In a two-period SOE model with production, a negative total factor productivity shock abroad

Question

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A negative total factor productivity shock abroad means that foreign firms are less productive, which decreases foreign output. This shock can also lead to a decrease in the demand for domestic goods and therefore decrease domestic output. However, it can also lead to a decrease in the relative price of foreign goods, making domestic goods relatively cheaper and increasing demand for them, thereby increasing domestic output. Overall, the net effect is a decrease in foreign output and an increase in domestic output.

In a Two-Period SOE Model with Production, a Negative Total