Output And Exchange Rates In The Short Run

Question 1

What are the determinants of aggregate demand?

Answer 1

Consumption expenditure (C)
- determined by disposable income (Y-T)

Investment (I)
Government Purchased (G)

Current account (CA)
- determined by real exchange rate and disposable income
(EP*\P, Y-T)

Question 2

Describe the effect of changes in the real exchange rate on the current account

Answer 2

• increase in the real exchange rate
• increases the CA

Question 3

Describe the effect of disposable income on the CA

Answer 3

• increase in disposable income
• decreases CA

Question 4

Where does equilibrium for aggregate demand and output occur

Answer 4

When aggregate demand = aggregate output

Question 5

What happens when demand > supply?

Answer 5

• excess demand
• forms produce more to meet higher demand
• output increases until equilibrium restored

Question 6

What happens when demand < supply?

Answer 6

• excess supply
• firms produce less
• Y falls until equilibrium restored

Question 7

Describe the output effect of a currency depreciation

Answer 7

• domestic currency depreciation means E has risen
• of E has risen then so go has q
• when q rises imports become more expensive
• exports less expensive
• CA increases
• expenditure increases
• AD increased
• shifting AD upward
• old equilibrium there is now excess demand
• output increases until equilibrium is reached

Question 8

What is the DD schedule?

Answer 8

• shows combinations of output and the exchange rate at which output/goods market is on short-run equilibrium
• slopes upward as a rise in E increased AD and output

Question 9

What factors shift DD curve?

Answer 9

• Changes in G
• Changes in T
• Changes in I
• Changes in P relative to P*
• Changes in C
• Changes in relative demand of domestic goods relative to foreign goods

Question 10

What is the AA curve?

Answer 10

• inverse relationship between output and exchange rates needed to keep the FX market and money market in equilibrium

Question 11

What causes shifts in the AA curve?

Answer 11

• Changes in Ms
• Changes in P
• Changes in demand for real monetary assets
• Changes in R*
• Changes in expected exchange rate

Question 12

Describe the shirt-run equilibrium, I.e intersection of DD and AA curves

Answer 12

• output market is in equilibrium (aggregate demand = aggregate output )
• FX market is in equilibrium (interest rate parity holds)
• money market is in equilibrium ( Ms/P = L(R,Y)