1. Multiple Choice WITH Explanation. [20 points]

Choose the one alternative that best completes the statement or answers the question andexplainyour reasoning.Do not forget to include equations, graphs, or any other material to support your choice (answer).No credits without explanation.

Assume aflexibleexchange rate. All else equal,aTEMPORARYincrease in theDOMESTICmoney supply causes:

a) a larger depreciation of the domestic currency relative to the foreign currency and a larger increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

b) a smaller depreciation of the domestic currency relative to the foreign currency and a larger increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

c) a larger depreciation of the domestic currency relative to the foreign currency and a smaller increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

d) a smallerdepreciation of the domestic currency relative to the foreign currency and a smaller increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

e)an equal depreciation of the domestic currency relative to the foreign currency and an equal increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

Do not forget to explain why the curves shift and why the variables change.Support your answer with a diagram of the the AA-DD model.

2.Answer True or False. Explain your answer. No credit without explanation. [35 points]

a)(20 points) Explain if the following statement is true or false: "In the short run, a temporary decrease in the real demand of money does not affect the level of output if the country has a fixed exchange rate but decreases the level of output when the country has a flexible exchange rate."

Assume that all other things remain equal. Do not forget toEXPLAINwhy the curves change and why the variables change. Use a graph of the AA-DD model to support your answer.

b)(15 points) Explain if the following statement is true or false: "Suppose Argentina is FIXING its currency (the peso) to the US dollar.Then, a decrease in the Money Supply in the US (foreign country) will induce a decrease in the Money supply in Argentina."

Assume that all other things remain equal. Do not forget toEXPLAINwhy the curves change and why the variables change. Use a graph of the AA-DD model to support your answer.