1. Explain the meaning of IS curve. Why does it have a negative slope? What factors determine the flatness or steepness of the IS curve? (10 marks)
2. Use the IS-LM graph to determine the effects on the equilibrium level of income (output) and the interest rate of the following:
(a) an increase in government spending, and
(b) an increase in taxes.
Why do income and the interest rate move in the same direction? (15 marks)
3. How is the IS curve altered by introducing international trade? What is the effect on IS curve of a rise in international trade? (15 marks)
4. Define the Marshall-Lerner condition. What are the likely effects of devaluation during a recession when supply elasticities are high? (10 marks)
5. Explain the J-curve phenomenon. Consider an economy with a fixed exchange rate with a fixed price level. What is the effect of depreciation on equilibrium income and trade balance in the first six months after depreciation? (10 marks)
6. Define uncovered interest parity. What is the relationship among the forward exchange rate, the spot exchange rate, and the interest rate? Suppose the (1-year) interest rate on bank deposits is 2% in Canada and 1.75% in United States. If the (1-year) forward US$-C$ exchange rate is C$1.25 per US$ and the spot rate is C$1.2 per US$, will the C$ depreciation or appreciation against the US$ over one year, and by how much? (15 marks)
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