Practice Questions 2.2 (Chapt. 17)

Practice Questions - 1 Practice Questions for Topic 2.2(Chapter 17 I Suggested MyEconLab questions Chapter 17 Section 17.1 Exercise 1.1 Section

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1 Practice Questions for Topic 2.2 (Chapter 17) I. Suggested MyEconLab questions: Chapter 17 Section 17.1: Exercise 1.1 Section 17.4: Exercise 4.1 Section 17.5: Exercise 5.1; Exercise 5.2 Section 17.6: Exercise 6.2; Exercise 6.4 II. Other questions: NOTE: Answers to all of the following questions follow on pages 4-7. 1. Consider an open economy in the short-run whose output market is described by the following equations: D = C+I+G+CA (Note: CA = NX ) C = 10+ 0.6( Y-T ) I = 15 G = 30 T = 25 CA = 10 EP*/P - 0.2( Y-T ) P=P* =1.0 i) Derive the equation for the aggregate demand function in two cases: when the exchange rate ( E ) equals 1.5 and when E = 1.8. In the diagram below sketch each of these aggregate demand functions, indicating the values of the intercepts and slope. ii) Given your answers to part i), prove that ( E =1.5, Y = 100) and ( E =1.8, Y =105) are both combinations of values for the exchange rate and output which lie on the current DD curve of this economy. Explain the basis of your proof. D Y=D Y

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2 2. The upper halves of the two panels above show the effects on the equilibrium exchange rate of a change in the domestic interest rate ( R ). In both cases the domestic interest rate increases from R 1 to R 2 and in response the exchange consistent with FX market equilibrium (interest parity) decreases from E 1 to E 2 . These changes in interest rate and exchange rate could be consistent with either a movement along an AA curve or a shift of the AA curve depending upon the reason for the change in domestic interest rate. i) Complete the money market diagram in the bottom half of panel a) showing a change in money market equilibrium which is clearly consistent with a movement along an AA curve with no shift in that curve. Explain what you have drawn and why it leads to a movement along an AA curve. ii) Complete the money market diagram in the bottom half of panel b) showing a change in money market equilibrium which is clearly consistent with a shift of an AA curve with no movement along that curve. Explain what you have drawn and why it leads to a shift in the AA curve. E Rates of return R 1 E 1 E 2 R 2 b) A shift of the AA curve R*+(E e -E)/E Real domestic money holdings E Rates of return R 1 E 1 E 2 R 2 R*+(E e -E)/E a) A movement along an AA curve Real domestic money holdings
3 3. Consider two economies which we shall refer to as the domestic economy and the foreign economy. (You can think of Canada as the domestic economy and the U.S. as the foreign economy.) The diagram below shows the initial short-run equilibrium in the domestic economy (point 1). i) Suppose that the

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This note was uploaded on 02/02/2012 for the course ECONOMICS 239 taught by Professor Wu during the Winter '11 term at Wilfred Laurier University .

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Practice Questions - 1 Practice Questions for Topic 2.2(Chapter 17 I Suggested MyEconLab questions Chapter 17 Section 17.1 Exercise 1.1 Section

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