The Open Economy: The Supply Side

Question 1

When we have a vertical ERU, what is the only shock that can impact output?

Answer 1

Supply shocks

Question 2

How will a demand shock impact the economy when we have a vertical ERU?

Answer 2

It will see the currency appreciate/depreciate but y will remain unchanged

Question 3

What has evidence shown about the impact of demand shocks on output? What does that mean about the shape of the ERU?

Answer 3

Evidence has shown that demand shocks also alter output. Given that this is the case, ERU cannot be vertical but must be downward-sloping

Question 4

What does a downward-sloping ERU suggest about the relationship between RER and inflation with output?

Answer 4

It shows that given ratios of RER and inflation can be consistent with various different levels of output

Question 5

What do we assume regarding consumer prices if we use a downward-sloping ERU?

Answer 5

That the price of imports will also impact wage setting

Question 6

If we also consider the prices of imports, how will the wage setting diagram be adjusted?

Answer 6

We will define the WS in terms of the real consumption wage (W/Pc)

Question 7

What is formula for the real consumption wage?

Answer 7

Nominal wage/CPI

Question 8

What does using the CPI mean between about the impact of exchange rates on WS-PS?

Answer 8

Means that changes in the exchange rate can impact the real consumption wage, which will shift WS

Question 9

How will a real depreciation affect the WS-PS equilibrium for wage and employment?

Answer 9

A real depreciation will see the real consumption wage decrease as imports become more expensive. This means WS will shift down and employment will fall

Question 10

For a diagram about a real depreciation effect on WS-PS and its relation to ERU:

Answer 10

Check notes -> will not shift ERU but will move it to a different point on the ERU curve where the change in employment will also impact the overall output in the economy