Due on 27th November (Monday), 3.30 pm, 2000. This is the last assignment for credit. Assignment #4 will be handed out as a practice assignment only.
Q1. Argue whether the following statements are true, false or uncertain. No marks will be awarded to undefended responses. Each question is worth 5 marks. [25] a.In a goods market equilibrium, desired savings must always equal desired investment. b.If the world real interest rate rises, the current account of a small open economy will worsen. c.If a Canadian company imports 20 Toyota cars from Japan at $20,000 each, and the Japanese company buys airline tickets on a Canadian airline with the money, the Canadian capital account will be unchanged. d.A surplus on the current account indicates that the country is an international net lender, and therefore the capital account must be positive. e.An increase in future marginal product of capital in a small open economy will improve the current account. Q2. Consider two large open economies. Let H stand for the home country and F stand for the foreign country. The desired savings and investment functions are as follows:
a.Write down the equilibrium condition and explain. [4] b.Calculate equilibrium values of world interest rate (r), current account (CA) for the home country and the foreign country, desired savings and desired investment in the home country and the foreign country. [8] c.Suppose the desired investment in home country rises by 45, such that
Recalculate part (b). Comment on your result. Depict the change from (b) to (c)using diagrams. [8] Q3. Due to a change in the regulatory structure, the desired capital stock becomes higher for both private investment and government investment. Increased government investment spending is financed by borrowing, not by higher taxes. If both desired investment and government spending rise at the same time, will there be twin-deficits if : a.the country under analysis is a small open economy [6] b.the country under analysis is a large open economy [6] Compare the results of part (a) with part (b) and provide an intuitive explanation for the observed differences/similarities. [3] Q4. Describe the asset market equilibrium condition and explain how it determines the price level in the economy. Explain how the following will affect the price level through changes in the asset market equilibrium: [6] a. an increase in money supply when government prints money to finance its expenditures [2] b. increased uncertainty in the stock market returns [2] Q5. Suppose the real money demand function is given by L(Y, i) = 640 + 0.1 Y - 5000i Suppose the central bank changes the nominal money supply depending upon income and inflation: M= 1000 + 0.1Y - 4000(π) where i = nominal interest rate on non-monetary asset, Y is real output and P is the price level. π is actual inflation. If your browser supports the current code, π should appear as a greek letter pi. a. If expected inflation equals actual inflation = 0.03, Y=1000, and r=2%, calculate the price level. [4] b. Recalculate price level if inflation rises to 0.04 while the other variables remain as in part (a). [3] c. Recalculate price level if expected inflation rises to 0.04 while the other variables remain as in part (a). [3] Q6 Explain how the following will affect the general equilibrium in a closed economy in the IS-LM-FE framework. Draw diagram to indicate the short run equilibrium and the general equilibrium. (Comment on how the general equilibrium values of the following variables will change - real wage, employment, output, real interest rate, consumption, investment and the price level) 5 marks each (a) future income declines (b) government purchases increase temporarily (c) liquidity of non-monetary assets rise (d) tougher immigration law reduce the working-age population ***