Microsoft Word - E736_AA_4.docx
Analytical Assignment #4
Professor Yamin Ahmad
There are four questions in this analytical assignment. Each question is worth the same ‐10
points. You should answer all four. Please be concise in your answers. Answer ONLY what the
question asks, as points are not awarded for verbosity! You should limit your answers to each
question to a single page.
In terms of a general hint to try and maximize points, try to relate the context of the questions to
any of the models that we have studied in lectures. Where appropriate, use graphs and equations
to help elucidate your answer! You may use your lecture notes and the textbook. You may not
work on this assignment with anyone else. Your submission must be put into the appropriate
submission folder by the assignment deadline indicated within Canvas.
Please include and sign the agreement below when turning in the assignment into the Canvas
Agreement: All of the work on this exam has been done independently by myself, without consulting
any other students in this class or faculty in other classes. As presented in class, the essays may be
done with a referral to formulae, but all of the written material in the essay is original, “synthetic”
independent work, with no copying of published or unpublished material. I attest that this assignment
has not been copied or distributed in any part or form.
Name (Please Print): _________________________________ Student Id#: ____________________
Signature: ____________________________________ Date: __________________________
[For electronic submissions, please put your initials in the signature space above to indicate
acquiescence to the agreement above.]
1. (10 points) What are the key channels by which fiscal policy affects output in a closed versus
open economy? Using the models studied in class, discuss what is meant by “crowding out”,
and how the crowding out effect works in an open economy. How does this effect differ to the
way it works in a closed economy? To what extent does the efficacy of fiscal policy (i.e. in
affecting output) depend on the type of exchange rate regime?
2. (10 points) In the data, the trade deficit appears to be procyclical (‐ take this as a statement
of fact). Define what is meant by a trade deficit and by the trade deficit exhibiting procyclical
behavior. Using one of the open economy models studied, use a diagram to outline a possible
explanation for the procyclical behavior of the trade deficit. Note: you may include a brief
explanation to accompany your diagram to detail the mechanism by which we are able to obtain
a procyclical trade deficit.
3. (10 points) France and Poland each have one worker whose monthly linear Production
Possibility Frontier indicates the following production possibilities:
Computers (C) 24 6
Grain (G) 4 3
a) (1pt) France’s opportunity cost of G in terms of units of C equals ______ ?
b) (1pt) Poland’s opportunity cost of G in terms of units of C equals ______ ?
For the following parts, please complete the questions by filling in the blank, and responding to
remainder of the question:
c) (2 pt) Poland’s comparative advantage is in ______ because:
d) (3pt) If France and Poland decide to trade, _________ will be the exporter of G while ______
will be the importer because:
e) (3 pts) If the economies choose to trade, the world relative price of goods must be ________
in order for trade to be mutually beneficial, because:
4. (10 points) In the following problem, assume that the UK currency is the pound sterling (PST)
and the currency in the rest of the Europe is the euro (EUR).
Suppose that the PST appreciates relative to the EUR.
For the following parts, please indicate what happens to the variables below by stating whether
they: increase, decrease, or stays the same, along with a single sentence as explanation for
why. You will not receive any credit without providing an explanation.
a. (1 pt each) In the UK:
‐ How would the export demand change? Why?
‐ How would the import demand change? Why?
‐ How would net exports change? Why?
b. (1 pt each) In the rest of Europe:
‐ How would export demand change? Why?
‐ How would import demand change? Why?
‐ How would net exports change? Why?
c. (4 pts) Suppose that the central bank in the UK (The Bank of England) decides to raise
interest rates because it is worried about high inflation. As a result, interest rates in the UK
become higher than interest rates in the REST OF EUROPE. This acts as an incentive for
EUROPEAN investors to increase the amount of funds they invest in British (UK) interest bearing
assets. In order to increase their purchases of those UK assets, which are priced in PST,
EUROPEAN investors have to convert EUR into PST. This conversion, in turn, increases the
demand for PST.
Based on the above information, please explain:
i) (1pt) Given that interest rates in the UK are now different than that in Europe, what
equation/condition may be used to explain this behavior of the (nominal) exchange
rate. (Note: you just need to state the name of the equation or condition that may
ii) (1 pt) what will happen to the EUR‐‐‐‐PST exchange rate. In other words, will the
increased demand for PST, make PST gain value (appreciate) or lose value
(depreciate) against the EUR? (Please indicate your answer by picking one of the
following: Appreciate/Depreciate/Stay the same.
iii) (2 pts) Why? Please give a brief explanation using what you chose in part c (i).