Note that this question is divided into two sub-parts. Parts a) and b) are independent of parts c) and d). a) Suppose that the price of a new Toyota Camry is 20,000 USD in Seattle and 25,000 CAD in Vancouver. The current nominal exchange rate is 0.8 USD/CAD. Does purchasing power parity hold? Why or why not? b) Suppose that one year from today the price of a new Toyota Camry is 20,250 USD in Seattle and 28,875 CAD in Vancouver. The future nominal exchange rate is 0.9 USD/CAD. Does relative purchasing power parity hold? Why or why not? c) Show the short run effects of an increase in government purchases on the IS-LM- FE model diagram for a small open economy, with Y on the horizontal axis and ron the vertical axis. Assume a fixed exchange rate regime. Be sure to label the original general equilibrium as well as the new short run equilibrium after the increase in government purchases (but before prices adjust). d) Discuss whether fiscal or monetary policy is likely to be more effective at stimulating the economy under this exchange rate regime. Note that marks will be awarded for clarity as well as quality of answers. Define any economic terms used to make your case. Consider the following closed economy: cd = 150+ 0.6Y - 1000r Id = 200 2000r Government purchases, G, equal 50. The liquidity function is given by: L(Y, i) = 125 + Y - 2500i The nominal money supply is equal to 750, the price level, P, is equal to 1 and the expected inflation rate is equal to 5%. The full employment level of output is 833.33 a) Derive the IS curve with the real interest rate, r, as a function of output, Y. b) Derive the LM curve with the real interest rate, r, as a function of output, Y. c) Find the long-run equilibrium values of the real interest rate, r, consumption and investment d) Suppose that contractionary monetary policy decreases the money supply to 500. Solve for the new nominal interest rate, i. Depict the short run equilibrium on an IS- LM-FE diagram with output on the horizontal axis and the real interest rate on the vertical axis