Pictures

Question 1

Draw the diagram of the FOREX market equilibrium and explain

Answer 1

Under asset approach to the exchange rate, st moves instantaneously to guarantee foreign exchange market equilibrium at all times (equilibrium given by intersection of two curves)

Question 2

What is the impact of an increase in it on the FOREX equilibrium diagram

Answer 2

Question 3

What is the impact of an increase in I*t, ρt, Etst+1 on the FOREX market equilibrium

Answer 3

Question 4

What is the money market equilibrium diagram

Answer 4

Question 5

What is the impact of a shock in the money market of mt up and pt down

Answer 5

Question 6

What is the impact of a shock in the money market of yt up and εt up

Answer 6

(mt-pt = φyt - ηit + εt)

Question 7

what is the impact of a temporary fiscal shock, gt up under flexible exchange rates

Answer 7

Question 8

What is the DD curve equation and what does it look like

Answer 8

yt=at+δqt+gt = at+δ(st+p*t-pt)+gt

Question 9

What is the AA curve equation and what does it look like

Answer 9

mt-pt=φyt - η(i*t+Etst+1-st+pt) + εt, comes from MM equilibrium and FOREX market equilibrium

Question 10

Explain the exchange rate overshooting using diagrams

Answer 10

From AA-1 to AA0, since m0 up and E0s1 up,

From AA0 to AAN, gradual transition to new LR as pt up hence (mn-pt) down and Etst+1

DD curve shifts from DD0 to DDn as pt up

Question 11

What is the diagram of a temporary fiscal shock

Answer 11

Starts in output market by increase in g, this increases income and demand for money, equilibrium in mm re-established by increase in I which leads to appreciation, spillover into OM by worsening of CA

Question 12

What is the effect of a negative at shock under fixed exchange rates

Answer 12

DD contracts, CB reduces the money supply through the AA curve to keep exchange rate fixed

Question 13

What is the impact of a positive gt shock under fixed exchange rates

Answer 13

DD expands, CB increase money supply through AA curve to keep exchange rate fixed

Would have gone to point like a under flexible but 0 under FER

Question 14

What is the diagram that shows the currency crisis speculator with money (ht), domestic credit (dt) and reserves (rt)

Answer 14

Question 15

Diagram of successful speculative attack in terms of st and shadow

Answer 15

Question 16

Explain the diagram for multiple equilibria in the second generation model

Answer 16

Due to expected future ER higher than the peg with a higher risk premium and not necessarily gov. deficits markets start selling off currency so higher interest rate required, this can only be done by contracting money supply and allowing rates to increase

Question 17

Diagram that shows the PPF under autarky and what are the intercepts

Answer 17

Question 18

Diagram that shows home and foreign PPFs under autarky

Answer 18

Question 19

diagram of world relative supply of cloth 2 country 2 sector

Answer 19

P price of cloth before trade home, p* price of cloth before trade foreign

Question 20

Diagram of equilibrium in relative world supply of cloth with complete specialisation

Answer 20

Downward sloping demand curve with price on y quantity on x intersect at price pt

Question 21

Diagram showing expansion of PPFs due to specialisation and gains from trade

Answer 21

Changes relative price of two products so allows each region to specialise what they have comparative advantage in Pt production with international trade, Ct consumption with international trade (bigger than autarky, can consume more of both)

Question 22

Diagram showing the 2 country 2 good model in terms of relative wage ω

Answer 22

If ωt>A(c) foreign would be least-cost producer of both so no demand for home to produce anything, if A(F)<ωt

Question 23

Diagram showing home’s relative productivity of labour with RS and RD for 4 goods indexed by 1-4

Answer 23

Home’s productivity highest in product 1, as long as relative wage below A(1) the home will be able to produce at lowest cost. If just between 1 and 2 home could only do product 1 and would have to import rest. If RS’ then could make 1,2,3 foreign only produce 4

Question 24

Diagram showing RS and RD with a continuum of products

Answer 24

Every time costs and hence price of producing good by home is cheaper than foreign, home will produce. pt(z)=wta(z), pt,*(z)=wt,*a*(z). If pt(z)>pt,*(z) good produced by foreign. RD: ωt=A(z) RS: horizontal left to right no. goods by home, more produced by home greater home’s output to greater wage

Question 25

Explain the technicalities of the RS curve

Answer 25

An individuals utility is a sum of the utility they get from consuming all products. On average trade between home and foreign will have to be balanced (equal in value) ## Footnote World income must be equal to total wages

Question 26

Equation for home income with trade wtL

Answer 26

Capturing z of total spending

Question 27

What is the impact on the RS and RD in continuum of goods of an increase in Home’s labour force

Answer 27

ωt=(1/1/(z-1))(L\*/L) comes at cost of lower wages (shown on y)

Question 28

What is the impact on RS and RD in continuum of goods of increase in home’s general productivity relative to foreign’s

Answer 28

Increase in output by home and relative wages. RD: ωt=A(z)

Question 29

Diagram of RS and RD for a good small country

Answer 29

L small bc country small. M low because don’t produce that many goods. Can command a higher relative wage. Note the 1for1

Question 30

What does this diagram show

Answer 30

Can produce Qbar using all different combinations of T and L. Where you produce depends on the price of the factors. Minimising cost when have tangency. Ratio w/r is the cost of the factors, then T/L is the proportions. As w/r increases from 1-\>2 increase proportion of land used in production

Question 31

Draw the diagram with y=w/r and x=L/T showing what happens when the price of labour increases relative to land

Answer 31

Wage increases so use more land in production (less labour) so point moves to the left

Question 32

Show the cloth and food sectors on a factor proportions diagram with y=T and x=L given factor prices w/r

Answer 32

Angles of the two tangents are the same as they represent factor prices. Food (cloth) is relatively more land (labour) intensive so ratio T/L higher (lower)

Question 33

Show the cloth and food sectors on a factor proportions diagram with y=w/r and x=T/L

Answer 33

At given w/r level dashed line, food has a higher land/labour ratio

Question 34

Draw the 2 good 2 factor model for home under autarky y=w/r x=T/L right of axis and x=pc/pf left of axis

Answer 34

Cloth and food produced with different proportions of land and food, On the left as the price of labour increases (w/r up) the relative price of cloth in relation to food goes up (because cost of producing cloth goes up relatively more). It is concave because of diminishing returns

Question 35

What is home and foreign’s PPFs under factor proportions under autarky

Answer 35

Home produces more cloth. Foreign produce more food. In the end under autarky both produce similar amounts of each.

Question 36

What is the impact of trade shown on PPFs for home and foreign for factor proportions

Answer 36

Home opportunity cost for cloth is lower so specialise. Both can have higher standard of living because they have explored their comparative advantage

Question 37

What is the impact of trade on the diagram y=w/r x=T/L right, x=pc/pf

Answer 37

Relative prices have converged. Downward in case of foreign, up in case of home. After trade equality of prices of two products. After trade home wages increase. foreign its the other way round

Question 38

Diagram of impact of trade when allowing for differences in technology

Answer 38

If home now effective-labour abundant AL/T\>(AL/T)\* Convergence of K/AL or T/AL not K/L or T/L

Question 39

Diagram of allocation of labour before trade for 2 good, 3-factor model

Answer 39

Workers move between sectors until wages equalised. Returns to K (T) triangle above w below VMPLc (VMPLf)

Question 40

Diagram of 2 good 3-factor after trade in terms of wage rate and labour in each sector

Answer 40

Cloth going to be exported Price of cloth goes up so pc shifts upward so value of MPL up. Economy shifts resources (workers) to cloth sector (increase in x). Returns to capital (left triangle) increase bc capital used in cloth. Returns to land (right triangle) decrease

Question 41

why is the real wages in units of cloth lower than before after a rise in pc (2 good 3 factor)

Answer 41

real wage: w2/pc2 is equal to the marginal product of labour (not value) which has gone down, because of diminishing returns - using more workers in cloth sector than before so marginal return (extra units of cloth) lower than before

Question 42

what happens to real wages in terms of food after a rise in the price of cloth in 2 good 3 factor

Answer 42

real wage measured in units of food w2/p1f=MPL, moved to point 2 so real wages in terms of food have gone up because lower L in food mean you go up the MPLf curve

Question 43

with complete specialisation, when home produces cloth under ricardian trade theory. What is home's relative wage

Answer 43

Question 44

Show on a diagram the con of FER: no longer a real shock absorber when there is a negative temporary at shock

Answer 44

DD falls, CB has to reduce money supply (AA) otherwise interest rates would change which would change sbar. Output falls more than under flexible

Question 45

Show negative at-shock under flexible exchange rate (not complicated just one change)

Answer 45

Output decrease less than under fixed

Question 46

Show impact of a devaluation of a currency under fixed ERs

Answer 46

CB announce willing to buy and sell FOREX reserves at a new higher value. AA shift right to accommodate extra demand. Because net exports increased due to competitiveness Cannot do this repeatedly will create tension with trading partners

Question 47

what happened in US between 1980-1985

Answer 47

high inflation (20%), Volcker hiked interest rates really high, huge capital inflows leading to appreciation, hurt US businesses as currency depreciated 30% (hurt margins)

Question 48

What is the policy trilemma in exchange rates

Answer 48

Question 49

diagram impact of a permanent shock

Answer 49

LR OM equil condition (ybar=abar+δqbar+gbar), ouput determined by supply side (rhs) in long run, permanent g rise must reduce purchases of other sectors, CA worsens as ED for output appreciates currency which reduces exports and increases imports. (complete crowding-out of net exports (CA)