PROBLEM SET 4 - INTERNATIONAL - QUESTIONS
ANSWERS
1. Suppose it takes 5 French francs to buy a dollar, the price level
in France is 1.2, and the price level in the United States is 1.5.
a. What is the real exchange rate between the United States and France?
b. What would happen to the real exchange rate if the dollar rose to
8 French francs?
2. Bonds in Germany have an interest rate of 6% per year, and bonds of
comparable risk in the United States have an interest rate of 4%. What
can we conclude about the expected change in the exchange rate between
the US dollar and the German mark?
3. Bonds in Brazil have an interest rate of 20% per year, and people
expect the dollar price of the Brazilian currency to depreciate by 15%.
Suppose you have reason to believe that people are too pessimistic about
the Brazilian currency. You believe that the Brazilian currency will only
lose 10% of its value with respect with the dollar. What would you expect
the US interest rate to be, and where should you invest?
4. Assume that the following model describes the market for goods and
services:
C = c0 + c1 (Y - T)
I = d0 + d1 Y - d2 r
Q = q1 Y
X = x1 Y*
a. What is the equation for equilibrium income in this model?
b. What is the multiplier for a change in government spending?
c. What is the multiplier for a change in foreign income?
5. Using the model in question 4 what is the change in net exports which
would happen if there was a change in taxes?
6. Using the model in question 4 what is the effect on the slope of
the IS curve of:
a. an increase in x1
b. an increase in q1?
7. Consider the IS-LM model combined with the interest parity condition.
Show what happens in the model if there is a tax increase
a. under a flexible exchange rate system.
b. under a fixed exchange rate system.
8. Consider the IS-LM model combined with the interest parity condition.
Show what happens in the model if there is a decrease in the money supply
a. under a flexible exchange rate system.
b. under a fixed exchange rate system.
9. Consider the following macroeconomic model
Y = C + I + G + NX
C = 100 +.8 Yd
I = 300 - 1,000 i
M/P = .8 Y - 2,000 i
NX = 45 - .1Y + 100 (E P*)/P
(E P*)/P = .75 - 5 i
where G = 200, t (the tax rate) = .25, and the money supply, M, equals
800. Suppose that the price level in the rest of the world, P*, is always
equal to 1.0 and that the US price level is predetermined at 1.0. What
is the equilibrium level of the three endogenous variables in the model
(Y, i, and E)?
10. Suppose that there is an increase in the autonomous portion of investment
by 110 (i.e. from 300 to 410 in the model in question 9. Describe the new
equilibrium income in the model. Does the D
Y which results correspond to the answer you would get based upon the multipliers
derived in response to question 4? Explain the difference.
11. Use the model in question 9 (and you may refer to the answer) to
calculate private savings, the government budget surplus, and the capital
inflow from the rest of the world given the equilibrium. Show that the
value of investment is the sum of these three. Now assume that government
spending goes up by 110 (to a total of 310). How does this affect the private
savings, the government budget surplus, and the capital inflow from the
rest of the world?
12. Explain why there is a difference in the short-run and the long-run
effect of a currency depreciation on net exports. Be sure to include the
effect of the Marshall-Lerner condition in your explanation.
ANSWERS