1. Short-run and Long-run equilibrium analysis using PPP model. The effects of a decrease in the domestic money supply. Suppose the Canadian economy was initially in a long-run equilibrium. Suppose that the Central Bank of Canada decided suddenly to implement a one-time decrease in money supply.

(a) Using equilibrium equations explain the long-run effects of a decrease in money supply on output, interest rate, price level and exchange rate. Provide the intuition for your answer.

(b) Using equilibrium equations explain how a one-time decrease in money supply today affects agentsexpectations today regarding future exchange rate? Provide the intuition for your answer.

(c) Using equilibrium equations and building on your answers to (a) and (b), explain the short-run effects of a decrease in money supply on output, interest rate, price level and exchange rate. Provide the intuition for your answer

(d) Using equilibrium equations explain the adjustment from the short run to the long-run equilibrium. Provide the intuition for your answer

(e) Repeat your analysis using figures that depict equilibrium in the exchange rate and money market

(f) Explain what do we mean my exchange rate over-shooting. Why do the exchange rate tend to overshoot? Use figures with time on the horizontal axis to depict exchange rate over-shooting following a decrease in the domestic money supply (Hint: Over-shooting can be both upwards or downwards.)