Suppose in an imaginary world there are only two countries, Inland and Outland with currencies Inlira and Outlira, respectively.The exchange rate between Inlira and Outlira is freely floating.

a. Suppose that there is a large trade deficit of Inland with Outland. To close the deficit Inland decides to imposea tariff on some of the products that she imports from Outland.

i. What will happen to imports, total output and total employment of Inland. Briefly explain.

ii. How does the exchange rate between Inland and Outland (Inlira/Outlira) be affected? What will happen to current account balance of Inland? Briefly explain the changes in the foreign exchange market.

b. Suppose that due to extraordinary conditions, the output level is beyond potential level of output in the Outland economy.

i. How should thetoolsof monetary policy be used to cure the output gap?

ii. How will the policy discussed in (b. i.) aboveaffectthe interest rate, total output, total employment level, the price level, the exchange rate, the current account balance?Explain the chain of events that involve themoneymarket, goods market and the foreign exchange market.

iii. Refer to (b.i.) above. Will the economy of Inland be affected, how? Explain briefly.