The following Mundell-Fleming model of a small, open economy will be used in all numerical exercises. It assumes a short-run framework in which prices are constant and output is demand-determined. C = 200 + 0.8(Y − T) I = 500 − 30r NX = 10 − 100e M/P = 50 + Y − 60r r = 2 G = 200 T = 100 M = 4000 P = 2 Assume that the exchange rate is floating. a.) Derive the equilibrium equations for IS* and LM*, sketch a graph of the two equations and solve for the equilibrium values of Y, e and NX. b.) Suppose the Treasury attempts to stimulate the economy by decreasing taxes T from 100 to 20. Calculate the new values of Y, e and NX. With the help of the graph you sketched in (a), explain the mechanism by which a new equilibrium is reached. c.) With all other exogenous variables at their original levels, suppose the Central Bank attempts to stimulate the economy by increasing money supply M from 4000 to 4200. Calculate the new values of Y, e and NX. Explain the mechanism by which a new equilibrium is reached.
The following Mundell-Fleming model of a small, open economy will be used in all numerical exercises. It assumes a short-run framework in which prices are constant and output is
C = 200 + 0.8(Y − T)
I = 500 − 30r
NX = 10 − 100e
M/P = 50 + Y − 60r
r = 2
G = 200
T = 100
M = 4000
P = 2
Assume that the exchange rate is floating.
a.) Derive the equilibrium equations for IS* and LM*, sketch a graph of the two equations and solve for the equilibrium values of Y, e and NX.
b.) Suppose the Treasury attempts to stimulate the economy by decreasing taxes T from 100 to 20. Calculate the new values of Y, e and NX. With the help of the graph you sketched in (a), explain the mechanism by which a new equilibrium is reached.
c.) With all other exogenous variables at their original levels, suppose the Central Bank attempts to stimulate the economy by increasing money supply M from 4000 to 4200. Calculate the new values of Y, e and NX. Explain the mechanism by which a new equilibrium is reached.
d.) In light of your answers to parts (b) and (c), compare the relative effectiveness of fiscal and
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