Concerning the recent financial tsunami originated from the collapses of mortgage and
security firms in the US, answer the following questions. Your explanations determine
the grades.
(1) The financial tsunami is widely believed to be triggered by the fall of real estate
prices in the US. Explain why the fall of real estate prices caused the sub-prime
mortgage market to collapse. (10%)
(2) Some blames China for the crisis, saying that its huge trade surplus with the US had
fostered the real estate bubble in the US. From the economics point of view, explain
why this argument might be true? (10%)
Assume country A and B are both small open economies with floating exchange rate.
They are identical except that country A’s money demand is relatively insensitive to
changes in the interest rate. Now assume that both countries cut tax by the same
amount. Does country A has a larger change in the equilibrium output? Why or why not?
Explain your answer. (10%)
Suppose there is a permanent productivity shock that shifts the production function
upward proportionally. The MPK schedule increases as a result.
(1) Explain why the interest rate may increase in response to the shock even thought
the shock is permanent. You may use graphs and/or equations to help answer the
question. (10%)
(2) How would consumption normally change in response to a higher interest rate?
Why you may still expect the consumption to change differently in this case? (10%)
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