bank conducts a contractionary monetary policy causes an appreciation of
exchange rate in the pesos currency. The economy is having goods with higher prices, and thus causes the
goods to be expensive relative to the Brazilians goods. This leads to a decrease in export and increase in
import, which NX decreases also decreases aggregate demand causes AD curve to shift to the left, AD 0 to AD1.
SRAS shifts down, SRAS0 to SRAS1 and that leads to lower inflation, 0 to 1, and decreases output, Y 0 to Y1.
The Brazils economy is the opposite since its NX increases, AD shifts to the right and SRAS shifts up. It
causes the inflation to go up and higher aggregate output. In the foreign exchange market, the demand for
Argentine pesos increases shifting D curve to the right, and thus leads to higher exchange rate.
e.
The year after (the events in part c occur), the Brazilian government conducts an expansionary
fiscal policy. On your diagrams above, clearly and accurately show what happens to economic output,
inflation, and the Argentine peso exchange rate. These changes should be drawn in BLUE.
f.
Provide an economic explanation of what you have drawn in your diagram above. Be sure to
discuss what happens to economic output, inflation, and the exchange rate and explain why these changes take
place.
Because the Brazilian government conducts an expansionary fiscal policy, the autonomous government
spending increases and that stimulates autonomous consumption. In fact, the Brazilians economy has higher
aggregate output of which AD curve shifts to the right, AD1 to AD2 and SRAS shifts upward, SRAS1 to SRAS2.
The inflation is even higher when the aggregate output increases, 1 to 2. Perhaps, in the Argentines economy,
the demand for Brazilians goods is even higher, so import is greater than export, and thus NX continues to
decrease further down. SRAS shifts downward, SRAS 1 to SRAS2 leads to lower aggregate output and lower
inflation. The foreign exchange market for the Argentine pesos continues to demand for more pesos and that
shifts D curve to the right, D1 to D2, and thus further increases the exchange rate, E1 to E2 .
Problem Set #5 (Fall 2011)
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Problem Set #5 (Fall 2011)
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