100b08ps6a - University of California Santa Cruz Econ 100B...

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University of California, Santa Cruz Fall Quarter 2008 Econ 100B INTERMEDIATE MACROECONOMICS Problem set 6 Answer Key 1. Problem 7, Chapter 19 a. Equilibrium condition and value of Y are given as follows:- b. If G goes up by 1 unit, Y goes up by the multiplier times G but the increase is smaller than in a closed economy as the multiplier is now smaller due to the presence of m1 (import propensity) in the denominator. Some of the additional demand due to a rise in G falls on imports and hence output goes up by less now. c. An increase in G in an open economy worsens trade balance i.e. net exports become negative. As Y goes up, this leads to an increase in imports and hence fall in net exports. d. A smaller country will have a higher propensity to import as being small and hence having lower domestic output,any increase income will be channelled towards an increase in demand for foreign goods. So the smaller economy has import propensity of 0.5 e.
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f. Fiscal policy as seen from above will have a smaller effect on output in the economy with higher import propensity i.e. the smaller economy. It will have a larger negative effect on net exports in the smaller economy. 2. Problem 5 Chapter 20 a. An increase in foreign output raises foreign imports and thus decreases foreign net exports. As a result it increases the domestic net exports. This causes the IS curve to shift out in the home country. As a result, in the home country, output and interest rate increases. The rise in interest rate causes nominal exchange rate to go up. With prices being fixed in the short run, the real exchange rate also goes up which causes net exports to decrease (assuming Marshall Lerner condition holds). The rise in output also causes net exports to decrease. However, this decrease in net exports does not offset the rise in net exports due to a rise in foreign demand. b. A rise in the foreign interest rate would lead to a decrease in the exchange rate if we hold expected exchange rate constant. Moreover the increase in foreign interest rate makes foreign bonds more attractive and causes a depreciation of the dollar. With fixed prices, this implies a decrease in the real exchange rate. If we assume Marshall Lerner condition holds, there is an increase in the net exports so the IS curve shifts out. The home interest rate increases but not as high as the foreign interest rate. The increase
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This note was uploaded on 02/08/2011 for the course ECON 100B taught by Professor Yisun during the Spring '07 term at UCSC.

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100b08ps6a - University of California Santa Cruz Econ 100B...

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