From question 2, suppose now that the domestic economy decides to reduce its money supply.
a. What are the initial effects of this monetary policy on the goods market, the money market, the foreign exchange market, and the balance of payments of the domestic economy? Which curve(s) will shift?
b. What is the adjustment mechanism under a fixed exchange rate regime? Illustrate and explain which curve(s) will shift during the adjustment, and then compare the new equilibrium with the initial equilibrium.
c. What is the adjustment mechanism under a flexible exchange rate regime? Illustrate and explain which curve(s) will shift during the adjustment, and then compare the new equilibrium with the initial equilibrium.