1)     (20 points) Explain, in five sentences or less, exactly why the trade deficit in the US increased from 1995 to 2000.  There are two specific reasons. Make sure you explain clearly (the intuition) why each reason would add to our trade deficit.

2)  (40 points total)

a.     (10 points) Suppose that you received your college degree from Penn State and nailed a great job over in Europe in the summer of 2001.  Given that your family remains in the US, you make sure that you visit the family every November by traveling from Europe to the US.  We are going to compare the cost of this vacation, in terms of euros,  during two different periods: November 2002 and November 2012.  We assume that the cost of the trip, in terms of $ US, remains the same at $1,000 in both periods.  Using the link below and rounding down to two decimals, compare the euro cost of the trip in November 2002 vs. the euro cost of the trip in November 2012.

See the St. Louis Federal Reserve site for $ per euro exchange rate (to get actual data click on “view data” on left hand side of page)

b.      (30 points – 15 points for explanation and 15 points for correct and completely labeled diagram) Using the same link above, we are now going to use our supply/demand framework for US $ to model the movement in the euro per $ exchange rate between December 2007 (the very beginning of the Great Recession) and November 2008 (pretty much the height of the global financial crisis). 

Note that the data is in $ per euro so you need to convert it into euro per dollar before proceeding.  For example, $ 1.2 per euro is converted by 1/1.2 = .833 meaning that $1 = .83 euro (this is the vertical axis on your graph, i.e., euro per $).

Rounding down again to two decimals, draw a supply and demand diagram like we did numerous times in the lectures labeling the vertical axis as euro per $ and the initial supply and demand curves labeled with 12/07, Label this initial point as point A. 

Now explain what happened to each curve and WHY between 12/07 and 11/08.  Label this new point (11/08) as point B with your supply and demand curves labeled accordingly

(Hint: the two obvious facts during this period is that the 1) US was in a deep recession and 2) we were at the height of the (global) financial crisis (in 11/08). Assume all else is constant.