ECON 42002 & 04: Fall 2008
Homework 2
Due in class on September 17, 2008
1.
In the country of Wiknam, the velocity of money is constant. Real GDP grows by 5% per year,
the money stock grows by 14% per year, and the nominal interest rate is 11%. What is the real
interest rate? (5 points)
2.
Consider an economy described by the following equations:
Y = C + I + G + NX
Y = 5,000
G = 1,000
T = 1,000
C = 250 + 0.75 (YT)
I = 100050r
NX = 500500ε
r = r
*
= 5
a.
In this economy, solve for national saving, investment, the trade balance, and the equilibrium
exchange rate. (5 points)
b.
Suppose now that G rises to 1,250. Solve for national saving, investment, and trade balance,
and the equilibrium exchange rate. Explain what you find.(5 points)
c.
Now suppose that the world interest rate rises from 5 to 10 percent (G is again 1,000). Solve
for national saving, investment, the trade balance, and the equilibrium exchange rate. Explain
what you find. (5 points)
3.
Use the model of the small open economy to predict what would happen to the trade balance, the
real exchange rate, and the nominal exchange rate in response to each of the following events.
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 Fall '08
 Hill
 Inflation, real wage

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