PS6 - Problem Set # 6 Solutions Chapter 5 #1 a. An increase...

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Problem Set # 6 Solutions Chapter 5 #1 a. An increase in saving shifts the (S – I) schedule to the right, increasing the supply of dollars available to be invested abroad, as in Figure 5–3. The increased supply of dollars causes the equilibrium real exchange rate to fall from Є 1 to Є 2. Because the dollar becomes less valuable, domestic goods become less expensive relative to foreign goods, so exports rise and imports fall. This means that the trade balance increases. The nominal exchange rate falls following the movement of the real exchange rate, because prices do not change in response to this shock. b. The introduction of a stylish line of Toyotas that makes some consumers prefer foreign cars over domestic cars has no effect on saving or investment, but it shifts the N X( Є ) schedule inward, as below. The trade balance does not change, but the real exchange rate falls from Є 1 to Є 2. Because prices are not affected, the nominal exchange rate follows the real exchange rate.
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c. In the model we considered in this chapter, the introduction of ATMs has no effect on any real variables. The amounts of capital and labor determine output Y. The world interest rate r * determines investment I( r * ). The difference between domestic saving and domestic investment (S – I) determines net exports. Finally, the intersection of the N X( Є ) schedule and the (S – I) schedule determines the real exchange rate, as in Figure 5–5. The introduction of ATMs, by reducing money demand, does affect the nominal exchange rate
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This note was uploaded on 10/25/2010 for the course MBA GloEco taught by Professor N.m. during the Spring '10 term at Institute of Business Administration.

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PS6 - Problem Set # 6 Solutions Chapter 5 #1 a. An increase...

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