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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 47.
1.
Consider an open economy in the shortrun whose output market is described by the
following equations:
D = C+I+G+CA
(Note:
CA = NX
)
C
= 10+ 0.6(
YT
)
I
= 15
G
= 30
T
= 25
CA
= 10
EP*/P
 0.2(
YT
)
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. 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 shortrun 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 .
 Winter '11
 WU

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