Consider a world with two countries, the US and Japan. Assuming the standard Keynesian assumptions, please answer the following questions: a) Assuming flexible exchange rates, suppose the US experiences a positive shock to their consumption function so that the entire consumption function for the US shifts upward. Give and explain two reasons why the consumption function would react in this way. b) Draw three diagrams (all pertaining to the US): on the top left, draw the Keynesian cross diagram, on the bottom left, draw an IS - LM diagram, and on bottom right, draw the FX market. Locate the initial point as point A and then show how each diagram is affected by the shock and label as point B, again, assuming flexible exchange rates. Now assume that the US and Japan are in a fixed exchange rate regime. Show how things change and label the new equilibrium, assuming fixed exchange rates as point C (Note: use the same diagrams - i.e., each diagram should have points A, B, and C). c) Explain why output is affected differently in a flexible vs. a fixed exchange rate regime. Be very specific being sure to explain in detail what we mean exactly by the term automatic stabilizers and how they apply in this context. d) Now comment on how the trade balance for Japan is affected assuming flexible exchange rates vs. fixed exchange rates. That is, explain how and why the trade balance for Japan is affected under flexible exchange rates and then, explain how the trade balance for Japan is affected under fixed exchange rates. Hint: the term expenditure switching should be an integral part of your answer.
Consider a world with two countries, the US and Japan. Assuming the standard Keynesian assumptions, please answer the following questions:
a) Assuming flexible exchange rates, suppose the US experiences a positive shock to their consumption function so that the entire consumption function for the US shifts upward. Give and explain two reasons why the consumption function would react in this way.
b) Draw three diagrams (all pertaining to the US): on the top left, draw the Keynesian cross diagram, on the bottom left, draw an IS - LM diagram, and on bottom right, draw the FX market. Locate the initial point as point A and then show how each diagram is affected by the shock and label as point B, again, assuming flexible exchange rates.
Now assume that the US and Japan are in a fixed exchange rate regime. Show how things change and label the new equilibrium, assuming fixed exchange rates as point C (Note: use the same diagrams - i.e., each diagram should have points A, B, and C).
c) Explain why output is affected differently in a flexible vs. a fixed exchange rate regime. Be very specific being sure to explain in detail what we mean exactly by the term automatic stabilizers and how they apply in this context.
d) Now comment on how the trade balance for Japan is affected assuming flexible exchange rates vs. fixed exchange rates. That is, explain how and why the trade balance for Japan is affected under flexible exchange rates and then, explain how the trade balance for Japan is affected under fixed exchange rates. Hint: the term expenditure switching should be an integral part of your answer.
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