1. Openness in the Goods Market (19 Points)

Let us consider a domestic open economy described as follows:

C = 10 + 0.5(Y-T)

I = 3 + 0.3Y

G=10

IM/e = 0.2Y

X = 0.3Y*/e

where e stands for the real exchange rate defined as the price of one unit of the domestic good in terms of foreign goods and Y* stands for the foreign output/income. The government budget deficit is equal to 2% of the domestic output/income denoted by Y.

a. Under the assumption that the foreign output/income expressed in terms of the domestic goods is half the size the domestic output/income, compute the equilibrium domestic output/income. (4 Points)

b. Does the domestic economy run a trade surplus or a trade deficit in equilibrium? (2 Points)