Question 2)

Assume that P/P remains constant, where P is the domestic GDP deflator and P is the foreign GDP deflator. Suppose that the nominal domestic currency depreciates.

(a) How does this nominal depreciation affect the relative price of domestic goods (that is, the real exchange rate)? Explain.

(b) Based on your answer in part (a), how does this nominal depreciation affect the (world) demand for domestic goods? Explain.

(c) ( Based on your answer in part (b), how does this nominal depreciation affect the domestic unemployment rate in the short run? Explain.