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Unformatted text preview: 1 Practice Questions for Topic 2.3 (Chapter 18) I. Suggested MyEconLab questions: Chapter 18 Section 18.2: Exercise 2.2; Exercise 2.3 Section 18.4: Exercise 4.1; Exercise 4.3 II. Other questions: NOTE: Answers to all of the following questions follow on pages 3-6. 1. Consider an open economy operating with a fixed exchange rate ( E ). The economy can be described by the following equations: Output Market: 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 E=E = 1.5 Asset markets: M d /P = L(R.Y) = 0.5 Y- 1000 R R * = 0.03 E e = E = E = 1.5 i) Given the above information, solve for the equilibrium levels of domestic output ( Y ), domestic interest rate ( R ), and domestic money supply ( M s ). Explain the basis of your answers. ii) Now suppose that the government of this economy is concerned about its current budget deficit and decides to eliminate that deficit by reducing govt. purchases from 30 to 24 with no change in taxes. What are the new equilibrium values of Y, R, and M s ? iii) Use the DD-AA diagram below to show the effects of this decrease in govt. purchases under fixed exchange rates. Indicate the new DD-AA equilibrium as point 2 and use the superscript 2 to label new curves and variable values. Explain the economys response to this cut in G as shown in your diagram by writing out the sequence of changes and their causes. iv) If the exchange rate had been allowed to float rather than being held fixed (and assuming E e remained fixed at 1.5) would this fiscal austerity ( G) have had a larger 2 or smaller impact on output? Explain why and use the DD-AA diagram to illustrate. [Note: Give a qualitative answer only; dont try to calculate equilibrium Y under flexible exchange rates.] v) Now suppose that the govt. of this economy wishes to eliminate its budget deficit while avoiding a recession and maintaining output unchanged at Y 1 . Explain how it could ....
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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