2. Write down and explain the condition for rest-of-world flow or goods market equilibrium to hold.
3. Assuming that the rest-of-world economy is extremely large relative to the small domestic economy, which two equations determine the equilibrium deviation of rest-of-world income and interest rates from their full-employment levels? How is the problem of short-term adjustment dealt with? Indicate the separate effects of rest-of-world monetary and real shocks.
4. Given rest-of-world equilibrium and the real interest rate thereby determined, which additional equation determines the equilibrium deviation of domestic income from its full-employment level, given flexibility of the exchange rate? Which equation determines the real exchange rate? And which equation then determines the nominal exchange rate?
5. Given rest-of-world equilibrium and the real interest rate thereby determined, which additional equation determines the deviation of domestic income from its full-employment level when the domestic authorities fix the nominal exchange rate? In this case, with less-than-full-employment, how is the real exchange rate determined? How is the money supply determined?
6. Show the equivalence of the two alternative equations that describe domestic goods market or flow equilibrium. Can both of these equations be used to portray domestic flow equilibrium graphically in ( r , Y ) space?
7. What assumption is necessary to ensure that full-employment is continually maintained? Under these conditions, what determines the real exchange rate? What determines the domestic and rest-of-world price levels? And what determines the nominal exchange rate?
8. What is the Fleming-Mundell proposition? Demonstrate this result graphically.
9. Suppose that there is less-than-full-employment in the domestic economy which the authorities want to eliminate. How can they do this when the exchange rate is flexible? How can they accomplish this task when the exchange rate is fixed? In the latter case, can they get the economy to full employment by adjusting the fixed exchange rate?
10. Express the basic model in consolidated form in the case of continuous full employment. Show how the three equations are obtained. What are the three endogenous variables in this situation?
11. Express the basic model in consolidated form in the case of fixed price levels and less than full employment, expressing the big-country real interest rate and the outputs of the two countries as deviations from their full-employment levels. What are the endogenous variables in this situation?
12. Assume that both expected inflation rates, the expected change in the real exchange rate and the risk premium on capital employed in the small country are zero. Assume for the moment that the full-employment levels of both countries' outputs move identically through time. Under what circumstances will the deviations of the two countries outputs from their full-employment levels be perfectly correlated.
13. What will be the effect of differential changes in the full-employment levels of the two countries' incomes and the big country's real interest rate on the deviations of the two countries' outputs from their full-employment levels. What will be the effects of an increase in the big-country's demand for money on the deviations of the two countries' outputs from their full-employment levels
14. Show graphically how domestic output and employment respond to a foreign monetay shock. Do domestic and foreign outputs move in the same direction relative to their full-employment levels? Does it matter whether the nominal exchange rate is fixed or flexible?
15. Show graphically how domestic output and employment respond to a foreign real shock. Do domestic and foreign outputs move in the same direction relative to their full-employment levels? Does it matter whether the nominal exchange rate is fixed or flexible?