HW4_Answerkey - ECON302 Suggested Answers to HW4: Q. #s 3,...

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ECON302 Suggested Answers to HW4: Q. #s 3, 5, and 6 in Ch. 12 on page 366; Q. #s 3 & 7 in Ch. 13 on page 399- 400; Q. #s 1 & 3 in Ch. 14 on page 427; #3, Ch. 12: a. The causes for world interest rate, r*, are changes in the world saving and world investment. If the saving decreases and/or investment demand increase, the world interest rate increases and vice versa. In addition, with fixed price, if the world demand for goods and services increases and/or reduces the world money supply, world interest rates will increase and vice versa. b. Under floating exchange rates, increase in r* would decrease the IS curve leftward (reduces Id), and LM curve would move to rightward (reduces Md due to higher interest rates). Income (Y) goes up to restore equilibrium with fixed real balances (M/ P) and which in effect increase money demand in the long run to adjust with new equilibrium of depreciated e and increase in Y. With decrease in e and increase in Y, the trade balance will improve. c. Under fixed exchange rates, increase in r* would shift both IS and LM curve to the left (due to downward pressure of exchange rate) when domestic currency is bought in international market in exchange for foreign currency. Ms falls and LM curve has to shift all the way to the left until it intersects with new IS curve at the fixed exchange rate. So output falls, with no change in e, and no change in trade balance.
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5. NX = f (e, Y); e = exchange rate which is inversely related to NX (downward sloping); and Y = domestic income which is also inversely related to NX (Shifts). a. Under floating exchange rate, expansionary fiscal policy will shift the IS curve to the right and e will rise with no change in Y (with vertical LM curve). b. Under fixed exchange rate, expansionary fiscal policy would shift both IS and LM curve to the right (due to upward pressure of e, the central bank sells domestic currency against foreign currency to keep e fixed) by increasing Ms. The Y will increase up to a point where the IS and LM curve intersects at the existing level of e. e
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HW4_Answerkey - ECON302 Suggested Answers to HW4: Q. #s 3,...

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