Question 1. Consider the following model of a closed economy:

05 Jun Question 1. Consider the following model of a closed economy:

Question
1. Consider the following model of a closed economy:

? ??=????1/2??1/2

? ????=??+??+??

? ??=????

? ??=350+0.8(??-??)

? ??=2500-10,000??

? ??=35

? ??=154

? ??=200

? ??=700

? ??=600

? ????=1800

? ??=9

a. What values of aggregate income (Y) and national saving (S) result from full employment of labor and capital?

b. What must the interest rate (r) be in order to establish long run equilibrium in the market for loanable funds?

c. According to the quantity theory of money, what is the equilibrium price of goods (P) for this economy?

d. If population growth increases the labor supply from 200 to 154, what will be the new equilibrium values of Y, S, r, and P?

2. Consider the following model of a small, open economy:

? ??=6000

? ????=??+??+??+????

? ??=????

? ??=600+0.7(??-??)

? ??=900-6000??

? ????=900-500??

? ??=500

? ??=2000

a. Assuming that the world’s real interest rate is 9% (rw* = .09), what will national saving (S) and investment (I) be for this economy?

b. What are the equilibrium values of net exports (NX) and the real exchange rate (?)?

c. What are the equilibrium values of net exports and the real exchange rate if the world’s real interest falls to 7%, all else equal?

d. What are the equilibrium values of net exports and the real exchange rate if the world’s real interest rate is 9%, but domestic government purchases (G) are reduced to 200, all else equal?

3. Suppose that last year, the nominal exchange rate between the Japanese yen and the British pound was ¥335.0 per £2.0, one unit of Japanese output cost ¥3000, and one unit of British output cost £7.0.

a. What was the real exchange rate between the U.K. and Japan last year, expressed as the cost of British output (in units of Japanese output)?

b. Suppose that, between last year and this year, the pound appreciated by 14% against the yen (a 14% increase in the number of yen required to buy 1 pound). What is the nominal yen-pound exchange rate this year?

c. If the British price level and the Japanese price level are the same this year as last year, what is the new real exchange rate between the U.K and Japan this year, expressed as the cost of British output (in units of Japanese output)?

d. Suppose, instead, that between last year and this year, the pound appreciated by 14% against the yen andJapan experienced a 20% increase in its price level (a 20% increase in the number of yen required to purchase one unit of Japanese output). All else equal, what is the new real exchange rate between the U.K. and Japan this year?

4. Consider the following model of a closed economy in which household income taxes are proportional to income:

? ????=??+??+??

? ??=????

? ??=200+0.80(??-??)

? ??=600

? ??=1000

? ??=0.20??

a. What is “autonomous expenditure” for this economy? Hint: by definition, it will not depend on the value of real aggregate income (Y).

b. What is the short run equilibrium value of real aggregate income (Y) for this economy?

c. All else equal, what is the new short run equilibrium value of income if government purchases (G) are increased by 200 (from 1000 to 1200)?

d. What is the spending multiplier for this economy? Hint: it is NOT equal to 1/(1-0.80).

e. Suppose that the government is required by law to keep its budget balanced, so that government purchases must always equal income tax revenue (G = T = 0.20Y). What is the spending multiplier in that case?

f. Would a balanced budget requirement make a nation’s real income more or less vulnerable to negative spending shocks? Explain.

5 Suppose that a Toyota Camry costs $35,000 in the U.S. and €30,000 in Europe, while the nominal dollar-euro exchange rate is 0.9€/$.

a. Describe how an arbitrageur could profit from this situation (What would they buy? What would they sell?)

b. Based on the Law of One Price, what is the equilibrium nominal exchange rate between the U.S. dollar and the euro? What is the equilibrium real exchange rate between the U.S. and Europe?

c. Suppose the price of everything in the U.S. (including a Toyota Camry) increased by 5%. All else equal, how would that affect the equilibrium euro price of the U.S. dollar (i.e. – e*(€/$)) in the long run (up or down, and by how much)? Explain.