Macroeconomics Canadian 15th Edition

Blanchard Solutions Manual

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Chapter 7
The Goods Market in an Open Economy

1. True/False/Uncertain

a. Uncertain – they simply reflect high domestic demand. Increases in domestic demand
could be from investment, government spending or consumption.

b. Uncertain or true – looser fiscal policy, all else equal, is usually associated with an
increase in the trade deficit.

c. False.

d. False.

e. True.

f. True.

g. False

2. Real Exchange Rates and The Balance of Trade

a. ε =EP*/P. Apply proposition 8 to (EP*)/P and then proposition 7 to (EP*).

b. If ∆P/P > ∆P*/P* and ∆E/E = 0, then ∆ε/ε <0, then the real exchange rate is decreasing
(appreciating from the point of view of the domestic country) over time. Given the
Marshall-Lerner condition, this implies net exports are falling. The price of domestic
goods is rising faster than the price of foreign goods, while the exchange rate is constant.
As domestic goods are becoming more expensive than foreign goods, consumers in both
countries shift their purchases away from goods in the high-inflation country to the low-
inflation one.

3. Coordination and Fiscal Policy

a. Y = C + I + G + X – Q = 20 + 0.8*(Y - 10) + G + 0.3Y*- 0.3Y

Y = [1/(1 - .8 + .3)](12 + G + 0.3Y*) = 2*(12 + G + 0.3Y*) = 44 + 0.6Y*

The multiplier is 2 (=1/(1-.8+.3)) when foreign output is fixed. The closed economy
multiplier is 5 (=1/.5). It differs from the open economy multiplier because, in the open
economy, only some of an increase demand falls on domestic goods.

b. Since the countries are identical, Y=Y*=110. Taking into account the endogeneity of
foreign income, the multiplier equals [1/(1-0.8 -0.3*0.6 +0.3)]=3.125. The multiplier is
higher than the open economy multiplier in part (a) because it takes into account the fact
that an increase in domestic income leads to an increase in foreign income (as a result of

Copyright © 2015 Pearson Canada Inc.

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 Macroeconomics, Fifth Canadian Edition
Instructor’s Solutions Manual

an increase in domestic imports of foreign goods). The increase in foreign income leads
to an increase in domestic exports.

c. If Y=125, then foreign output Y*= 44+0.6*125=119. Using these two facts and
the equation Y = 2(12+G+0.3Y*) yields: 125 = 24+2G+0.6*(119). Solving for G
gives G=14.8. In the domestic country, NX = 0.3*(119)-0.3*(125) = -1.8; T-G =
10-14.8=-4.8. In the foreign country, NX*=1.8; T*-G*=0.

d. If Y=Y*=125, then we have: 125=24+2G+0.6*(125), which implies G=G*=13.

In both countries, net exports are zero, but the budget deficit has increased by 3.

e. In part, fiscal coordination is difficult to achieve because of the benefits of doing

nothing, as indicated from part (c).

4. A U.S. Recession and the Canadian Economy

a. The share of US spending on Canadian goods relative to Canadian GDP is

(0.8)(0.40)=32% of Canadian GDP.

b. A 5% decline in US GDP would be about a 0.5% decline in US imports which

corresponds to 0.16% of Canadian GDP.

c. If exports to all countries fell by 5%, this would reduce Canadian exports by 1.8%
of Canadian GDP, with a multiplier of 2, Canadian GDP would fall by 3.6%,

d. This is a pretty fair characterization of the Canadian economy. The US demand

for our exports is 32% of our GDP. That is big.

5 Dynamics of a Depreciation

a. Initially, net exports and output fall.

b. After six months, net exports and output increase.

6. Export Ratios

Answers will vary.

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