Question

PROBLEM NO 2. An Open Economy in the Short Run and The Medium Run (25 Points) a. Indonesia's equilibrium condition of goods and services market can be expressed by the following equation: Y = CAY - T) + (Y, r) +G-IMY, )) { + X(Y*, £) where: Y=domestic output; Y*= foreign output; C= consumption: T=tax; l=investment, r=real interest rate; G=government spending, € = Real Exchange Rate. If it is assumed that the Marshall-Lerner condition holds. Explain in words the effects of a depreciation of Rupiah (domestic currency) on Indonesia's: export, import, trade balance, and output! (5 points) b. Suppose the United States (US) economy is experiencing a recession or a decrease in its level of output Y*. To tackle the problem, the US central bank (The Fed) is to decrease its policy rate (*). By using IS-LM-UIP (uncovered interest parity) framework, explain in words and graphically the effect of the decrease in Y* and l* on domestic output (Y) and exchange rate (E) if the Bank Indonesia does not change the domestic interest rate (1)! (10 points) Equilibrium in the labor market (in the medium run) is determined by the real wage that is set by the wage setter and price setter. Suppose that the wage-setting equation is given by W/P = 1.5 - 2u+Z where W is the nominal wage; P is the price level; u is the unemployment rate, and z is the minimum wage policy. Assume that the markup of the products' prices is 20% and z is 10%, and that the expected price level is equal to the actual price level. (i) Write the equations that show the required condition in the equilibrium of labor market (real wage chosen in wage setting is equal to the real wage implied by price setting) and calculate the natural rate of unemployment (Un) for this economy! (4 points) Explain in words and show graphically, what would happen to the natural rate of unemployment (Un) if the government enacts a policy to increase the minimum wage! (6 points)

Answer 1

a. If there is depreciation of rupiah in Indonesia than the exports of domestic country I.e. the Indonesia will increase as now the rupiah will become cheaper in international market but as the rupiah has depreciated now the imports will become expensive so there will be decrease in imports, therefore there will be trade surplus as the exports is greater than imports and output will going to increase.

(b) If the