MGEC61 Midterm Answer Key.docx

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Department
Economics for Management Studies
Course
MGEC61H3
Professor
Iris Au
Semester
Fall

Description
MGEC61 Midterm Answer Key – Fall 2013 Question 1 (20 points) – 1 point will be subtracted for each incorrect entry A B C Gross domestic product 7000 8000 7500 Consumption 4200 4800 4500 Investment 875 1750 1340 Government spending 1925 1000 2110 National Saving 875 2200 890 Current account 0 450 – 450 Non-reserve portion of financial account 168 – 196 28 Official reserve transactions – 255 – 137 392 Capital account 87 – 117 30 MGEC61 Midterm Answer Key – Fall 2013 1 Question 2 (20 points) (– 2 pts from the whole question for not having 4 decimal points) Part (a) (4 points) e  Exeected exchange rate, E : (2 pts – 1 pt for showing work & 1 pt for the answer) E = P/P* = 4.5/3 = 1.5  Exchange rate, E: (2 pts – 1 pt for showing work & 1 pt for the answer) e (1 R)  1 R*E  E 1 R* E e= 1 0.041.5  E = 1.4857 E  1 R  1 0.05 e e or, R =R* E E  E  E = 1.5  E = 1.4851 E 1 R -R* 1 0.05-0.04 Part (b) (4 points)  New output, Y = 48840  New expected exchange rate: E = 1.6 (1 pt)  Domestic interest rate: (2 pts) MS  L(R,Y)  19602 = 0.1(48840) – 16560R  R = 0.03188 P 4.5  Exchange rate: (1 pt) e (1 R)  1 R*E E 1 R* E e  1 0.04 1.6 E   1 R  = 1 0.03188   E = 1.6126 e e E E E 1.6 or, R =R* E  E  1 R -R* = 10.03188-0.04  E = 1.6131 Part (c) (4 points)  Domestic price level, P: (2 pts – 1 pt for showing work & 1 pt for the answer) MS 19602  L(R,Y)  = 0.1(48840) – 16560(0.05) = 4.8328 P P  Exchange rate, E: (2 pts – 1 pt for showing work & 1 pt for the answer) E e (1 R)  1 R*  E 1 R* E e= 1 0.041.6  E = 1.5848 E  1 R  1 0.05 e e or, R =R* E E  E  E = 1.6  E = 1.5842 E 1 R -R* 1 0.05-0.04 Part (d) (8 points) The level of R* that keeps E at 1.4857: (4 pts – 2 pts for showing work) E e 1.4857 (1 R)  1 R*  R* = 10.03188  1 = – 0.04183 E 1.6 Alternatively, The level of R that keeps E at 1.4851: (2 pts) E  E 1.61.4851 R = R*  R* = 0.03188 –  R* = – 0.04549 E 1.4851  Since R* CANNOT be negative (2 pts), so the central bank of Foreign CANNOT bring E back to its initial long-run level. (2 pts) MGEC61 Midterm Answer Key – Fall 2013 2 Question 3 (20 points) Part (a) (15 points) (Graph: 4 points and it must be labeled properly for full credit) Suppose foreign money demand decreases permanently, L*(R*, Y*) : Short Run:  L*(R*, Y*)  R*  to R* to clear the foreign money market. (1 pt) e e,1  Since this is a permanent change, agents expect DC to appreciate, i.e., E  to E . (1 pt) E E  When DC is expected to appreciate and R* , the (R * ) curve shifts down to E 1 Ee,1E (R *  E ) . e 0 E  E  At E , R > (R * E ) home experiences capital inflows  demand for DC . (1 pt)  Point B is the short r1n equilibrium:  DC appreciates to E . (1 pt) Long Run:  Foreign price level is given by*  MS*  P*  MS* . (2 pts) L* R*, Y*  L*(R*, Y*)  ,0  (MS*/P*)   R*  back to its initial value, R* . (2 pts) E E ,0 E e,E  The (R * E ) curve shifts up toR *  E ).  Point C is the long run equilibrium:  Overall, DC appreciates to E . (1 pt) Conclusion: TRUE (1 pt) because DC appreciates more in the short run than in the long run. (1 pt – you must explain what undershooting mean for full credit)  No credit will be given if you mention E/E  or E/E appreciates or depreciates.  There is a difference between E and E , you must make a clear distinction; otherwise, no credit will be given. Part (b) (5 points) In the short run:  R*   DC denominated assets become more attractive  Home experiences capital inflows (i.e., exports FC assets)  credit entry under KA. (2 pts) In the long run:  R* returns to its initial level  the interest rate differentials disappear  capital flows stop  no change in the imports and
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