A) The role of money demand is very important in the so-called "Monetary Approach" to the determination of interest rates. Briefly discuss how the following three considerations influence individual demands for money: i) expected returns relative to other assets, ii) the riskiness of the money as an asset, iii) liquidity.
B) Explain the concept of a "real exchange rate" and discuss how this variable would be expected to change, 1) in the case of a relative change in demand for one trading partner's output, 2) in the case of a relative change in supply of one trading partner's output.
c) Using a diagram, illustrate and briefly explain the phenomenum of exchange rate overshooting. What empirical fact does this theory offer an explanation for?
d) Briefly discuss the effects on the exchange rate of an increase in the domestic interest rate according to both the "asset market approach" and to the"monetary approach". What are the predictions of the two models? Are the two predictions in agreement? If not, how can the two predictions be reconciled?
e) Using a diagram, illustrate and briefly explain the short-run effects of a temporary contraction of the domestic money supply on the simultaneous equilibrium of the domestic money market and the foreign exchange market.
f) Using a diagram, illustrate and briefly explain the long-run effects of a permanent contraction of the domestic money supply on the simultaneous equilibrium of the domestic money market and the foreign exchange market.