International Economics Final Exam Makeup

Transcription

1 International Economics Final Exam Makeup David Jinkins 26 January, 2015 There are three questions 18 sub-questions which are labeled with letters. There are six pages. You have four hours to write the exam. This is a closed book exam. You are advised to show your work and explain your answers, as incorrect answers with some correct thinking will receive partial credit. 1. Firms and trade (a) In our discussion of firms in international trade, we drew a figure like Figure 1 to explain how a firm with market power sets its price. Please redraw and completely label this figure. (b) Show on the figure the equilibrium price, the equilibrium quantity, and the region equal to the monopolist s profits. (c) Suppose we have country closed to trade in which there is a monopolistically competitive market with free entry, all firms pay the same fixed entry cost, and all firms have the same constant marginal cost of production. If we open this country up to trade, there will be more firms competing in the market: i. What happens to the average cost of production of each domestic firm when we add more firms to the economy? ii. With more firms competition is more fierce. What happens to the equilibrium price charged by each domestic firm? (d) Should we expect firms to open foreign manufacturing facilities in nearby countries or distant countries? (e) In a Ricardian model, gains from trade are due to comparative advantage in technology. In a Heckshcher-Ohlin model, gains from trade arise from efficient use of immobile factors of production. Suppose we have a monopolistically competitive domestic market with firms of different levels of constant marginal cost. Why does opening this economy up to trade increase welfare? 1

2 (f) Suppose a firm takes output prices and wages as given. The firm s problem can be written: max P Q wl(q) Q Here P is the output price, Q is the quantity produced, w is wage, and L(Q) is the amount of labor required to produce Q. The solution to the firm s problem satisfies the first-order condition: P wl (Q) = 0 The questions below ask you to show how firm behavior changes if the firm is a monopolist rather than a price taker. i. Write out the monopolistic firm s problem. ii. What is the first-order condition for the monopolistic firm? iii. Let P(Q) be the inverse demand curve. Why is a monopolist s marginal revenue curve always below his inverse demand curve (hint: comparing your solution to ii. with the price-taking first order condition may be helpful here)? 2. Money and international finance: (a) Money plays three important roles in the economy. Please explain what each term means: i. Medium of exchange ii. Unit of account iii. Store of value (b) If the interest rate on non-money assets were zero and there were no risk, why would investors prefer to hold money? (c) How is the interest rate on Euro-valued illiquid assets related to the interest rate on DKK-valued assets and the Euro-DKK exchange rate? Please use a detailed and completely labeled graph in your explanation. (d) How is the real DKK money supply related to the DKK interest rate? Please use a detailed and completely labeled graph in your explanation. (e) How should we expect a one-time temporary increase in the supply of DKK to affect the exchange rate. Please use a detailed and completely labeled graph in your explanation. 3. Fixed exchange rates (a) Which refers to a government policy of lowering the value of domestic currency against a foreign currency: depreciation, revaluation, devaluation, or appreciation? 2

3 (b) Suppose that Danish production suddenly and temporarily contracts. All else equal, should we expect the Danish central bank to buy or sell foreign currency in order to maintain the peg against the Euro? (c) Suppose there is a speculative attack and some investors believe the Danish government will not be able to maintain its currency peg against the Euro. This causes pressure on the DKK to depreciate against the Euro. Should we expect the Danish central bank to buy or sell foreign currency in order to maintain the peg against the Euro? (d) Why is it sometimes impossible for a central bank to maintain a currency peg? (e) Using the AA-DD diagram in Figure 2, please explain why monetary policy is ineffective under a fixed exchange rate. (f) Using the AA-DD diagram in Figure 2, please explain why expansionary fiscal policy is more effective under a fixed exchange rate. (g) Explain the meaning of the monetary trilemma of Figure 3? 3

4 Figure 1: 4

5 Figure 2: 5

6 Figure 3: 6