Assume that capital is perfectly mobile. The foreign and domestic

economies are initially at potential GDP. The domestic economy is small

and the foreign economy is large. Using the AD-AS model analyze the long

run impact on domestic

X

M, I, C, Y

and

P

of the following independent

shocks.

(10) a. Suppose domestic investment depends positively on expected

GDP meaning that if

Y

is expected to rise then investment increases. Sup-

pose domestic agents expect the domestic government to run a deficit. As-

same the exchange rate is fixed.

(10) b. The foreign central bank sells foreign government bonds. The

exchange rate is floating.