ECONTWO 3rd Term, AY 2017-18

Assignment 4 (External Balance) J.Tanchuco

The following equations and parameters are given for an economy. In these equations and
parameters, C is aggregate consumption spending, I is investment spending, G is government
consumption, X is exports, M is imports, MS is the money supply level and Md is the level of demand for
money. Use these equations and parameters to answer the questions below.

C = 800 + 0.90Yd X = 1,000

I = 400 -2i M = 2,000
G = 500 MS = 1,100
Tx = 200 + 0.15Y MD = 700 + 0.2Y -4i

i.)What is the Yis equation in this economy? (Hint: Yis = 2,212.765957 – 8.510638298i) What is the
meaning of this Yis equation for this economy? What is the ilm equation in this economy? (Hint:
iLM = -100 + 0.05Y) What is the meaning of this iLM equation for this economy?

ii.)What is the relevant level of equilibrium income, Ye in this economy? (Hint: Ye = 2,149.253731)
What is the meaning of this equilibrium income level? What is the relevant equilibrium interest
rate level, ie in this economy? (Hint: ie = 7.4626866%) What is the meaning of this equilibrium
interest rate for this economy?

iii.) What is the magnitude of the following aggregate spending multipliers: consumption,
investment, government spending and export. (Hint: ΔY/ΔCo = ΔY/ΔIo = ΔY/ΔG = ΔY/ΔX = 2.99)
What is the meaning of each aggregate spending multiplier?

iv.)What is the magnitude of the imports multiplier in this economy? (Hint: ΔY/ΔM = -2.99)
What is the meaning of this imports multiplier in this economy?

v.)What is the magnitude of the tax multiplier in this economy? (Hint: ΔY/ΔTo = -2.67) What is
the meaning of the tax collections multiplier for this economy?

vi.)What is the magnitude of the money supply multiplier in this economy? (Hint: ΔY/ΔMS =
1.49) What is the meaning of the money supply multiplier for this economy?

vii.) What is the level of savings in this economy? Demonstrate that at the equilibrium income
and interest rate levels, the sum of savings and tax collections(S + Tx) is equal to the sum of
investments, government spending, exports less imports(I + G + X – M)

viii.) The full employment level of income in this economy, Yf was determined to be equal to
5000. What is the necessary change in government spending such that this economy will be at
equilibrium income Ye’ at the full employment income Yf = 5,000? What is the necessary change
in [autonomous]tax collections, To such that this economy will be at equilibrium income Ye’ at
the full employment income Yf = 5,000? What is the necessary change in money supply such
that this economy will be at equilibrium income Ye’ at the full employment income Yf = 5,000?
Reviewer(External Balance)

1.)What are the 3 options available to the government of an economy facing an external imbalance?
Explain briefly each how each option can be used to correct the imbalance.

2.)A devaluation/depreciation will result in the prices of imports relatively expensive. Conversely, a
devaluation /depreciation will result in the prices of exports relatively cheaper. Do you agree with these
two statements? Answer yes or no but justify your answer.

2b.)A devaluation/depreciation will necessarily correct a trade deficit in an economy? Do you agree with
this statement? Answer yes or no but justify your answer.

2c.)A devaluation/depreciation will necessarily accelerate the inflation rate in an economy? Do you
agree with this statement? Answer yes or no but justify your answer.

3.)Terms to remember (Money and general equilibrium)

Appreciation (in the exchange rate) Autarky

BOP curve Contractionary fiscal policy
Contractionary monetary policy Counter trade
Depreciation (in the exchange rate) Devaluation (in the exchange rate)
Equilibrium income, Ye(in the context of general equilibrium, external balance)
Equilibrium interest rate, ie(in the context of general equilibrium, external balance)
Expansionary fiscal policy Expansionary monetary policy
Export price elasticity, εx Fixed exchange rate system
Floating exchange rate system Foreign exchange rate
Full employment level of income, Yf(in the context of general equilibrium, external balance)
High powered money, H Inflation
Import licenses Import price elasticity εm
Import quotas Marshall-Lerner condition,/εx + εm/ > 1
Net foreign assets Open market operations
Over valuation (in the exchange rate) Re-valuation (in the exchange rate)
Sterilization (in response to any external imbalance and adjustments) Tariffs
Trade restrictions Trade balance
Trade deficit, X < M Trade surplus, X > M
Undervaluation (in the exchange rate)

4.)A revaluation/appreciation will result in the prices of imports relatively cheaper. Conversely, a
devaluation /depreciation will result in the prices of exports relatively expensive. Do you agree with
these two statements? Answer yes or no but justify your answer.

4b.)A revaluation/appreciation will necessarily correct a trade surplus in an economy. Do you agree with
this statement? Answer yes or no but justify your answer.
4c.)An economy posted a trade deficit. What do you think will be the effect on the high powered money
and domestic credit levels in the domestic economy? Answer increase or decrease but justify your
answer.

5.)An economy posted a trade surplus. What do you think will be the effect on the high powered money
and domestic credit levels in the domestic economy? Answer increase or decrease but justify your
answer.

6.)Many economies have relied on their external balances to promote economic growth and higher
levels of average incomes. Do you agree with this statement? Answer yes or no but justify your answer.
What are the advantages of relying on the external balances to sustain economic growth? What do you
think are the disadvantages of relying on the external balances to sustain economic growth?

7.)Do you agree that the effectiveness of using monetary policy to address an external imbalance is
improved by the greater openness of the economy? Answer yes or no but justify your answer.
Openness is measured by the sum of exports and imports divided by the economy’s GDP.

8.)Do you agree that the [in absolute terms] magnitude of any multiplier will be increased by greater
openness in an economy? Answer yes or no but justify your answer.

9.)There are some economies which have persistently undervalued their currencies(; i.e. foreign
exchange rates). What economic logic can be cited to justify this undervaluation? What are some
negative consequences of doing so?

10..) What is sterilization in the context of an external imbalance? Why do you think some economies
consider sterilization in the same context as a prudent policy?