1.

a.Draw a 2 panel diagram for a small open economy to show the market for loanable funds and the market for foreign currency exchange. Show the initial equilibrium using all the appropriate variables on the diagrams. In both diagrams, explain the source of supply and demand also.

b. Now suppose the French suddenly develop a strong taste for British Columbia wines. Show on the diagram and explain what happens to the demand for dollars in the market for foreign-currency exchange?

c. As a result of change to demand for dollars in part b) what happens to the value of dollars in the market for foreign-currency exchange? What happens to the quantity of net exports? Carefully explain all the relevant details of this part.a.

question 2 : Suppose the oil price has increased and it increased the cost of production:

a.Use an aggregate-demand/aggregate-supply model to show the short-run effect of increase in oil prices. Label the initial equilibrium as A and the new short run equilibrium as B. (Show all the labels and explain clearly what happens in the short run).

b.Now use the diagram from part (a) to show the new long-run equilibrium if the government wants to use fiscal policy to bring the economy to its natural level of output. What type of policy the government should use? What happens to prices and output in the long run? Label the new long run equilibrium as C.

c. Redraw the diagram from part a). Now assume that the government wants to keep the price level stable at its initial long run level. What type of fiscal policy should it use? What happens to output and prices in this case? Can the government use a policy to bring the price and output both to the initial long run level? Why or Why not?

Question 3: If the Phillips curve equation is given by:

Unemployment Rate = 7 - 0.5 (actual inflation - expected inflation)

a. Suppose = actual inflation is 6 % and expected inflation= 2%. What is the actual rate of unemployment? What is the natural rate of unemployment?

b.Draw the short run and long run Phillips curves on a diagram to show the two curves. Use the numerical values from part a) and label the numbers appropriately on the graph.

c. Continue from part a) and given that Okun's Law holds which states that 1% increase in unemployment rate reduces output by 2% of the full employment level of output, how much is the actual GDP compared to the full employment GDP in our case in this question. Compare the actual and natural level of unemployment and decide on the basis of that.