Consider an hypothetical economy in the short-run with fixed prices (includ- ing foreign prices) and characterized by the following equations. NOTE: When evaluating goods market equilibrium it is convenient to use the following simplified definintion of real aggregate expenditure Y = C + I + G + X−Q. (I.E.notY =C+I+G+X−εQasiscorrectingeneral). C =600+0.9(Y −T) G = T = 10 Q=0.1Y −20E L(i,Y)=0.2Y −50i I =40−10i X = 120 + 40E Ms/P =641 i=i∗ +(Ee −E)/E i) Given i∗ = 3.0 and Ee = 1.0, what would the expected appreciation or expected depreciation of the domestic currency be in equilibrium?

 ii) Would the domestic economy as in part 

i) above be running a trade surplus or a trade deficit in equilibrium?

 iii) Assume that the government engages in an expansionary fiscal policy whereby now G = 16. How does this new fiscal policy impact the domestic economy’s trade balance in equilibrium? Illustrate your answer in a graph.

 iv) Starting from the situation as in part i) above, now assume that the gov- ernment engages in a contractionary monetary policy by decreasing the money supply to Ms/P = 521. What would the expected appreciation or expected depreciation of the domestic currency be in the new equilibrium? 

v) How would the contractionary monetary policy in part iv) affect the domestic economy’s trade balance compared to your answer in part iii)?    

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