Intb exam#2

increase in real exchange rate

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appreciation
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
2

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
revaluation

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

J-Curve
(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