Economics 208 Assignment 3 Due: November 7 in class Answer the following questions. Be sure to explain your answers and show your work. 1. Immigration is a topic of much debate. Suppose that Home is considering relaxing its immigration policy and allowing more immigrants to enter the country from Foreign. Suppose that textile production is labour-intensive and pharmaceutical production is capital-intensive. In the short-term, capital is fixed (i.e. specific) to each industry but labour is fully mobile between industries. In the long-run, capital is also fully mobile between industries. (a) In the short-run, use a diagram for the world labour market to show the gains for Home and for Foreign from immigration from Foreign to Home. Some people in Home oppose immigration. Why do they? Who gains from immigration in Home? (b) Explain the long-run impact of immigration on those who oppose it in question (a)? 2. Illustrate and explain the determinants of the spot exchange rate between the Canadian dollar and the Euro. Provide an example of an event that would depreciate the Canadian dollar relative to the Euro. Explain how arbitrage ensures that exchange rates equalize across foreign exchange markets. 3. Suppose that Canada's real exchange rate with the US equals 1. What does this imply for PPP? Suppose that US inflation suddenly increases. What is the response of the exchange rate if PPP holds in the long run? 4. Suppose that Home and Foreign currently have capital controls in place that prevent the free flow of funds between the two countries. Suppose that iH>iF on deposits. (a) Home and Foreign announce that they will abolish all capital controls. Explain the arbitrage process that would occur to ensure covered interest rate parity holds. Why is this condition an equilibrium one? (b) If uncovered interest rate parity holds as well, what does this imply about the forward rate and the expected future exchange rate? 5. Consider the long run monetary model using the quantity theory of money demand. Consider two countries: Japan and Korea. In 1996 Japan experienced relatively slow output growth of 1% and Korea had relatively robust output growth of 6%. Suppose the Bank of Japan allowed the money supply to grow by 2% per year, while the Bank of Korea chose to maintain relatively high money growth of 12% per year. Treating Korea as the Home country, answer the following questions: (a) What is the inflation rate in Korea? In Japan? (b) What is the expected rate of depreciation in the Korean won relative to the Japanese yen? (c) Suppose the Bank of Korea increases the money growth from 12% to 15%. If nothing in Japan changes what is the new long run inflation rate in Korea? (d) Explain how this increase in the money growth rate affects Korea's interest rate, prices, and exchange rate in the long run. 6. Use the money market and FX diagrams to answer the following questions. This question considers the relationship between the euro and the Canadian dollar. The exchange rate is in Canadian dollars per euro. Suppose that there is an increase in money demand in Canada. (a) Assume this change in money demand is temporary. Illustrate and explain how this change affects the money and FX markets. (b) Assume this change in money demand is permanent. Illustrate and explain how this change affects the money and FX markets.