week6 - Output and the Exchange Rate in the Short Run...

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Output and the Exchange Rate in the Short Run Viktoria Hnatkovska week 6 1
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Overview Objective : Combine our knowledge of exchange rates and current account to study their interaction. Determinants of aggregate demand in the short run:    demand and  A short run model of output markets Output market equilibrium: The  schedule A short run model of asset markets: The  schedule A short run model for an open economy: Putting output markets and asset markets together E f ects of temporary and permanent changes in monetary and f scal policies Macroeconomic policies and the current account 2
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Determinants of Aggregate Demand Aggregate demand is the aggregate amount of country’s goods and services demanded by individuals, f rms and institutions throughout the world. A country’s overall short-run output depends partially on the aggregate demand for its products. In the long-run, economy is at its full employment level. Therefore, a country’s output in the long-run depends only on the domestic supplies of factors: labor and capital. Long run models are useful when all prices of inputs and outputs have time to adjust. In the short run, some prices of inputs and outputs may not have time to adjust, due to labor contracts, costs of adjustment, or imperfect information about willingness of customers to pay at di f erent prices. This chapter builds on the short run and long models of exchange rates to explain how output is related to exchange rates in the short run. 3
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Determinants of Aggregate Demand In chapter 12 we showed = + + +  Start by assuming and are given. What determines and  ? Determinants of consumption expenditure include: Disposable income, : income from production ( )m inustaxes( ), so that = . Larger disposable income means more consumption expenditure, but consumption typically changes less than the change in disposable income due to consumption smoothing. Real interest rates may in f uence the amount of saving and spending on consumption goods, but we assume that they are relatively unimportant here. Wealth may also in f uence consumption expenditure, but we assume that it is relatively unimportant here. So, = ( )
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Determinants of Aggregate Demand Determinants of the current account include: Real exchange rate: prices of foreign products relative to the prices of domestic products, both measured in domestic currency:   Real exchange rate changes a f ect the current account because they re f ect changes in the prices of domestic goods and services relative to foreign. Disposable income: it a
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This note was uploaded on 01/28/2011 for the course ECON 304 taught by Professor Michaelpeters during the Spring '10 term at The University of British Columbia.

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week6 - Output and the Exchange Rate in the Short Run...

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