ECMC61_Assignment_2_Solution_Fall_2011

ECMC61_Assignment_2_Solution_Fall_2011 - ECMC61...

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ECMC61 – International Economic: Finance Assignment 2 Answer Key – Fall 2011 Question 1 (15 points) Suppose the policy makers run expansionary monetary policy and contractionary fiscal policy at the same time: G AD ↓⇒ DD shifts to the left to DD(G 1 ) (1 pt) A leftward shift in DD alone will decrease Y and cause DC to depreciate. MS AA shifts up to AA(MS 1 ) (1 pt) An upward shift in AA alone will increase Y and cause DC to depreciate. Short-run equilibrium: DC depreciates unambiguously. (3 pts) The overall effect on Y is ambiguous: If the shift in DD > the shift in AA, then point B is the equilibrium – DC depreciates (say to E 1 ) & Y to Y 1 . If the shift in DD < the shift in AA, then point C is the equilibrium – DC depreciates (say to E 2 ) & Y to Y 2 . If the shift in DD = the shift in AA, then point D is the equilibrium – DC depreciates (say to E 3 FE . E DD(G 1 ) DD(G 1 ) DD(G 1 ) DD(G 0 ) E 1 B D E 3 E 2 C Graph: 5 pts – must show show all possible outcomes. E 0 A AA(MS 1 ) AA(MS 0 ) Y Y 1 Y FE Y 2 Question 2 (25 points) Part (a) (4 points) Output, Y: Y = Y FE = 2(40000) 1/2 (14400) 1/2 = 48000 (1 pt) DD function: Y = 30000 – 250P + 500E Solving P first: From DD equation: E = 36 + 0.5P (1) From AA equation: E = 1750/P – 134 (2) 1 ECMC61 Assignment 2 Answer Key (Fall 2011)
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Equate (1) and (2): 36 + 0.5P = 1750/P – 134 P 2 + 340P – 3500 = 0 P = 10 (1 pt) or P = – 350 (reject) Sub P = 10 into either (1) or (2) E = 36 + 0.5(10) = 41 (1 pt) Or, E = 1750/10 – 134= 41 Solving E first: From DD equation: P = 2E – 72 (1) From AA equation: P = 1750/(134 + E) (2) Equate (1) and (2): 1750/(134 + E) = 2E – 72 E 2 + 98E – 5699= 0 E = 41 or E = – 139 (reject) Sub E = 41 into either (1) or (2) P = 2(41) – 72 = 10 Or, P = 1750/(134 + 41) = 10 Part (b) (6 points) (1 pt for showing work) Short run: P = 10 (1 pt) Exchange rate, E: (1 pt) 26400 + 6000 – 250(10) + 500E = 17500 + 10(35000/10) + 150(40) – 200E 29900 + 500E = 58500 – 200E E = 40.8571 Output, Y: (1 pt) Y = 29900 + 500(40.8571) = 50328.55 Or, Y = 58500 – 200(40.8571) = 50328.58 Long run: Given the changes a temporary, both DD and AA curves will reverse back to its initial position before the long run arrives. Thus, the initial long-run equilibrium will the new long-run equilibrium: Output, Y: Y = Y FE = 48000 (1 pt) Exchange rate, E = 41 (1 pt) Part (c) (4 points) (1 pt for showing work) Suppose the central bank wants to keep Y at 49000 in the short run: To keep Y at 49000, the central bank should run contractionary monetary policy. Level of E that will keep Y = 49000 in the short run:
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ECMC61_Assignment_2_Solution_Fall_2011 - ECMC61...

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