5. In a few sentences, explain the difference between a fixed exchange rate and a flexible exchange rate. What are the basic advantages and disadvantages of each? (4 points)
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- 7) Suppose that as a policy maker you increased money supply to increase in-vestment to decrease unemployment level in the country. However, at the end of the period it is revealed that the policy increased the unemployment level in the country. Explain this unexpected outcome by considering policy's implications in the foreign exchange market?7, If the interest rate is 8% in the US and 5% in Europe, then according to the interest rate parity theory, in the long run: (a) Will the dollar appreciate or depreciate with respect to the euro? (b) By what percent?5. Money Market and Exchange Rate (1) Explain how the money markets of two countries are linked though the foreign exchange market.
- 17. Question 17 options: ---------- is the technique of protecting against the potential losses that result from adverse changes in exchange rates5. Balance of payments and the foreign exchange market The following graph shows the market for euros in terms of dollars. The market is initially in equilibrium at $1.00 per euro and 4 billion euros. Suppose an economic expansion in the United States leads to an increase in the incomes of American households, causing imports from Europe to rise. On the graph, show the effect of an expansion in the United States that leads to an increase in American incomes.3. If the exchange rate changes from 1.50 Canadian dollars per U.S. dollar to 1.67 Canadian dollars per U.S. dollar, we say that the Canadian dollar has appreciated against the U.S. dollar. True False
- 5. Consider an economy that is characterized by the following equations: Y=C+I+G+ NX Y = 6,000, G = 2500, CT = 0.5C, LT = 2,000 C = 500+ 0.5(Y-T) T = CT + LT 1 = 900 - 50r NX = 1,500 250€ r=r' = 8 Note that CT is the total consumption tax given by 0.5C indicating that every $1 of consumption is taxed at 50 cents. LT is the lump-sum tax. The total tax, T, is the sum of CT and LT.4 G) Suppose that parliament passes an investment tax credit, which subsidizes domestic investment. How does this policy affect national saving, domestic investment, net capital outflow, the interest rate, the exchange rate, and the trade balance?Advanced Analysis: Refer to the following table, in which Qd is the quantity of loonies demanded, P is the dollar price of loonies, Qs is the quantity of loonies supplied in year 1, and Qs' is the quantity of loonies supplied in year 2. All quantities are in billions. Further, assume that the exchange rate is fixed at 110. Qd P Qs Qs' 10 125 30 20 15 120 25 15 20 115 20 10 25 110 15 5 Instructions: Enter your answers as whole numbers. a. In year 1, what would be the minimum initial size of the U.S. reserve of loonies such that it could maintain the peg throughout the year? billion loonies b. What about the minimum initial size that would be necessary at the start of year 2? billion loonies Next, consider only the data for year 1. c. What peg should the United States set if it wants the fixed exchange rate to increase the domestic money supply by $1.2 trillion? dollars per loonie
- 5) Indicate whether each of the following creates a demand for or a supply of European euros in foreign exchange markets: a. Liberty purchases an Airbus plane assembled in France b. Mercedes-Benz decides to build an assembly plant in Knoxville c. A Liberty student decides to spend a year studying at the Sorbonne in Paris d. An Italian manufacturer ships machinery from Rome to Venice on an Egyptian freighter e. It is widely expected that the euro will depreciate in the near future2. Determining long-term exchange rates Consider two countries, the United States and Japan, that trade with each other. Suppose that the productivity growth in the United States accelerates, but it remains the same in Japan. The following graph shows the supply and demand for the Japanese yen in the United States before the change in productivity. The vertical axis is the exchange rate of the yen in terms of the dollar, and the horizontal axis is the quantity of yen Show how the change in productivity affects the equilibrium exchange rate by shifting one or both of the curves on the graph Note: Select and drag one or both of the curves to the desired position. Curves will snap Into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther EXCHANGE RATE (Dollars per yeni Demand QUANTITY (Millions of yen) As a result of the change in productivity, the U.S. doilar appreciates depreciates Demand 161 Supply5. Balance of payments and the foreign exchange market The following graph shows the market for euros, which is initially in equilibrium. Suppose an economic expansion in Canada leads to an increase in the incomes of Canadian households, causing imports from Europe to rise. On the graph, illustrate the effect of an economic expansion on the market for euros by shifting the appropriate curve or curves. Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther. EXCHANGE RATE (Dollars per euro) Supply 1.25 XXX 1.00 0.75 2.00 1.75 1.50 0.50 0.25 0 Demand Supply Flexible exchange rates Fixed exchange rates (?)