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MIT 14 02 - Quiz 3 -14.02

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14.02 Principles of MacroeconomicsSpring 05Quiz 3Thursday May 19, 20059 am - 10:30 amPlease answer the following questions. Write your answersdirectly on the quiz. There are 6 True/False questions, followed by2 long questions. The quiz is for a total of 100 points. There isa blank page at the end of the quiz to be used for scratch paper.Good luck and have a great summer!NAME:MIT ID NUMBER:TA:CLASS TIME:EMAIL:(Table is for corrector use only.)1 2 3 4 5 6 TotalI. T/FII. LQ 1II. LQ 2III. LQ 3Total1I. True/ False (30 points)Answer each as TRUE or FALSE (note - there is no uncertainoption), providing a few sentences of explanation for your choice.Each question counts for 5 points.1. A decrease in government spending and a real depreciation is the rightpolicy mix to improve the trade balance without changing the level of domesticoutput.2. It is possible to have a real exchange rate appreciation and a nominalexchange rate deprec iation at the same time.23. In an open economy with …xed exchange rates, the aggregate demandcurve is downward sloping since an increase in prices reduces the real moneystock, which reduces the interest rate, therefore investment, and therefore out-put.4. In an open economy with ‡exible exchange rates, the announcement todayof contractionary monetary policy to be enacted in the future leads to an appre-ciation of the current nominal exchange rate (assume that this announcementis c redible).35. In an open economy with …xed exchange rates, if the …nanc ial marketsexpect a devaluation in the near future, then, in order to maintain the exchangerate today, the central bank has to decrease the domestic nominal interest rate.6. Booms are always associated with decreases in the trade balance becaus eof increases in domestic demand and prices.4II. Goods Market in the open economy (35 points)Consider the following economy. The exchange rate is …xed and equal to one.Consumption, investment, government spending, taxes imports and exports aregiven by:C = 10 + 0:8(Y  T ); I = 10; G =G; T = 10; IM = 0:3Y ; X = 0:3Y 1. Write down the equilibrium condition for the goods market, and deriveoutput Y and net exports NX = X  IM as functions ofG and Y . What isthe multiplier in this economy? (5 points)52. Consider an increase inG by G = 1. Derive the e¤ects on output Yand on net exports N X. Explain in words. (5 points)3. Assume that the foreign economy is the mirror image of the domesticeconomy, so:C = 10+0:8(Y T ); I = 10; G =G ; T = 10; IM = 0:3Y ; X = 0:3YWrite down the equilibrium condition for the goods market in the foreigneconomy, and derive foreign output Y as a function ofG and Y . (5 points)64. Using the equations giving Y as a function ofG and Y , and Y as afunction ofG and Y , solve for d omestic and foreign output as functions ofGandG (i.e solve the system of two equations). (5 points)5. Consider again an increase inG by G = 1. Derive the e¤ects on domesticoutput, Y and foreign output, Y , and on net exports, N X. (5 points)76. Compare the e¤ects ofG on Y and NX in part 2 and part 5. Explainwhy they di¤er. (10 points)8III. AS-AD in the open economy with …xed exchange rates (35points)Consider the following economy:IS : Y = C(Y ) + I(Y; i) + G + N X(Y; Y ;EPP )LM :MP= Y L(i)IP : (1 + i) = (1 + i )EEeAssume throughout that this economy operates under a …xed exchange rate,so E = Ee=E.1. Show that the IS and IP relation imply a negative relation between Y andP , given G;E; Y ; P . Call this the aggregate demand relation (AD). Explainhow it di¤ers from the AD relation derived in th e closed economy. (6 points)9Suppose the aggregate supply relation is given by the same relation as in th eclosed economy:P = Pe(1 + )F (1 YL; z)2. Draw the AD and AS curves in the P; Y space. (5 points)103. Assume that initially P = Peand Y = Yn(where Ynis the natural level ofoutput). Starting from this equilibrium, consider an increase in G. Characterizethe short run e¤ects on output, the price level, the real exchange rate, and netexports. (7 points)4. Characterize the medium run e¤e cts of the increase in G on output, theprice level, the real exchange rate, and net exports. (7 points)115. “In the medium run, budget de…cits lead, one for one, to trade de…cits.”Discuss. (one or two paragraphs) (5 points)6. “In the medium run, budget de…cits have no e¤ect on investment. Fearsthat de…cits will lead to low capital accumulation and lower output in the futureare simp ly unfounded.” (one or two paragraphs) Discuss (5 points)12Scratch


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MIT 14 02 - Quiz 3 -14.02

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