Explain the GG, MM and PPP lines and equilibrium in the Dornbusch model.

Solutions

Expert Solution

In “Dornbusch Model” we try fig how the overall “price level” and “exchange rate” will be determined in an economy. So, here “GG” line show the “goods market” equilibrium which is upward sloping, => as “exchange increases”, => AD increases through increase in “export”, => domestic “P” also increases, => GG shows the goods market equilibrium in “P” and “E” frame work.

Now, the MM line shows the money market equilibrium which is downward sloping, => as “P” increases, => “real money balance” decreases, => the domestic “interest rate” increases, => exchange rate will appreciate, => negative relationship between “P” and “E”.

Now, PPP line shows the simultaneous goods and money market equilibrium. So, along the PPP line the goods and the money market is in equilibrium. Consider the following.

So, the above fig shows the “GG”, “MM” and “PPP” lines and “E1” be the equilibrium, => the equilibrium exchange rate is given by “E*” and “P*”.

Rahul Sunny answered 1 year ago

Next > < Previous

Related Solutions

Explain the monetary model, the Mundell-Fleming model and/or the Dornbusch model and its extensions.

(a) Explain the causes of exchange rate overshooting in the Dornbusch model when there is an...

(a) Explain the causes of exchange rate overshooting in the Dornbusch model when there is an increase in the money supply. Provide an intuitive explanation as well. (b) Critically discuss the assumptions of the basic Dornbusch model. (c) Without going into the full analytic details, explain why an assumption of rational expectations will lead to a similar intuitive explanation as in (a). (c) Explain the suggested Frankel modification to the model. What are the testable implications of this modification?

Explain the monetary model of exchange rate, with reference to PPP and the quantity theory of...

Explain the monetary model of exchange rate, with reference to PPP and the quantity theory of money

Consider a grating with 84 lines/mm and 15 mm of illuminated area. Calculate the wavelengths of...

Consider a grating with 84 lines/mm and 15 mm of illuminated area. Calculate the wavelengths of the first and second order diffraction at a reflective angle of 25 degrees if the angle of incidence is 45 degrees.

Purchasing Power Parity and Monetary Models of Exchange Rates How does the Dornbusch overshooting model indicate...

Purchasing Power Parity and Monetary Models of Exchange Rates How does the Dornbusch overshooting model indicate exchange rate volatility and large exchange rate movements? What problems may this create based on the role of expectations on current exchange rate movements due to monetary policy, and the role of exchange rate movements in asset prices?

How does the Dornbusch overshooting model indicate exchange rate volatility and large exchange rate movements?

How does the Dornbusch overshooting model indicate exchange rate volatility and large exchange rate movements? What problems may this create based on the role of expectations on current exchange rate movements due to monetary policy, and the role of exchange rate movements in asset prices?

1.For gratings with a larger number of lines per mm, how is the spread of the...

1.For gratings with a larger number of lines per mm, how is the spread of the diffraction pattern affected? Support your argument with theory.

Using the IS curve Fed rule model, explain what happens to the equilibrium values of the...

Using the IS curve Fed rule model, explain what happens to the equilibrium values of the interest rate and output if: a) There is an increase in T with the money supply held constant b) A decline in G with the Fed changing the money supply enough to keep output constant c) An increase in P with no change in government spending or taxes

A diffraction grating with (354+ A) lines per mm is used to form an interference pattern...

A diffraction grating with (354+ A) lines per mm is used to form an interference pattern on a screen placed (45.0 + B) cm from the grating. The second-order maximum is observed at (24.6 + C) cm from the central maximum. Find the wavelength of the light. Give your answer in nanometers (nm) with 3 significant figures. A= 41 B= 6 C= 1 Vertically polarized light with an intensity of (763 + A) W/m2 passes through two polarizing filters. The...

In the long run exchange rate model based on PPP, what happens to the exchange rate...

In the long run exchange rate model based on PPP, what happens to the exchange rate when 1)Money supply increases permanently, A rise in interest rate and A rise in output level Thanks.

Subjects