1. Consider an economy that is operating below its potential output level. Suppose that the government increases its spe

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1 Consider An Economy That Is Operating Below Its Potential Output Level Suppose That The Government Increases Its Spe 1 (105.77 KiB) Viewed 13 times

1. Consider an economy that is operating below its potential output level. Suppose that the government increases its spending more than what would be required to achieve potential output level. With the aid of an AD-SRAS-LRAS diagram, and in words, describe the transition of the economy from the short run to the long run. What are the consequences of increasing output beyond its potential? (4 points) 2. An economy described by the Solow-Swan model has the following production function: == -6(E) 0.5 where Y is aggregate output, K is capital and L is labour. Also, assume the saving rate is 0o = 0.3. population growth n= 4% and depreciation d = 5%. (a) Compute the steady-state values of capital-labour ratio, K/L, and output per worker, Y/L. (2 points) Assume the economy is initially in its steady state. Suppose policymakers pursue policies that would increase the saving rate to 0₁ 0.36. (b) Compute the new steady-state values of capital-labour ratio, K/L, and output per worker, Y/L. (2 points) (c) Draw a carefully-labelled diagram to illustrate the effect of the change in the saving rate on the economy in the long run. Explain the effect of the change in saving rate on steady-state capital-labour ratio and steady-state output per worker? (3 points) 3. The annual demand for and supply of pesos in the foreign exchange market are: Demand = 30, 0006, 000e Supply 22, 000 + 10, 000e where the nominal exchange rate is expressed as dollars per peso. The exchange rate is fixed at 0.6 dollars per peso. (a) Determine whether the peso is overvalued, undervalued or neither. (2 points) (b) Suppose that foreign investors come to expect a possible devaluation of the peso to 0.5 dollars per peso. If these foreign investors hold domestic financial assets in the amount of 7,000 pesos, what is the minimum level of international reserves the country should have to maintain the value of its fixed exchange rate? (2 points)