Question 3)

Consider an open economy with a flexible exchange rate. Let IS stand for the product market equilibrium condition, LM for the financial market equilibrium condition, and IP for the interest parity condition.

a) What are the equations for the IS, LM and IP curves, defining the symbols you use (4 marks)

b) why the 3 curves in the ISLMIP diagram have their particular slopes. (4 marks)

c) In an ISLMIP diagram, show the effects on output and the exchange rate of a large fall in aggregate demand, followed by a cut in the interest rate to 0 by the central bank (4 marks)