I'm still not sure how the whole "college-cram" thing works, but if it might give me some help with the Macro project, I figured it's worth a try.
Here is the problem:
Eastland's currency is called the eastmark, and Westland's currency is called westmark. The supply of and demand for eastmark are given as:
Demand=25,000-5000e+50,000(Re-Rw)
Supply=18,500+8,000e-50,000(Re-Rw) where nominal exchange rate e is measured as westmarks per eastmarks, and Re and Rw are the real inerest rates prevailing in Eastland and Westland.
If Re=Rw=0.10 or 10%, what is market equilibrium value of the eastmark?
Any help, pointer, or anything that you can offer will be greatly appreciated.
Comments
Dzenana, this is a straightforward word problem with a twist that can throw you off if you aren't careful. (Read my post about word problems to see what I mean.)
In economics, the equilibrium value is the point where the supply and demand are equal. Graphically, this means the intersection of the supply curve and the demand curve. Rather than graph this problem, though, we can work it out using algebra.
First, let's deal with the twist. Since the real interest rates for Eastland and Westland are equal, the expression (Re-Rw) is zero. Thus, the expression "50,000(Re-Rw)" in both the supply formula and the demand formula becomes 50,000 times zero, or zero. That whole section can then drop right out of both formulas.
To find equilibrium, then, we set the two formulas equal to each other:
25,000 - 50,000e = 18,500 + 8,000e
Delete 18,500 from both sides and add 50,000e to both sides to get this:
25,000 - 18,500 = 8,000e + 50,000e, or
6,500 = 58,000e
Divide both sides by 58,000 to find e:
0.112 = e
Since e is the exchange rate, that means that market equilibrium is achieved when the exchange rate is 0.112 westmarks per eastmark.
P.S. Oh, and that's how this whole "college-cram" thing works!
I sure will.
The second part of this problem is asking if Westland raises real interest rate to 12%, what happenes to market equilibrium value of the eastmark, and is this action likelly to reduce or increase aggregate demand in Eastland?
From what I understand about this, in short I made the following conclusion:
Since the real interest rate of Westmark is rising, this will inversly affect the value of Eastmark, which in return will decline. So the equilibrium value of eastmark declines as a result of increase in real intrest value of the wesstmark. Is there a way to mathematically calculate the new equilibrium? I have input all the knowns in the Demand equition and got the number that is less than the original equilibrium, so even in that sense it seems to me that equilibrium value of the eastmark declines.
Since NX is function of real exchange rate, and since Westland is raising its real interest rate while Eastland is keeping their constant, this action will reduce aggregate demand for Eastmark.
Does this makes any sense at all?