1. Multiple Choice WITH Explanation. [20 points]

Choose the one alternative that best completes the statement or answers the question andexplainyour reasoning.Do not forget to include equations, graphs, or any other material to support your choice (answer).No credits without explanation.

Assume aflexibleexchange rate. All else equal,aTEMPORARYincrease in theDOMESTICmoney supply causes:

a) a larger depreciation of the domestic currency relative to the foreign currency and a larger increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

b) a smaller depreciation of the domestic currency relative to the foreign currency and a larger increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

c) a larger depreciation of the domestic currency relative to the foreign currency and a smaller increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

d) a smallerdepreciation of the domestic currency relative to the foreign currency and a smaller increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

e)an equal depreciation of the domestic currency relative to the foreign currency and an equal increase in the level of income than aPERMANENTincrease in the DOMESTIC money supply.

Do not forget to explain why the curves shift and why the variables change.Support your answer with a diagram of the the AA-DD model.