2. The Open Economy a) Suppose that the nominal exchange rate between Canada and China is: 1 CAD = 5.35 CNStT The price of a Big Mac in Canada is 4.60 CAD. The price of a Big Mac in China is 21 CNY. What is the real exchange rate between Canada and China in terms of Big Macs? b) Consider the following: 0 If prices stay the same, what is the new real exchange rate if the CAD appreciates to: 1 CAD = 5.5 CNY Suppose the real exchange rate adjusts to 1. If the Bank of China follows a fixed exchange rate policy at 5.5 CNY/CAD and the price level in Canada is unchanged, what must happen to prices in China? If the real exchange rate is fixed and the Bank of China is using a fixed exchange rate, what is the relationship between inflation in Canada and inflation in China? Hint: %Ae = %A + %AT* 9 1. c) Consider the small open economy of Canada. The natural rate of output is 1,000. Government spending is 100 and the government balances its budget. The investment and consumption functions are: I(r) = 250 0 c = 25+0.75(Y O T) The world interest rate is . Suppose that: NX(e) = 51.5 - E What is the trade balance and the real exchange rate? (1) Show graphically what will happen to savings, investment and net exports if the government gives households a deficit financed tax break