Question 1

A small open economy is described by the following set of equations:

C = 300 + 0.6(Y T)

I = 700 80r

NX = 200 50

G = T = 500 (Balanced Budget)

(M/P)^d = Y 200r

M = 3, 000

P = 3 r = 5

(a) Derive and graph the IS and LM curves.

(b) Calculate the equilibrium exchange rate, income and net exports.

(c) Assume a floating exchange rate. Calculate what happens to the exchange rate, income, net exports, and the money supply if the government increases its spending by 200. Use a graph to explain what you find.

(d) Now assume a fixed exchange rate. Calculate what happens to the exchange rate, income, net exports, and the money supply if the government increases its spending by 50. Use a graph to explain what you find.