1. Consider an open economy which is in a long-run equilibrium, with Y = Y*. There is then a permanent increase in the annual flow of government purchases of goods and services, G. Explain what happens in the short run (no factor-price adjustment). Show in an AD/AS diagram.
2. Explain what happens in the long run (full factor-price adjustment). Show in an AD/AS diagram. (Assume that the current value of Y* is constant.)
3. If the increase in G leads to no long-run increase in Y, explain what will happen to national saving.Draw the investment and saving in the long run graph and show the changes.
4. In the open economy, higher real interest rate attracts foreign investment, which means foriegn financial capital flows in.Suppose there is only one foreign country, please draw the graph andshow the changes in the foreign exchange market. Please explain the effect on the exchange rate and whether the domestic currency will appreciate or depreciate against the foreign currency.
5. If the effect on the exchange rate is long term, what will happen to the net exports?Explain, in words, why an increase in government purchases may be desirable in the short run, but possibly undesirable for the economy in the long run.
6. Does it matter what the increase in government spending is for?Explain.