Question 1:Suppose the United States imposes tariffs on Canadian products. This has the effect of making Canadian goods more expensive in the U.S. Explain how this trade policy would affect the aggregate demand curve in Canada under each of the following conditions. Use diagrams of money market, the foreign exchange market and the output market for a small open economy in your answer and explain all the details clearly.

a.[3 marks]The Bank of Canada has adopted a flexible exchange rate.

b.[3 marks]The Bank of Canada has adopted a fixed exchange rate. (only explain, no new diagrams required)

Question 2:Suppose the government of a closed economy reduces taxes by $30 billion. There is no crowding out and the marginal propensity to consume is .

a.[1.5 marks]What is the initial effect of tax reduction on aggregate demand? What is the total effect of tax cut on aggregate demand?

b.[1.5 marks]How does the total effect of this $30 billion tax cut compare with the total effect of a $30 billion increase in government spending? Why?

Question 3: [5 marks]Consider a closed economy described by the following equations:

Y = C + I + G

C = 100 + 0.75(Y - T)

I = 500 - 50 r

G = 125

T = 100;

Y is GDP, C is consumption, I is investment, G is government expenditures, T is taxes, and r is the interest rate. If the economy were at full employment, GDP would be 2000.

a.Explain the meaning of each of these equations. What is the marginal propensity to consume in this economy?

b.Suppose the central bank's policy is to adjust the money supply to maintain the interest rate at 4 percent, so r = 4. Solve for GDP. How does it compare to the full employment level?

c.Assuming no change in monetary policy, what change in government purchases would restore full employment? Use the fiscal policy multiplier to determine the level of G.

d.Assuming no change in fiscal policy, what change in the interest rate would restore full employment level of output of 2000?