1. Suppose that, in the two-good model of a small open-economy in which two goods, a
and b, are produced domestically and traded internationally, the representative con-
sumer's preferences change so that the marginal rate of substitution of good a for b
increases for each consumption bundle. Determine the eects of this change in prefer-
ences on the production, consumption and trade of a and b in the SOE. Explain. Hint:
rst determine the change in consumption that is caused by the change in preferences.
2. Suppose that, in the two-good model of a SOE, there is an improvement in the tech-
nology for producing good a in the SOE. Determine the eects of this change on
production, consumption and trade of a and b. Explain your results in terms of income
and substitution eects.
3. Assume a two-period SOE model in which the representative consumer has income of
120 in the current period and 132 in the future period. The world interest rate is 12%
per period. The consumer has perfect complements preferences and wants 100 units
of current consumption for every 98 units of future consumption.
(a) Suppose current government expenditures are 15 and 20 in the future. Determine
current and future consumption and the current account surplus.
(b) Now suppose current government expenditures increase to 25. Everything else is
unchanged. Repeat (a).
(c) Explain the dierence in your results for (a) and (b).
4. Suppose better transaction technologies are developed that reduce the domestic de-
mand for money. Use the monetary SOE model to answer the following:
(a) Suppose that the exchange rate is
exible. What are the equilibrium eects on the
price level and the exchange rate?
(b) Suppose that the exchange rate is
exible, and the domestic monetary authority
acts to stabilize the price level. Determine how the domestic money supply changes
and the eect on the nominal exchange rate.
(c) Suppose that the exchange rate is xed. Determine the eects on the exchange
rate and the price level, and the dierence from your results in (a) and (b).