Also decreases the cost of foreign produced goods

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also decreases the cost of foreign produced goods imported for domestic residents who now buy more of them; as a result, imports increase. This causes net exports and aggregate demand to decrease for any given inflation. This is represented by a leftward shift of the aggregate demand curve from AD1ato AD1. Economic output is now somewhat lower for any given inflation. At inflation of π1a, there is now less excess demand for goods and services in the economy, causing inflation to rise less than it would have without this reduction in net exports and aggregate demand. Fifth, the appreciation of the domestic currency from E0to E1decreases the costs of imported goods. This decreases the cost of production for any given level of economic output. This is represented by a downward shift of the short-run aggregate supply curve from SRAS0(πe= π0) to SRAS1(πe= π0). Inflation is now lower for any given level of economic output. At inflation of π1a, there is now less excess demand for goods and services in the economy, causing inflation to rise less than it would have without this reduction in short-run aggregate supply.
Exam #3 (Spring 2016) 9/12 When these Year 1 effects are complete, there is a new short-run equilibrium where: (1)Economic output has increased from Y0to Y1, (2)Inflation has increased from π0to π1, and (3)The exchange rate has appreciated from E0to E1. Although the economy is in short-run equilibrium, it is no longer in general equilibrium.
Exam #3 (Spring 2016) 10/12 d.Scenario #2.Suppose that the (same) economy, which is characterized by sticky wages and prices, perfect capital mobility, and a fixed exchange rate, is initially (i.e., in Year 0) in general equilibrium. Based only on this information, use an AD/AS Model diagram (on the left) and a Foreign Exchange Market diagram (on the right) to clearly and accurately showthe economy’s initial (1) economic output, (2) inflation, and (3) exchange rate. These diagrams should be drawn in BLACKAD1AD0D1aD0= D1Q Q Assets E E1aE1= EY0= YPY1 ππ1π0SRAS0(πe= π0= SRAS1(πe= π0S0YP.0Y ) )
Exam #3 (Spring 2016) 11/12 e.In Year 1, the government increases government purchases by $500 billion. Incorporating only this additional information, clearly and accurately showin your diagrams above what, if any, effects this has on the economy’s (1) economic output, (2) inflation, and (3) exchange rate. This diagram should be drawn in REDf.Provide an economic explanationof what you have shown in your diagrams above. Discusswhat happens, if anything, to the economy’s (1) economic output, (2) inflation, and (3) exchange rate. Be sure to explain whatcauses these changes and explain whythese changes occur. . In Year 1, four events occur: First, an increase in government purchases increases aggregate demand for any given inflation. This is represented by a rightward shift of the aggregate demand curve from AD0to AD1. Economic output is higher for any given inflation. At the initial inflation of π0, there is now excess demand for goods and services in the economy, causing inflation to rise.

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