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1. Suppose the government of Country A decides to
increase its spending on public infrastructure by borrowing
from the domestic market. How will this affect the
aggregate demand, interest rate, and exchange rate in
Country A in the short run?
a) Aggregate demand will increase, interest rate will
increase, exchange rate will appreciate.
b) Aggregate demand will increase, interest rate will
decrease, exchange rate will depreciate.
c) Aggregate demand will decrease, interest rate will
increase, exchange rate will appreciate.
d) Aggregate demand will decrease, interest rate will
decrease, exchange rate will depreciate.
Answer: A. Rationale: An increase in government spending
will shift the aggregate demand curve to the right, leading
to a higher output and price level. To finance the spending,
the government will borrow from the domestic market,
increasing the demand for money and raising the interest
rate. A higher interest rate will attract foreign capital
inflows, increasing the demand for the domestic currency
and causing it to appreciate.
2. Consider the following data for Country B:
| Year | Nominal GDP (billions of dollars) | Real GDP
(billions of 2010 dollars) | GDP Deflator
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