Consider two countries that trade heavily with one another – Cornsylvania and Techoland. The national currency of Cornsylvania is the cob, while the Techoland national currency is the byte. The output of Cornsylvania is mainly agricultural, while the output of Techoland is mainly high technology electronic goods. Suppose that each economy is in a long-run macroeconomic equilibrium.

a. Use diagrams showing AD, SRAS and LRAS to illustrate the state of each economy.

b. Now suppose that there is an increase in demand for electronic goods in both countries and a simultaneous decline in demand for agricultural goods. Use your diagrams to show what happens to output and the price level in the short run in each country. What happens to the unemployment rate in each country?

c. Show, using your diagrams, how each country could use monetary policy to reduce the short-run fluctuation in output.

d. Show, using your diagrams, how movements in the cob–byte exchange rate could reduce short-run fluctuations in output in each country.