Suppose that PPP does NOT hold.
1. Explain the role of movements in the relative price of non-traded goods for real exchange rate fluctuations, using a simple decomposition of the real exchange rate into two parts to illustrate your answer.
2. How does a real exchange rate depreciation, due to any source, affect equilibrium real income, the home equilibrium interest rate, and the home price level? Use diagrams to illustrate your answer.