Question 2: IS-LM model in an open economy with flexible exchange rates (35 Marks) The following equations are those for a small, open economy, which takes the world real rate of interest as given. In particular: = 21+0.5Y -400r Money demand P " =18+0.6(Y -T)-200r Desired consumption 1 = 28-200r Desired investment NX" = 24-0.1Y -2e Desired net exports Y = C + ['+ G+ NX Goods market equilibrium a) Derive the IS and LM curves for this economy. As well, find an equation for the real exchange rate (e) by setting the IS and LM curves equal to each other. Assume that the economy is at full employment. Based on your equation for e, discuss how it would respond to a rise in government spending (G) and separately to a rise in the level of taxation (7). If the effects differ, explain why. b) Suppose that the velocity of money is 1.83 and that the real value of money (M/P) is 60. If the level of government spending (G) is 10 and the budget is balanced, find the levels of real output (Y), the real exchange rate (e) and the world real rate of interest ( " ) that are consistent with goods-market equilibrium in this economy. [Hint: You should expand the term 1.83 to 1.8333333... etc. in order to get a more accurate estimate when doing your calculations.]