Small Open Economy Model Consider the Small Open Economy Model studied in class. Assume that the purchasing power parity (PPP) holds and that the country adopts a fixed exchange rate regime. (a)...

Small Open Economy Model Consider the Small Open Economy Model studied in class. Assume that the purchasing power parity (PPP) holds and that the country adopts a fixed exchange rate regime.

(a) Suppose current total factor productivity (TFP) increases (due to a new invention, for example). Which are the equilibrium effects of this shock on the real wage, employment, the real interest rate, output, and domestic prices? Use the equilibrium diagrams for the current labour market, the current goods market, and the current money market in the Small Open Economy Model to answer this question .

(b) How does the composition of output change after the increase in TFP?

(c) Compare the predictions in (1) and (2) against the business cycles regularities studied in class. More precisely: Based on this model, can shocks to current TFP explain the way in which employment, consumption, investment, and the price level correlate with output in the data? Justify your answer.