Intb exam#2

increase in real exchange rate


see lec 11 slide 33,

-Decrease in real exchange rate(q):
decrease in exports and increase in imports.
-DD schedule: decrease in q= decrease in y
vs. AA schedule: decrease in q= increase in y
-real appreciation of the currency worsens the CA assuming assuming all else equal an

depreciation of the domestic currency (a rise in E)

-increase in real exchange rate aka EP*/P:
rise in exports but rise/fall imports since only considers the value of imports in terms of domestic output units not the volume of foreign products imported.
(cheaper for foreigners to buy more & more expensive

aggregate demand (D)

-definition: amount of a country's goods and services demanded by household and firms throughout the world
-consists of: consumption demand, investment demand, government spending demand, and net export demand (aka the current account)
D = C(Y - T) + I +

determinants of consumption demand

-disposable income aka Yd that is, national income less taxes, Y - T.
-C = C(Yd)
-Consumption increases when the disposable income increases. However, when disposable income(Y-T) rises, consumption demand generally rises by less because part of the income

Determinants of the Current Account

CA= the demand for a country's exports less the country's own demand for imports. aka (exports-imports) measured in terms of domestic output
It is determined by two main factors:
1. the domestic currency's real exchange rate against foreign currency and

AA schedule


A rise in real income (aka output) affect aggregate demand by...

Y ? implies equal rise in Yd ? implies Im ? implies CA ? implies AD ?, but Y ? implies Yd ? implies C ? implies AD ? by more.
Thus: ?domestic real income= ?AD, other things equal, ? domestic real income= ? AD

Balance of Payments

-If central banks are not sterilizing and the home country has a balance of payments surplus, any associated increase in the home central bank's foreign asset implies an increased home money supply.

Liquidity Trap (lec 12)


Determination of Output in the short-run

-firms adjust to level of output (income) NOT price

AA Schedule (money/Asset market)

-Output and exchange rate have an inverse (neg.) relationship so has a downward slope
-The schedule of exchange rate and output combinations that are consistent with equilibrium in the domestic money market and the foreign exchange market is called the AA

DD Schedule

-Out and exchange rate have a positive relationship
Shifting the DD curve:
-changes in the exchange rates cause movements along a DD curve.
1. Changes in G: more government purchases cause higher aggregate demand and output in equilibrium. Output increase

Domestic Price Level (P)

the domestic currency price of a representative domestic expenditure basket
The domestic currency price of a representative foreign expenditure basket is: P* times E, the foreign price level times the nominal exchange rate.

Nominal Exchange Rate (E)

E= q(p/p*)
-Under the fixed exchange rate regime, a downward adjustment of the rate E is termed

Real Exchange Rate (Q)

the price of the foreign basket in terms of the domestic one.
Q= (E times P*)/P.

Disposable Income (Y-T)


Volume vs Value affect

-assuming all else equal and
the volume effect
outweighs the
value effect
means appreciation= worsens CA and depreciation= improves CA
-Volume effect: shifts on export and import quantities
vs. Value effect: changes the domestic output equivalent of a giv

(assignment #3 short an)

shows a change in a country's trade imbalance as a response to a sudden currency depreciation/ shows the time lag which depreciation improves the CA

Increase in Gov spending
(assignment #3 short an)

-would shift DD curve to the right, increasing output & appreciating the currency

Monetary Policy (graph q4 pratice exam, lec12)

definition: policy in which the central bank influences
the supply of monetary assets.
-Monetary policy is assumed to affect asset markets first.
-improves CA (depreciate)
-can only affect intn reserves under fixed rates but no output or MS
-An increase i

Fiscal Policy

definition: policy in which governments
(fiscal authorities) influence the amount of government
purchases and taxes.
-Fiscal policy is assumed to affect aggregate demand and output first.
-worsens CA (appreciates)
-can affect output, employment & intn. re