Question

Consider the following short-run model of an open economy:

*Y = C+I+G+NX*

*C = 100+(2/3)(Y-T)*

*I = 200*

*NX = X-(1/E)IM*

*X = (1/E)400*

*IM = (1/6)E Y*

Domestic and foreign prices are constant with
*P=P ^{*}=1*. Thus, the real exchange rate is equal
to the nominal rate

The policy makers want to achieve the following targets for
output, consumption and net exports: *Y ^{T}=1200,
C^{T}=780 and NX^{T}=0*. Show how these targets
can be achieved using government consumption (

Answer #1

Objective: Y = 1200, C = 780, NX = 0

Equation 1 : Y = C+I+G+NX

Equation 2 : C = 100 + (2/3)(Y-T)

Equation 3 : I = 200

Equation 4 : NX = X-(1/E)IM

Equation 5 : X = (1/E)400

Equation 6 : IM = (1/6)EY

Equation 7 : P = 1

Using Equation 5 and 6, substituting in Equation 4

NX = (1/E)400 - (1/E)(1/6)EY

NX = 400/E - Y/6

Setting NX = 0

we have,

400/E = Y/6

Setting Y = 1200

E = 400*6/1200 = 2

Now, Setting, Y = 1200 in equation 2

C = 100 + (2/3)(1200 - T)

Also, set C = 780

780 = 100 + (2/3)(1200 - T)

Simplifying,

T = 1200 - 680*3/2 = 180

Now substituting, Y = 1200, C = 780, I = 200, NX = 0 into equation 1

1200 = 780 + 200 + G

G = 220

1. G = 220

2. T = 180

3. E = 2

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