An open economy with absolute mobility of capital is described as follows: consumption function is given as C =50 +0, 8(Y - T), where Y is output, and T is net taxes, Investment function is given as I = 20-10i, where I isnominal interest rate. Government spending G22-4E+0, 3Y where E - nominal exchange rate (price of foreign currency in terms of domestic currency). Forone unit of foreign currency, you can get 3 units of domestic currency. The real money supply is M* /P= 50. Thedemand for real money is described by the following function: L(Y,i) = 0, 5Y-10i.20, tax Tr = 10, export Ex = 6E +10, import Im%3DFind BP curve, if the economy is initially in the internal and external equilibrium. Write an equation for BP withoutspaces and % signs

Answered: An open economy with absolute mobility…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Suppose that the government decides to cut spending. In a three graphs diagram, show theimpact of this policy on real interest rate, national saving, investment, net capital outflows,demand for currency (NX), and supply of currency? Will the currency appreciate ordepreciate?
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a Figure 1 shows the exogenous world interest rate (r*) determines the level of investment (I) and the difference between saving (S) and investment determines net capital outflow and net exports (NX) for a small open economy. What would happen to I, NX and S if: i. The government of this small open economy uses expansionary fiscal policy. ii. The government of other countries (abroad) uses contractionary fiscal policy. b Suppose the price of a cup of tea is Rs.50 in Pakistan and $2 in USA, the value of nominal exchange rate is $0.006364 per PKR. Calculate the value of real exchange rate (ε) and interprete its meaning. Also, discuss the relationship between net exports (NX) and real exchange rate. c Briefly explain the theory of purchasing power parity (PPP) with the help of example.
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