ECON 305 Intermediate Macroeconomics: Assignment 6 Solution
QUESTION 1 – Openness in Goods and Financial Markets
a) Explain the three types of trade that countries conduct.
b) Define the nominal exchange rate of a country. Define the real exchange rate of a
country. Why is the real exchange rate the appropriate price for thinking about decisions
by consumers and firms about whether to buy domestic or foreign goods and services?
c) Explain how the nominal exchange rate, and domestic and foreign price inflation affect
the real exchange rate.
d) If the domestic country’s real exchange rate (currency) depreciates, how would you
expect this to affect the domestic country’s trade balance in goods and services? Explain.
e) What do we mean by purchasing power parity (a theory of real and nominal exchange
rates)? If the domestic country’s price level declines, what does purchasing power parity
predict would tend to happen to the nominal exchange rate and foreign price level?
f) What is the source of large differences between the GDP and GNP of oil exporting
countries? In answering the question, explain carefully the difference between gross
domestic product and gross national product.
g) Suppose the uncovered interest parity condition holds, and that the domestic interest
rate is lower than the foreign interest rate. What does this imply about the current versus
future expected currency value for the domestic country?
h) Assume that the one-year interest rate in the United States is 4% and that the one-year
interest rate in Canada is 3%. According to uncovered interest rate parity, what does this
imply about the current versus the future expected value of the US dollar? Explain.
i) Explain why a simple comparison of the interest rates on domestic and foreign bonds
might provide misleading information about which bonds yield the highest expected
QUESTION 2 – An Open Economy Model of the Goods Market
a) Explain the difference between: (a) the demand for domestic goods; and (b) the domestic
demand for goods. In your answer, write down equations which describe (a) and (b).
b) Explain the determinants of (a) exports and (b) imports. Write an algebraic expression for
c) Explain why the demand for domestic goods curve (ZZ) has a different slope than the
domestic demand curve (DD).
d) Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect an increase
in taxes, T, will have on output, exports, imports, and net exports. Clearly label all curves and
clearly label the initial and final equilibria.
e) Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect an increase