Suppose the economy is operating below the natural level of ...

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Suppose the economy is operating below the natural level of output. Discuss the arguments for and against using a devaluation in such a situation.
 
  What will be an ideal response?

Question 2

Suppose there is an increase in the saving rate. Explain what effect this will have on output, output per worker, the rate of growth of output, and the rate of growth of output per worker.
 
  What will be an ideal response?

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Answer to Question 1

With a devaluation, Y returns to the natural level much more rapidly. This would cause an increase in NX, an increase in demand, and an increase in Y. Graphically, the AD curve would shift to the right. Economy self-corrects. This is an advantage. However, with a devaluation, individuals might begin to doubt the country's commitment to a fixed exchange rate regime. This could lead to an exchange rate crisis.

Answer to Question 2

The increase in s will cause an increase in S/N and I/N. At the initial K/N, depreciation is less than investment. Alternatively, there is excess investment to offset the amount of capital that wears out. So, the capital stock will increase. This will cause an increase in K/N, Y/N, and S/N. As Y/N rises, so will C/N.