INTERMEDIATE MACROECONOMICS ASSIGNMENT TWO.
Submit QUESTION 1, 4, 6,
QUESTION 1. Suppose Zambia is an open economy in the long run described by the following
equations
Y= C=I+G+NX, Y=4000 C= 240+0.8(Y-T) I=740-20r T=800 G=500 NX=300-100e, r
=r*=2% Where Y is national output/income, C is consumption, I is investment, r=r* is world
interest rate, G is government spending, T is taxes and ‘e’ is real exchange rate.
(a) Solve for public saving, private saving, national saving, investment, trade balance (net exports),
and equilibrium exchange rate.
(b) Graph the equilibrium condition for this economy.
(c) Suppose fiscal policy abroad raises the world interest rate to 3%
(i) Solve for public saving, private saving, national saving, investment, net capital
outflow, trade balance (net exports), and equilibrium exchange rate.
(ii) Graph and explain the effect of this policy on the equilibrium condition.
(d) Suppose instead that government spending is reduced to 400.
(i) Solve for public saving, private saving, national saving, investment, net capital
outflow, trade balance (net exports), and equilibrium exchange rate.
(ii) Graph and explain the effect of this policy on the equilibrium condition.
(e) Calculate, graph and describe in words the effect of a decrease in taxes from 800 to 500 on
national savings, investment, trade balance and exchange rate.
QUESTION 2 Using the model of a small economy, predict what would happen to net exports,
real exchange rate, savings and investment for this economy if
(a) It banned the imports of foreign cars.
(b) A change in world economic conditions made the exports of this economy to fall.
(c) A fall in consumer confidence about the future induced consumers to spend more and
save less.
Question 3: Given a small open economy, briefly explain and graph the effect of the following on the
real exchange rate, net exports and net capital outflow of the economy:
(a) A reduction in taxes
(b) An increase in government spending
(c) Large foreign economies stopped subsidizing their investment.
Question 4: suppose the 0.6 Zambia kwacha can be exchanged for 1 South African Rand, and a
holiday in South Africa costs 5,000 Rand, while a holiday in Zambia costs 4,000 kwacha .
(a) Define nominal and real exchange rate.
(b) Calculate and interpret the real exchange rate and use it to explain which country is cheaper to
spend a holiday.
QUESTION 5.Suppose that some foreign countries begin to subsidize investment by instituting an
investment tax credit.
a. What happens to world investment demand as a function of the world interest rate?
b. What happens to the world interest rate?
c. What happens to investment in our small open economy?
d. What happens to our trade balance?
e. What happens to our real exchange rate?
QUESTION 6
(a) What are the net capital outflow, and net exports? Explain how the two are related.
(b) Define nominal and real exchange rate. How is real exchange rate calculated and interpreted
(give a hypothetical example).
(c) How does the real exchange rate affect net exports? (explain in terms of depreciation and
appreciation of the exchange rate)
(d) What is the balance of payments? How is the current account balance related to the capital
account balance?
QUESTION 7: Given that Zambian is a small open economy, and that its currency has been
depreciating:
(a) Explain what depreciation of the kwacha means (illustrate with an example)
(b) Explain any 2 policies- domestic fiscal policy, foreign fiscal policy, or trade policy- that
would cause the kwacha to depreciate
(c) Explain how (and why) the kwacha depreciation would affect the amount of imports and
exports in Zambia?
(d) Explain any 2 policies-one fiscal policy, one trade policy- that you would recommend to the
government that would lead to the appreciation of the kwacha
QUESTION 8: Assuming that in 2013, one kwacha could be exchanged for 2 Rand, and now in
2015one kwacha can be exchanged for 1.5 Rand. Suppose from 2013 to 2015, the total inflation was
25 percent in South Africa and 20 percent in Zambia, has it become more or less expensive to live in
South Africa compared to Zambia? (Answer by referring to answer obtained from calculating real
exchange rate)
QUESTION 9 Suppose Zambia is a small open economy (it cannot affect the world interest rate)
with perfect capital mobility and a floating exchange rate: with the help of clearly labelled diagrams,
show and briefly explain the effect on income/output, exchange rate and net exports of the following
policies:
(i) An expansionary monetary policy where the government through the central bank
increases the money supply
(ii) An expansionary fiscal policy where government increases its spending
(iii) A trade policy where government imposes an import quota
(iv) How will the above policies affect the macroeconomic variables if the exchange rate
regime was floating?
