The correct answer is "increase; fall". Here's why:

Step 1: The central bank increases the money supply. This is done to stimulate the economy, especially during a recession.

Step 2: An increase in the money supply leads to a decrease in interest rates. This is because when there is more money circulating in the economy, the cost of borrowing that money (i.e., the interest rate) decreases.

Step 3: Lower interest rates encourage investment and consumption, which increases aggregate demand.

Step 4: An increase in aggregate demand leads to an increase in equilibrium income. This is because when demand for goods and services increases, firms respond by increasing production, which leads to an increase in income.

Step 5: Meanwhile, the decrease in interest rates also leads to a decrease in the demand for the country's currency by foreign investors (since they can get a higher return elsewhere). This leads to a depreciation of the country's currency, or in other words, a fall in the equilibrium exchange rate.

So, in summary, an increase in the money supply in a small open economy with perfect capital mobility and a floating exchange rate will cause the equilibrium income to increase and the equilibrium exchange rate to fall.

Question

The correct answer is "increase; fall". Here's why:

Step 1: The central bank increases the money supply. This is done to stimulate the economy, especially during a recession.

Step 2: An increase in the money supply leads to a decrease in interest rates. This is because when there is more money circulating in the economy, the cost of borrowing that money (i.e., the interest rate) decreases.

Step 3: Lower interest rates encourage investment and consumption, which increases aggregate demand.

Step 4: An increase in aggregate demand leads to an increase in equilibrium income. This is because when demand for goods and services increases, firms respond by increasing production, which leads to an increase in income.

Step 5: Meanwhile, the decrease in interest rates also leads to a decrease in the demand for the country's currency by foreign investors (since they can get a higher return elsewhere). This leads to a depreciation of the country's currency, or in other words, a fall in the equilibrium exchange rate.

So, in summary, an increase in the money supply in a small open economy with perfect capital mobility and a floating exchange rate will cause the equilibrium income to increase and the equilibrium exchange rate to fall.

Knowee AI · Accepted Answer

The correct answer is "increase; fall". Here's why:

Step 1: The central bank increases the money supply. This is done to stimulate the economy, especially during a recession.

Step 2: An increase in the money supply leads to a decrease in interest rates. This is because when there is more money circulating in the economy, the cost of borrowing that money (i.e., the interest rate) decreases.

Step 3: Lower interest rates encourage investment and consumption, which increases aggregate demand.

Step 4: An increase in aggregate demand leads to an increase in equilibrium income. This is because when demand for goods and services increases, firms respond by increasing production, which leads to an increase in income.

Step 5: Meanwhile, the decrease in interest rates also leads to a decrease in the demand for the country's currency by foreign investors (since they can get a higher return elsewhere). This leads to a depreciation of the country's currency, or in other words, a fall in the equilibrium exchange rate.

So, in summary, an increase in the money supply in a small open economy with perfect capital mobility and a floating exchange rate will cause the equilibrium income to increase and the equilibrium exchange rate to fall.

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