Arithmetic

1:
A.
A classical economist wears a t
–
shirt printed with the slogan “Fast Money Raises
My Interest!” Use the quantity theory of money and the Fisher equation to explain
the slogan.
B.
Assume
that the demand for real money balance (
M
/
P
) is
M
/
P
= 0.6
Y
–
100
i
,
where
Y
is national income and
i
is the nominal interest rate. The real interest rate
r
is fixed at 3 percent by the investment and saving functions. The expected
inflation rate equals the
rate of nominal money growth.
a
.
i)
If
Y
is 1,000,
M
is 100, and the growth rate of nominal money is 1 percent,
what must
i
and
P
be?
b
.
ii)
If
Y
is 1,000,
M
is 100, and the growth rate of nominal money is 2 p
ercent,
what must
i
and
P
be?
C. If Canada has low inflation and Mexico has high inflation, what will happen to the
exchange rate between the Canadian dollar and the Mexican peso.
QUESTION
–
2:
Suppose that the money
demand function total form:
A)
If output (Y) grows at rate 3 percent, at what rate will the demand for real
balances grow, assuming constant nominal interest rates?
B)
What is the velocity of money in this economy?
QUESTION
–
3:
Suppose that the International Monetary Fund (IMF) is concerned about currency
depreciation in a small open economy. Use the basic version of our exchange
–
rate
model for your answers.
A)
What type of fiscal policy should the IMF propose to the g
overnment of
the small open economy to generate a currency appreciation?
B)
Illustrate graphically the impact of the IMF proposal on the exchange
rate of the small open economy.
C)
What will happen to the trade balance of the small open economy,
assuming
that it started from a position of balanced trade?
QUESTION
–
4
:
Consider an economy described by the following equations:
Y = C + I + G + NX
Where, Y = 5
,
000, G = 1,000, T = 1,000, C = 250 + 0.75(Y
–
T), I = 1,000
–
50r
NX = 500
–
500
e, r = r* = 5
Where r
is real interest rate and e is real exchange rate.
A)
For the above hypothetical economy, solve for (i) national saving (ii)
investment (iii) trade balance (iv) equilibrium real exchange rate
B)
Suppose now the G rises by 500. Repeat part (A) and compare
changes in the values from part A and B. Illustrate A and B in a graph.
C)
Suppose now that the world interest rate (r*) rises to 10 percent.
Repeat part (A), with original G = 1,000, compare new values with
part (A) values and illustrate them in a graph.
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