Assume now that the world consists of only two countries: Brandtlandia and Hollandia. Every year many tourists visit each other’s countries. The only other good Brandtlandia imports are tulip bulbs. Brandtlandia uses the Thaler as currency, and Hollandia the Guilder. The policy options in Brandtlandia are copied here for your convenience. Policy 1: Open the economy to trade with no-trade protection. Policy 2: Open the economy to trade but impose a tariff on the import of tulip bulbs that would set the price of tulip bulbs to 80 Thaler per tulip bulb. Policy 3: Open the economy to trade but limit imports to a quota of 50 tulip bulbs. Brandtlandia currently uses policy option 1, and the equilibrium exchange rate (e) is 2 Guilder for 1 Thaler (and this is the exchange rate notation you need to use for this question). If Brandtlandia implements policy option 2, what will be the initial effect on the exchange rate if the exchange rate is flexible? Explain your answer. Suppose that the central bank of Hollandia wants to offset the effect of policy option 2 on the exchange rate. How would it do so? What might be the reasons for doing so? Assume that the exchange rate is flexible and Brandtlandia chooses policy option 1. The price of a tulip bulb in Hollandia is 20 Guilder, and 15 Thaler in Brandtlandia. Also, assume that all prices (including the exchange rate) are fixed in the short run. Is there purchasing power parity here? Explain your answer. Is the Guilder overv

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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A) Assume now that the world consists of only two countries: Brandtlandia and Hollandia. Every year many tourists visit each other’s countries. The only other good Brandtlandia imports are tulip bulbs. Brandtlandia uses the Thaler as currency, and Hollandia the Guilder.

The policy options in Brandtlandia are copied here for your convenience.

Policy 1: Open the economy to trade with no-trade protection.
Policy 2: Open the economy to trade but impose a tariff on the import of tulip bulbs that would set the price of tulip bulbs to 80 Thaler per tulip bulb.
Policy 3: Open the economy to trade but limit imports to a quota of 50 tulip bulbs.

Brandtlandia currently uses policy option 1, and the equilibrium exchange rate (e) is 2 Guilder for 1 Thaler (and this is the exchange rate notation you need to use for this question).

If Brandtlandia implements policy option 2, what will be the initial effect on the exchange rate if the exchange rate is flexible? Explain your answer.
Suppose that the central bank of Hollandia wants to offset the effect of policy option 2 on the exchange rate. How would it do so? What might be the reasons for doing so?
Assume that the exchange rate is flexible and Brandtlandia chooses policy option 1. The price of a tulip bulb in Hollandia is 20 Guilder, and 15 Thaler in Brandtlandia. Also, assume that all prices (including the exchange rate) are fixed in the short run. Is there purchasing power parity here? Explain your answer. Is the Guilder overvalued or undervalued? What will happen in the long run to the exchange rate? Explain your answer.

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