Assume a free-floating exchange rate. Draw a diagram like Figure 25.6, only this time show an initial equilibrium national income with a balance of pa
Assume a free-floating exchange rate. Draw a diagram like Figure 25.6, only this time show an initial equilibrium national income with a balance of payments surplus.
\r\n(a) Mark the size of the surplus.
\r\n(b) Show the resulting shifts in the (X–M) and the E curves.
\r\n(c) Mark the eventual equilibrium.
\r\n(d) Show the size of the income and substitution effects (of the change in the exchange rate).
\r\n(e) Under what circumstances will the income effect be (i) ‘desirable’; (ii) ‘undesirable’?
\r\n(f) Could the income effect of the change in the exchange rate ever be larger than the substitution effect?