Problem 1: Working With Exchange Rates [19 Points] Suppose that there are two economies that trade only with each other. They are (i) Localia and (i) Farilia. Localia's currency is called \"Localios\" (LCL). Farilia's currency is called \"Farons\" (FAR). Suppose that both countries start in Long-Run Equilibrium in their AD-AS figures, and we begin with an exchange rate for Localios to Farons of 1:1. We start with a flexible exchange rate. 1. Start by drawing the Supply and Demand figure for each country that determines their exchange rate and the quantity of their currency in their exchange markets. [2 points] Mow suppose that there is an increase in the interest rate in Localia. 2. Use the Supply and Demand figure for each country to show what happens to their exchange rate and the quantity of their currency in their exchange markets as a result of this change. Does the LCL appreciate or depreciate? Does the FAR appreciate or depreciate? [3 points] Why does an increase in the interest rate in Localia's interest rate affect Localia's exchange rate? Explain your answer in words. [1 point] Use the AD-AS model to show how this shift affects short-run Real GDP (Y) and the short- run price level (p) in Localia. [2 points] Use the AD-AS model to show how this shift affects short-run Real GDP (Y} and the short- run price level (p) in Farilia. [2 points] Would the change in Localia's Real GDP be larger or smaller if they had a fixed exchange rate? |s the flexible exchange rate acting as a stabilizer in this case? [3 points] Would the change in Farilia's Real GDP be larger or smaller if they had a fixed exchange rate? Is the flexible exchange rate acting as a stabilizer in this case? [3 points] If Farilia wanted to maintain a fixed exchange rate in this case, what would they need to do with their foreign exchange reserves to maintain it? Explain your answer using the supply and demand figures for Farons and Localios. [3 points]