1. Consider the following data for the “home” country of Afar (whose currency is the Afarian pound, £); the “foreign” currency is the U.S. dollar ($): 2000 2006 E £20/$ £22/$ Phome 100 140 Pforeign 100 110 a. Calculate the real exchange rate for 2000 and 2006. b. Did the Afarian pound appreciate or depreciate in nominal terms? in real terms? Explain your answer intuitively. c. What do you think has happened to Afar’s trade balance (E- Z) between 2000 and 2006? d. Does (relative) purchasing power parity hold for Afar between 2000 and 2006? Why or why not? e. What would the nominal exchange rate e have to be in 2006, in order for purchasing power parity to hold (i.e., to keep the real exchange rate constant at its 2000 level)? 2. (Question 3 from Chapter 5) Other things equal, how would you expect the following shifts to affect a currency’s real exchange rate and against foreign currencies. For full credit show your answer graphically a. The overall level of spending doesn’t change, but domestic residents decide to spend more of their income on non-traded products and less on tradable products. As a result the price of non-traded products rises, while the price of tradable goods remains the same. (Hint: home prices are higher). b. (Question 9 from Chapter 5) A country imposes a tariff, which increases prices on imports from abroad. How does this action change the long run real exchange rate between home and foreign currencies? How is the long run nominal exchange rate affected? For full credit show your answer graphically 3. If capital investment increases in the home country causing a surge in productivity, what is the effect on the real exchange rate? What will be the effect on the nominal exchange rate? For full credit show your answer graphically 4. Use the DD-AA model to study the economy’s response to an increase in the money supply? In answering your question show graphically a temporary increase in the money supply and a permanent increase in the money supply. For the permanent increase, explain the changes that occur with a permanent increase in the money supply versus a temporary increase. 5. Why does a temporary increase in government spending cause the current account to fall by a smaller amount than does a permanent increase in government spending? Show graphically both a temporary and permanent change in fiscal and explain the changes that occur with a permanent change. 6. The diagram below represents the U.S. economy in the early 2000s, when there was substantial unemployment and a trade deficit. Graph the effects of each of the following on both national income (Y) and the equilibrium trade balance (E-Z): SH + SG – I = (s+t)Y-I-G Trade Balance E-Z and Net Y* Foreign Investment National Income SH + SG - I E-Z=E-mY a. The government adopts a tax cut. b. Government spending is increased for “national security” purposes. c. Consumers borrow more and reduce their (household) saving rate. d. The dollar falls in value, making U.S. goods more competitive. e. China becomes more competitive and floods the U.S. market with cheap imports.
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