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