Exercise 2

An iPad costs 700 Canadian dollars. The nominal exchange rate is 1.1 Canadian dollars per

US dollar.

1. According to the law of one price, what should the price of the same Ipad be in the United States?

2. If the current price is 600 US dollars, is the Canadian dollar undervalued or overvalued? By how much?

3. Why do we not necessarily observe people or companies buying Ipads in the country where they are cheaper and reselling them in other countries (i.e. arbitration)?

4. Suppose the Canadian government imposes an (additional) tax of 20 dollars CAD for each Ipad sold in Canada. What can we expect?

Exercise 3

Following the launch of new electric cars by Toyota and Honda, demand for Japanese cars increases for all values of the real exchange rate, domestic GDP and foreign GDP. In other words, all things being equal, Domestic consumers prefer imports even more than before.

1. What is the effect on the NX curve of this change in consumer preferences?

2. What is the impact on equilibrium GDP on the goods market (i.e. for a given interest rate) and on Canada's net exports?

Exercise 4

Suppose the foreign interest rate, i*, increases and we are in a small open economy with perfect capital mobility (for an unspecified reason and without affecting foreign GDP). The exchange rate of this economy is flexible.

a) What will be the effects on real GDP, interest rate, exchange rate and net exports

of the domestic country?

b) If the government wants to protect the value of the currency in a), what tax policy

would you recommend? What will be the consequence on domestic GDP?

c) If the government wants to protect the value of the currency in a) but prefers to do so through

monetary policy, what would you recommend? What will be the impact on domestic GDP?

d) How would your answer to a) change if the exchange rate were fixed?