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ps8_answers - PART I SHORT QUESTIONS(5 points each 1...

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PART I. SHORT QUESTIONS (5 points each) 1. T/F/U (justify your answer). The bilateral exchange rate between US and Japan is 124 (1$ can buy 124 ¥) . Therefore, American tourists in Japan find everything very cheap. UNCERTAIN. We cannot infer how cheap the relative price of Japanese goods is by looking at the nominal exchange rate. To know whether goods in Japan are relatively cheaper or more expensive than American goods, we need to consider the real exchange rate. That is, not only the nominal exchange rate but also the prices of the goods in both countries. 2. T/F/U (justify your answer). Devaluation is always associated with gains in competitivity. FALSE. If domestic prices increase in the same proportion as the increase in the nominal exchange rate, devaluation has no impact on the real exchange rate. In that case, there is no gain in competitivity. 3. Complete the blanks: Current Account Export 1000 Imports _1500_ __ trade balance ________ -500 Investment income received 300 Investment income paid __400_ __ net investment income_ -100 Net transfers received 50 Current Account balance _ -550 __ Capital Account _increase in foreign holdings of US assets__ 500 Increase in US holdings of foreign assets __ -50 __ Net Capital Inflows _ _550 __ PART III. OPEN ECONOMY WITHOUT CAPITAL MOBILITY (15 points each) Imagine a small open economy in a world of no capital mobility. The economy is characterized by the following behavioral equations: C = c 0 + c 1 (Y-T) I = b 0 + b 1 Y – b 2 i
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G = G 0 T = T 0 X = x 0 + x 1 Y* + x 2 ε IM = q 0 + q 1 Y – q 2 ε M d = m 0 + m 1 Y – m 2 i M s = M 0 Where Y* is the level of foreign output and ε is the real exchange rate.
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