QUESTIONChapter 15 & 16

A.(Ch. 15) Suppose that US income rises. As a result, Canada's exports to United States increase. What happens to the position of Aggregate Demand curve in Canada? Assume that the Bank of Canada allows the exchange rate to be flexible. How does your answer change if you assume that Bank of Canada maintains a fix exchange rate? Illustrate your answer with diagrams.

B.(Ch. 16) Consider a closed economy described by the following equations:

Y = C + I + G

C= 100 + 0.75(Y - T)

I = 500 - 5r

G= 125

T = 100

Where Y is GDP, C is consumption, I is investment, G is government expenditure, T is Taxes and r is the interest rate. If the economy were at full employment level (that is, at its natural rate), GDP would be 2000.

a.Explain the meaning of each of the equations above.

b.What is the marginal propensity to consume in this economy? What does it mean?

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

d.Assuming no change in monetary policy, what change in government purchases would restore full employment?

e.Assuming no change in fiscal policy, what change in the interest rate would restore full employment?