he parameters m, and x, are the propensities to import and export. Assume th e real exchange rate is fixed at a value of 1 and treat foreign income, Y, as fixe Iso assume that taxes are fixed and that government purchases are exogenous (ie ecided by the government). We explore the effectiveness of changes in Gund temative assumptions about the propensity to import. Write the equilibrium condition in the market for domestic goods and solve for Y
he parameters m, and x, are the propensities to import and export. Assume th e real exchange rate is fixed at a value of 1 and treat foreign income, Y, as fixe Iso assume that taxes are fixed and that government purchases are exogenous (ie ecided by the government). We explore the effectiveness of changes in Gund temative assumptions about the propensity to import. Write the equilibrium condition in the market for domestic goods and solve for Y
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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answer only part d, e & f
Transcribed Image Text:1. Multipliers, openness, and fiscal policy
Consider an open economy characterized by the equations below
C =c, +c(Y -T)
I = d, + d,Y
IM = m,Y
X = x,Y *
The parameters m, and x, are the propensities to import and export. Assume that
the real exchange rate is fixed at a value of 1 and treat foreign income, Y*, as fixed.
Also assume that taxes are fixed and that government purchases are exogenous (ie.,
decided by the government). We explore the effectiveness of changes in Gunder
altenative assumptions about the propensity to import.
a. Write the equilibrium condition in the market for domestic goods and solve for Y.
b. Suppose government purchases increase by one unit. What is the effect on output?
(Assume that 0<m, <g +d, <1. Explain why.)
c. How do net exports change when government purchases increase by one unit?
Now consider two economies, one with m, = 0.5 and the other with m, =0.1. Each
economy is characterized by (e, + d,)= 0.6 .
d. Suppose one of the economies is much larger than the other. Which economy do
you expect to have the larger value of m, ? Explain.
e. Calculate your answers to parts (b) and (c) for each economy by substituting the
appropriate parameter values.
f. In which economy will fiscal policy have a larger effect on output? In which
economy will fiscal policy have a larger effect on net exports?
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