Question

A small open economy is described by the following equations: C
= 50 + .75(Y - T)

I = 200 - 20i

NX = 200 - 50E

M/P = Y - 40i

G = 200

T = 200

M = 3000

P=3

i* = 5

b. Assume a floating exchange rate and constant expectations. Calculate what happens to the exchange rate, the level of income, net exports, and the money supply if the government increases its spending by 50. Use a graph to explain what your findings. (5 points)

c. How does the equilibrium in (b) change if financial agents’ expectations change? (5 points)

d. Now, suppose that money demand depends on disposable income, so that the equation for the money market becomes M /P = L (i, Y -T). Analyze the short-run impact of a tax cut in a small open economy on the exchange rate and income under floating exchange rates. (5 points)

e. Now assume a fixed exchange rate. Calculate what happens to the exchange rate, the level of income, net exports, and the money supply if the government increases its spending by 50. Use a graph to explain what you find. (5 points)

f. The Mundell-Fleming model take the world interest rate i* as an exogenous variable. Let’s consider what happens when this variable changes. Which causes might drive the world interest rate up? (5 points).

g. Assume that the world interest rate rises. What happens in the foreign exchange market and the money market, under a fixed exchange rate? Show graphically effects to aggregate income, the exchange rate, and the trade balance, and give a brief explanation. (5 points)

h. Under a fixed exchange rate, how can authorities control the trade balance? (5 points)

Answer #1

b. If government increases it's spending by 50 then there will be a decrease in the exchange rate, increase in the level of income and in the net exports.

c. The equilibrium in (b) changes if the financial agents expectations change because the level of income increases with a decrease in the exchange rate.

d. If the money demand depends on the disposable income then the short run impact on of a tax cut in a small open economy on the exchange rate will decrease and income under floating exchange rate will also decrease.

e. In a fixed exchange rate if the government increases it's spending by 50 then the exchange rate will also change, level of income increases with a fixed rate, the net exports will decrease with a decrease in the money supply.

An open economy is described by the following system of
macroeconomic equations, in which all
macroeconomic aggregates are measured in billions of Namibian
dollars, N$.
Y = C + I + G + X – M
C = 160 + 0.6Yd
T = 150 + 0.25Y
I = 150
G = 150
E = 300
M = 50 + 0.1Y, Yf = 1500
Where: Y is domestic income
Yd is private disposable income
C is aggregate consumption spending
T is...

An economy is initially described by the following
equations:
C = 500 + 0.75(Y - T); I = 1000 - 50r; M/P = Y - 200r;
G = 1000; T = 1000; M = 6000; P = 2;
where Y is income, C is consumption, I is investment, G is
government spending, T is taxes, r is the
real interest rate, M is the money supply, and P is the price
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a. Derive the IS equation and the LM...

IS-LM Model (Closed Economy)
The following equations describe a small open economy.
[Figures are in millions of dollars; interest rate (i) is in
percent]. Assume that the price level is fixed.
Goods Market
Money
Market
C = 250 +
0.8YD
L = 0.25Y – 62.5i
YD = Y + TR –
T
Ms/P = 250
T = 100 + 0.25Y
I = 300 – 50i
G = 350; TR = 150
Goods market equilibrium condition: Y = C + I...

The following equations are those for a small open economy,
which takes the world real rate of interest ( r w
) as given. In particular:
M/P = 24 + 0.8Y - 400r
C =2+0.8(Y-T) - 200r
I =30 - 200r
NX =24-0.1Y - 2e
Y =C +I +G+NX
You are given the following values for various variables:
rw = 0.05; M/P = 100;G
= 10 and the budget is balanced. Using the model, find the values
for Y, e...

Given an economy described by the following set of
equations.
Y = C(Y - T) + I(r) + G
C = 200 + 0.80(Y - T)
I = 300 - 2r
G = 400
T = 200
(M/P)d = 0.80Y - 8r
Ms = 5,600
Price-level = P = 2
What is the equilibrium level of GDP?

Given an economy described by the following set of
equations.
Y = C(Y - T) + I(r) + G
C = 200 + 0.80(Y - T)
I = 300 - 2r
G = 400
T = 200
(M/P)d = 0.80Y - 8r
Ms = 5,600
Price-level = P = 2
What is the equilibrium level of investment?

Given an economy described by the following set of
equations.
Y = C(Y - T) + I(r) + G
C = 200 + 0.80(Y - T)
I = 300 - 2r
G = 400
T = 200
(M/P)d = 0.80Y - 8r
Ms = 5,600
Price-level = P = 2
What is the equilibrium level of consumption?

Given an economy described by the following set of
equations.
Y = C(Y - T) + I(r) + G
C = 200 + 0.80(Y - T)
I = 300 - 2r
G = 400
T = 200
(M/P)d = 0.80Y - 8r
Ms = 5,600
Price-level = P = 2
What is the equilibrium level of consumption?

Use the Mundell-Fleming model to examine the effects - for case
of a small open economy. But allow for the assumption that
in the money demand equation, price P depends on domestic
production price (assumed fixed) and the price of imported
goods. Show on a diagram how the IS and LM curves shift if
there is an exchange rate appreciation, and examine with drawing
the effects in this model of an increase in government spending
with floating exchange rates under...

Use the Mundell-Fleming model to examine the effects - for case
of a small open economy. But allow for the assumption that
in the money demand equation, price P depends on domestic
production price (assumed fixed) and the price of imported
goods. Show on a diagram how the IS and LM curves shift if
there is an exchange rate appreciation, and examine with drawing
the effects in this model of an increase in government spending
with floating exchange rates under...

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