1.Suppose Tom wants to borrow $250 from Dana. There is 35% tax on interest income. The agreed after-tax real interest rate is 5%. How much should Tom pay to Dana in interest, if they expect inflation to be

7 percent?

9 percent?

How does this affect Geoff's incentive to borrow?

2.What is the effect of a decrease in interest rates on the price level? Discuss the process of adjustment to the new equilibrium. Explain (with words + graphs) for both long run and short run.

3.Using the FOREX exchange rate market, applied to home country of Canada,

(a)analyze the situation in which a government imposes a fixed exchange rate. Also, where the capital tends to move? Consider each of situations: the government imposes a fixed exchange rate which is undervalued; the government imposes a fixed exchange rate which is overvalued.

(b) determine what that government should do in order to solve the capital movement as you found above in the situation with undervalued currency. Explain with words + graphs.

4.The equilibrium interest rate in Canada is 8%. Canada is a small open economy. The interest rate in the U.S. is 4%. Now suppose that the interest rate in the U.S. rises to 6%. What can explain this change in the U.S. interest rate?

Analyze the country of Canada: after the interest rate in U.S. becomes 6%, explain what happens in Canada with savings, investment, NCO, exchange rate and trade balance?

Explain with words + graphs.

5.Depict an economy with an inflationary gap. Describe the adjustment process in this economy towards full employment. What is the new equilibrium real GDP and price level that the economy will ultimately reach? What are the reasons of an inflationary gap? Explain with words + graph.