Suppose that there is a TEMPORARY INCREASE IN THE DEMAND FOR IMPORTS that exogenous (due to changes in tastes, not due to changes in the real exchange rate or disposable income)
(a) Using AA-DD diagram for a floating exchange rate system, show what happens to national income and the exchange rate as a result of this temporary increase in the demand for imports. EXPLAIN what causes any curves to shift.
(b) On another AA-DD diagram, show how this same temporary increase in the demand for imports would impact on national income in the short run if there were a FIXED EXCHANGE RATE system instead. Explain what causes any curves to shift.
(c) Under which regime (floating or fixed) is the impact on national income greater? Your answer must be consistent with your previous answers in this question.
(d) Suppose the exogenous increse in demand for imports were PERMANENT INSTEAD. On a diagram showing how the real exchange rate is determined using relative supply and demand curves, indicate how the increase in the demand for imports affect that diagram and determines a new real exchange rate. Show AA-DD diagram what would happen to output and the exchage rate in the short run and the long run under a floating exchange rate system as a result of the increase in the demand for import. Assume the country begins at a long run equlibrium.