.Section 1: Multiple Choice Questions (3 Points Each)

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Section 1: Multiple Choice Questions (3 points each)
1. If domestic residents decide to spend more of their income on domestic non-traded goods then
A. Real exchange rate will depreciate, nominal exchange rate will depreciate
B. Real exchange rate will appreciate, effect on nominal exchange rate ambiguous
C. Real exchange rate will depreciate, effect on nominal exchange rate ambiguous
D. Real exchange rate will appreciate, nominal exchange rate will appreciate
E. None of the above
2. The aggregate real money demand schedule L(R,Y)
A. Slopes upward because a fall in the interest rate raises the desired real money holdings
of each household and firm in the economy.
B. Slopes downward because a fall in the interest rate reduces the desired real money
holdings of each household and firm in the economy.
C. Has a zero slope because a fall in the interest rate keeps constant the desired real
money holdings of each household and firm in the economy.
D. Slopes downward because a fall in the interest rate raises the desired real money
holdings of each household and firm in the economy.
E. None of the above.
3. In case of a permanent increase in money supply in the monetary approach to exchange rates,
exchange rate overshooting exhibits which of the following.
A. Exchange rate gradually moves first and then jumps to its long run value.
B. Exchange rate jumps first and then gradually adjusts to its long run value.
C. Exchange rate gradually moves first, overshoots its long run value, and then gradually
adjusts to its long run value.
D. Exchange rate jumps above its long run value and then jumps down to its long run value.
4. An appreciation of a country’s currency
A. Lowers the relative price of its exports and lowers the relative price of its imports.
B. Raises the relative price of its exports and raises the relative price of its imports.
C. Raises the relative price of its exports and lowers the relative price of its imports.
D. Lowers the relative price of its exports and raises the relative price of its imports.
E. None of the above.
5. Which of the following statements is the most accurate?
A. The law of one price applies only to the general price level.
B. The law of one price applies to the general price level while PPP applies to individual
commodities.
C. The law of one price applies to individual commodities while PPP applies to both the
general price level and to individual commodities.
D. PPP applies only to individual commodities.
E. The law of one price applies to individual commodities while PPP applies to the general
price level.
Section 2: Short Answers (5 points each) Note: You are not required to draw any diagrams for these
1. If the TFP of an economy increases temporarily, what will be the effects of this change on the
exchange rate in the monetary approach to exchange rates? Will the effect be different if the
change is permanent?
2. The Pakistani government increased the money supply considerably in the first week of July
2012 to solve the power shortage problem. It was feared at the time that this increase in money
supply would result in a huge depreciation of the Pakistani rupee. However, the rupee has not
depreciated as much as was expected. Using the monetary approach to exchange rates, explain
why the rupee did not depreciate?
3. Using the definition of real exchange rates, fischer relation, and the interest parity condition,
show that the difference in real interest rates of two countries is equal to the expected
depreciation or appreciation of the real exchange rate. (You have to do this mathematically)
4. What is the effect of an increase in the price level of the home country on the current account?
Differentiate between value and volume effects.
Bonus Question (You will get 4 marks if you get this correct): How will the effect of change in
price of a commodity depend on its elasticity of demand? Does your answer to the above
question change if most of the traded goods of an economy have inelastic demands?
5. What are some of the problems with having a current account surplus? Mention at least 2
Section 3: Long Question (20 points)
Consider the DD-AA model of exchange rate and output determination in the short run. Suppose that
the economy is initially in equilibrium when the government decides to impose new tariffs on imports.
1. If the tariff is temporary, what will be effects of this tariff in the goods market and the asset
market? (2)
2. How will the DD and AA schedules shift and what will be the effects on short run output and
exchange rates? (3)
3. Describe the chain of events in both markets that will lead to the change in output and
exchange rates. (5)
4. Looking at the DD-AA diagram, how can the government keep the exchange rate fixed to pre-
tariff levels by changing the money supply? (3)
5. How will your answer to part 2 and 3 change if the tariff change is permanent? (7)

.Section 1: Multiple Choice Questions (3 Points Each)

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Section 1: Multiple Choice Questions (3 points each)

2. The aggregate real money demand schedule L(R,Y)

4. An appreciation of a country’s currency

5. Which of the following statements is the most accurate?

Section 3: Long Question (20 points)

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