Q1. (20 pt) Suppose currently that at the equilibrium domestic income, Turkish economy runs a trade surplus. The policymakers think that current equilibrium income is too high above the potential output YPOT (therefore causes inflationary pressures) and want to reduce it to the potential income level YPOT. At the same time, they want to eliminate the trade surplus at YPOT, The ZZ and NX diagrams below depict the current state of the economy. Assume that in this economy, a real exchange rate depreciation leads to an improvement in the trade balance, and a real exchange rate appreciation results in a deterioration (worsening) of the trade balance. Y=ZZ YPOT YEQ YPOT YEQ NX a. (5 pt) Now suppose that in an attempt to establish the economy's equilibrium at the potential output level YPOT, the policymakers reduce the government spending G by AG. Show the effects of this policy change on the diagrams given above. Do you think this policy action would also help the government to reduce/eliminate the trade surplus? Why or why not? Explain clearly. b. (8 pt) Seeing that a contractionary fiscal policy is not sufficient to reach the two objectives simultaneously, the policymakers now subsequently decide to implement first an exchange rate policy change together with a fiscal policy change. What is the policy mix that will help the government reach the two objectives simultaneously: reach the potential output YPOT and eliminate the trade surplus at YPOT, Show the impact of these policy changes on the diagram above. c. (7 pt) Instead of implementing fiscal policy change first as in part a, suppose the government first implemented an exchange rate policy change. Do you think the sequencing of exhange rate and fiscal policies is important and more effective in reaching the two objectives simultaneously in this scenario? Why or why not? Explain clearly. ||