Question 4 (20 points)

The Suez Canal was blocked in March 2021. The blockage disrupted the global supply chains and affected the shipments of a wide array of goods ranging from crude oil to lumber, from grains to instant coffee, etc. The silver lining is the disruption to the supply chains did not have a long- lasting effect on the global economy.

Now, consider two small open economies, Canada and Portugal, they are initially in their respective long-run equilibrium. Both countries benefit from the smooth operation of the Suez Canal. Suppose the recent blockage of the Suez Canal affected the production processes in both Canada and Portugal as the blockage caused shortages in raw materials and inputs.

a)In the context of the asset approach to the exchange rate, examine the short-run effects of the Suez Canal blockage on the C$/? exchange rate, and real money balance in both Canada and Portugal. Explain in words and ONE foreign exchange market diagram (only the first diagram will be graded). (15 points).

b)In the context of the monetary approach to the exchange rate, what happens to the C$/? exchange rate in the long run? (5 points)

Note:

1. 1)Quote the exchange rate as EC$/?, where C$ = the Canadian dollar & ? = the euro (currency in Portugal).
2. 2)Use the subscripts "C" and "P" to represent all the variables and terms used for Canada and Portugal respectively in your written explanation and diagram. Also, DO NOT ANSWER the question by stating let the C$ be DC and ? be FC. You are required to follow the notations used in the question. If not, you will receive a grade of ZERO for the whole question.
3. 3)Compare your answer to initial long-run equilibrium.

Question 4 (20 points) The Suez Canal was blocked in March 2021. The blockage disrupted the global supply chains and affected the shipments of a wide array of goods ranging om crude oil to lumber, from grains to instant coffee, etc. The silver lining is the disruption to the supply chains did not have a long- lasting effect on the global economy. Now, consider two small open economies, Canada and Portugal, they are initially in their respective long-run equilibrium. Both countries benet from the smooth operation of the Suez Canal. Suppose the recent blockage of the Suez Canal affected the production processes in both Canada and Portugal as the blockage caused shortages in raw materials and inputs. a) In the context of the asset approach to the exchange rate, examine the short-run effects of the Suez Canal blockage on the C$/ exchange rate, and real money balance in both Canada and Portugal. Explain in words and m foreign exchange market diagram (only the rst diagram will be graded). (15 points). b) In the context of the monetary approach to the exchange rate, what happens to the C$/ exchange rate in the long run? (5 points) Note: 1) Quote the exchange rate as Ecs/e, where C$ = the Canadian dollar & = the euro (currency in Portugal). 2) Use the subscripts \"C\" and \"P\" to represent all the variables and terms used for Canada and Portugal respectively in your written explanation and diagram. Also, DO NOT ANSWER the question by stating let the C$ be DC and E be PC. You are required to follow the notations used in the question. If not, you will receive a grade of ZERO for the whole question. 3) Compare your answer to initial long-run equilibrium