1. Assume the economy of Andersonland is in a long-run equilibrium with full employment. In the short run, nominal wages are fixed.

(a) Draw a correctly labeled graph of short-run aggregate supply, long-run aggregate supply, and aggregate demand. Show each of the following.

(i) Equilibrium output, labeled Y1

(ii) Equilibrium price level, labeled PL1

(b) Assume that there is an increase in exports from Andersonland. On your graph in part (a), show the effect of higher exports on the equilibrium in the short run, labeling the new equilibrium output and price level Y2 and PL2, respectively.

(c) Based on your answer in part (b), what is the impact of higher exports on real wages in the short run? Explain.

[C] Higher exports will decrease real wages because the price level will increase but nominal wages will not vary siginificantly.

(d) As a result of the increase in exports, export-oriented industries in Andersonland increase expenditures on new container ships and equipment.

(i) What component of aggregate demand will change?

[Di] Investments will increase.

(ii) What is the impact on the long-run aggregate supply? Explain.

[Dii] LRAS should shift right because an increase in investment in capital increases production/output.

 

 

 

2. Japan, the European Union, Canada, and Mexico have flexible exchange rates.

(a) Suppose Japan attracts an increased amount of investment from the European Union.

(i) Using a correctly labeled graph of the loanable funds market in Japan, show the effect of the increase in foreign investment on the real interest rate in Japan.

(ii) How will the real interest rate change in Japan that you identified in part (a)(i) affect the employment level in Japan in the short run? Explain.

[Aii] The decrease in real interest rates in Japan due to foreign investment will increase domestic demand and output therefore resulting in more workering being hired.

(b) Suppose in a different part of the world, the real interest rate in Canada increases relative to that in Mexico.

(i) Using a correctly labeled graph of the foreign exchange market for the Canadian dollar, show the effect of the change in real interest rate in Canada on the international value of the Canadian dollar (expressed as Mexican pesos per Canadian dollar).

(ii) How will the change in the international value of the Canadian dollar that you identified in part (b)(i) affect Canada’s current account balance with Mexico? Explain.

[Bii] Due to the increase of the international value of the Canadian dollar, Canadian exports to Mexico will decline as Canadian goods are more expensive but imports will increase as the Canadian dollar now has more purchasing power.