Consider the following Mundell-Fleming short-run model of a small open economy under floating exchange rates given in equations (1)-(9). Assume there is perfect capital mobility so that the domestic interest rate equals the world interest rate, i.e., r= r*. The nominal exchange rate is denoted by a. (1) 6 = 600 + 0.6 (Y -7) (2) / = 550 - 40r (4) G = 570 (5)7 = 150 + 0.2Y (6) NX = 200 - 15 ( P/P )e ()PE = C+I+ G+ NX ()Y = PE Goods market equilibrium (8) - -= 15 - 50 r (9)- Money market equilibrium Suppose that the central bank sets the nominal money supply M' = 6000 and that F = 2. Also suppose that the foreign price P* = 1 while the world interest rate r* = 5. 1. The equilibrium output level in this economy Y" is given by A) Y 1 = 2004.50 B) Y = 1020.48 C) You = 2166.65 D) Y = 1620.56 2. The equilibrium exchange rate am is given by: Ajew = 14.35 and we have a trade deficit Bye" = 16.72 and we have a trade deficit C)ex = 6.32 and we have a trade surplus Dje" = 18.86 and we have a trade deficit3. Consider a monetary expansion: If the CB (central bank) decides to increase the money supply so that M$ = 7000, then A) equilibrium output will stay the same, but the exchange rate will increase (appreciate) increasing the trade surplus B) equilibrium output will stay the same, but the exchange rate will fall (depreciate) by 2.25 units reducing the trade surplus by 105.2 units. ") equilibrium output will rise by about 344 units and the exchange rate will fall (depreciate) by 5.79 units reducing the trade deficit by 173.7 units. D) equilibrium output will rise by about 252.75 units and the exchange rate will fall (depreciate) by 3.62 units reducing the trade deficit by 155.38 units. 4. Consider the impact of a fiscal expansion in the above economy (instead of a monetary expansion so that M* = 6000 as before). If lumpsum taxes decrease by 100 units (i.e., A T = - 100) them: A) equilibrium output will stay the same, but the exchange rate will rise (appreciate) increasing the trade deficit by 60 units. B) equilibrium output will stay the same, but the exchange rate will fall (depreciate) reducing the trade surplus by 100 units. () equilibrium output will rise by about 1556 units and the exchange rate will fall (depreciate) by 10.5 units reducing the trade deficit by 352 units. D) equilibrium output will rise by about 1250 units and the exchange rate will fall (depreciate) by 2 units reducing the trade deficit by 50 units. Refer to the following model of the economy for Q5-Q8 (Same model but under fixed exchange rates) Consider the Mundell-Fleming short-run model of an open economy above, but now under fixed exchange rates given in equations (1)-(9) below. As before, we assume there is perfect capital mobility so that the domestic interest rate equals the world interest rate, i.e., r= r*. However, now the CB decides to fix the nominal exchange rate at e (1) C = 600 + 0.6 (Y - 7) (2) / = 550 - 40m (4)G =570 (5) 7 = 150 + 0.2 Y (6) NX = 200 - 15 ( P /P ) ()PE = C+I+ G+ NX (7)Y = PE Goods market equilibrium (8) -= 15Y - 50 r Money market equilibrium Suppose that P = 2. Also suppose that the foreign price D*= 1 while the world interest rate r* = 5.\f10. Consider a Phillips curve of the form , = x_,- 0.5(w - w") + v where expected inflation is given by -1. (Assume that v = 0.) Now, initially, a = 5 (percent), 1_1=5 (percent), and a" = 6 (percent). Suppose that the CB believes that inflation is too high and decides to use contractionary monetary policy so that inflation falls to 4 percent. That is * = 4. But expected inflation is still _, = 5. (That is, people still expect 5% inflation for the future even though current inflation has fallen.) As a result of the CB's disinflationary policy, the following occurs: (Hint: According to Okun's Law the following relation holds (approximately): 1 percent increase in u 3 percent decrease in real GDP ) A) unemployment rises by 1%, output falls by 3% and the sacrifice ratio is 3. B) unemployment falls by 1%, output rises by 3% and the sacrifice ratio is -3 () unemployment rises by 2%, output falls by 6% and the sacrifice ratio is 6 D) unemployment falls by 2%, output rises by 3% and the sacrifice ratio is 3. PART 2 (Q11-Q20) (40 pts) (4 pts each) 11. Consider a Phillips curve of the form . = n_, - 8(x - w") + v . In the case of demand-pull inflation, other things being equal: A) both the inflation rate and the unemployment rate rise at the same time. B) the unemployment rate rises, but the inflation rate falls. () the inflation rate rises, but the unemployment rate falls. D) both the inflation rate and the unemployment rate fall. 12. In the Mundell-Fleming model, the domestic interest rate is determined by the: Aj intersection of the LM and Is curves. B) domestic rate of inflation world rate of inflation. world interest rate. 13. In the short-run model of a small open economy, net exports depend on the exchange rate, where the exchange rate is defined as the amount of currency per unit of currency- A) negatively; foreign; domestic B) negatively; domestic; foreign C) positively; domestic; foreign D) positively; foreign; domestic 14. If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the nominal exchange rate e along the vertical axis, then the IS* curve. A) slopes downward and to the right because the higher the exchange rate, the higher the level of net exports and, therefore, the higher the level of income that equilibrates the goods market. B) is vertical because there is only one investment level that is consistent with the world interest rate. ") is vertical because the exchange rate does not enter into the IS* equation. D) slopes downward and to the right because the higher the exchange rate, the lower the level of net exports, and therefore, the lower the level of income that equilibrates the goods market.