duction function: Y = K1/2L1/2 Balance equation: Y = C + I + G + NX Consumption function: C = 0.6(Y-T) Investment function: I = 10 – 100r Demand for net export: NX = 8/ε – 8 Suppose that initially K = 1, L = 400, G = T = 5, and the world real interest rate is r* = 0.06   Now consider the following shock. Find the new value of net exports and the real exchange rate, demonstrate the effect on the two graphs of the open economy model, and explain the intuition.   Shock: Demand for imports increases, so that now NX = 8/ε – 18

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