Economics 110b spring 2012 dr maria cândido 8 4 10

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Chapter 13 / Exercise 5
Macroeconomics
Roger A. Arnold
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Economics 110B Spring 2012 Dr. Maria Cândido8 4.(10 points) Consider an open economy whose government took policy measures that led to an appreciation of its currency. Assume that the goods market is initially in equilibrium and that trade is balanced at the initial level of output. Use the open economy goods market model(ZZ-NX) to graphically illustrate the effects of the currency appreciation in the goods market in the short run. Clearly label all curves and the initial and final equilibria. Describe the effect of this policy on the equilibrium output in the goods market, and in consumption, investment, exports, imports, net exports, budget deficit and private saving.
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Macroeconomics
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Chapter 13 / Exercise 5
Macroeconomics
Roger A. Arnold
Expert Verified
Economics 110B Spring 2012 Dr. Maria Cândido9 5.(9 points) Consider an open economy under a flexible exchange rate regime. Assume that the economy is initially at the natural level of output and that there is a trade deficit. Use the Mundell-Fleming or IS-LM-IP model to answer the questions below. a.What should be the appropriate mix of monetary and fiscal policies in order to reduce the trade deficit and keep output constant? Explain and show this in a graph. b.What happens to the interest rate and to the exchange rate as a result of this combined monetary and fiscal policy? Explain and show this in the graph above. c.Discuss what happens to the components of demand as a result of this combined policy action.
Economics 110B Spring 2012 Dr. Maria Cândido106.(12 points) Consider an open economy with fixed exchange rates and perfect capital mobility that is initially operating at the natural level of output. Throughout this problem, assume that foreign output, foreign interest rate and foreign price level are fixed. Also assume that the expected inflation remains constant. Now, suppose that the government reduces spending. a.Using the IS-LM framework, graphically illustrate and explain the short-run effects of this policy on the output, interest rate, exchange rate, and the components of demand (consumption, investment, exports, imports and net exports). b.To prevent any short-run change in the level of output when government spending is reduced, what kind of exchange rate policy should the government pursue? Explain. c.Suppose the government did not enact the exchange rate policy you suggested in part b. Using the AS-AD framework, graphically illustrate and explain the medium run effects of the reduction in government spending on output, domestic price level, real exchange rate, real interest rate, investment and net exports.
Economics 110B Spring 2012 Dr. Maria Cândido117.(8 points) a.What is a “liquidity trap”? Show and explain how are the shapes of the money demand and LM curves affected by the presence of a liquidity trap. b.Suppose a liquidity trap exists. Graphically illustrate and explain the effects of an increase in government spending using the IS-LM model.
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