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Atul A. Dar
Economics 3301.1
Assignment 2
October 19, 2017
This assignment is due in class on October 26th. You must use the same group you used for the last assignment. Those
who made individual submissions can continue to do so. You will be marked for both the content the clarity of your
answers. IMPORTANT: do not hand in assignments that are identical to those of others.
Question 1 (8 points)
A. Suppose there is an increase in taxes. In the IS-LM model, which curve will be affected and how? How will this affect
output and the interest rate. Explain with the help of a graph. (3 points)
B. Suppose the central bank is committed to maintaining a fixed interest rate monetary policy. What type of monetary
action would it take to prevent the interest rate from changing in (A)? How would output change as a result?
(2 points)
C. How would consumption, total saving and investment change in A. and in B? Explain fully. (3 points)
Question 2 (12 points)
Consider a simple Keynesian model of the goods market only. Assume that there is no government, so G=T=0.
Consumption function: C= c0 + c1Y – c2ī
Investment function: I = h0 – h1ī
Equilibrium condition: Y=C+I
c0 > 0, 0< c1 < 1, and c2 > 0
h0> 0, h1 >0
Note: since we are considering only the goods market, the interest rate is assumed to be exogenous. Also, in this model,
consumption is also inversely related to the interest rate.
a. Solve for equilibrium income. (3 points)
b. Suppose that c0= e0 + e1F̄, where F is an exogenous measure of consumer confidence, and the constants e0 and
e1 are both positive. Show the impact of a change in consumer confidence on equilibrium output. (3 points)
Then use the consumption function to determine the impact of a change in consumer confidence on equilibrium
consumption. (3 points)
c. What is the impact of a change in the exogenous interest rate on equilibrium income? (3 points)
Question 3 (15 points)
A. Define the real exchange rate. Explain briefly how it would affect the choice between domestic and foreign goods.
(3 points)
B. For the country assigned to you (see below), obtain data for its exchange rate (per US dollar) for the period 20002016. This data can be obtained from the OECD site: https://data.oecd.org/conversion/exchange-rates.htm.
Be sure that you identify the currency of your country. If you are not sure what this is, use the following link:
https://www.moneycurrencyconverter.com/world-currencies.html
Then go the IMF site you used in the first assignment, and obtain the GDP deflators for your country and the US for
2000-2016. Calculate the real exchange rate, and present it and the nominal exchange rate in a table. If you wish, you
can additionally present them in two separate charts (although this not mandatory). (4 points)
Based on the data in your table, answer the following questions: (2 points each)
1. Do you think that the nominal exchange rate is a good indicator of changes in the cost of US goods relative to
those of your country? Explain.
2. Can you identify periods of real appreciation and depreciation of your country’s currency? Explain.
3. From the data, can you draw any implications for how your country’s exports and imports might have changed
over this period?
4. Is there a long-term tendency for the real exchange rate ton appreciate, depreciate, or remain constant? Explain.
Downloading exchange rate data from the OECD site: scroll down to the bottom of the table and click on “Highlighted
Countries” and choose your country. Then make sure that “None” is selected in the panel just to the right of the
countries panel. Then scroll back up to the top of the table and click on the “download” button and choose the “Selected
data only” option. You can open the downloaded file in Excel.
Question 4 (5 points) Parts A and B are independent
Consider the following information for 1-year Canadian and US bonds.
Value at maturity (X)
Price (PB)
Canada (1-year bonds)
CA$10 thousand
CA$ 9.61536 thousand
US (1-year bonds)
US$ 13.333 thousand
US$ 12.69810 thousand
1. What are the rates of interest on Canadian and US bonds (2 points)
2. If the current exchange rate E=CA$0.95/US$1, then if the interest parity condition holds, what is the market is
expecting the exchange rate 1 year from now to be. (2 points)
3. Suppose you buy a US bond at the exchange at CA$ 0.95/US$1 and 1 year from now the exchange rate turns out
to be CA$ 0.90/US$1. As a result, what is the actual rate of return earned on the US bond (in Canadian dollars?
(1 point)
Countries for Question 3
Student ID
A00403579
A00411822
A00373934
A00396917
A00323165
A00398061
A00397827
A00367480
A00401920
A00374814
A00384026
A00425248
A00339183
A00380063
A00380719
A00389207
A00395588
A00383991
A00362070
A00360826
A00379403
A00396053
Country
Argentine
Japan
Austria
Germany
Belgium
Spain
Greece
France
Finland
UK
Canada
Ireland
Norway
Korea
Portugal
New Zealand
India
Denmark
Bulgaria
Netherlands
Italy
Mexico
A00384419
A00403085
A00405867
A00405868
A00380390
A00415359
A00368008
A00378599
A00388881
A00400070
A00405709
A00373646
A00396285
A00402240
A00376541
A00393515
A00404631
A00394254
A00391779
A00394817
A00374845
A00404657
A00374847
A00399174
UK
South Africa
Estonia
Brazil
Saudi Arabia
Switzerland
Australia
China
Czech Republic
Peru
Israel
Iceland
Poland
Turkey
Costa Rica
Colombia
Russia
Indonesia
Croatia
Lithuania
Chile
Hungary
Latvia
Slovenia
…
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