Suppose a small open economy can be described by the following set of equations:

Long-run output: YFE = 48000

Consumption: C = 11250 + 0.75(Y - T) - 2000r

Investment: I = 13500 - 1500r

Net exports: NX() = 9000 - 1000, where = the real FC/DC exchange rate

Taxes: T = 15000

Government spending: G = 12000

Money supply: MS = 25200

Real money demand: L(r + e, Y) = 0.2Y - 200(r + e)

Expected inflation rate: e = 0%

Note: Real interest rates, r, is expressed in percentage points. For example, if r = 5, then r = 5%. Keep

your answer to at least 4 decimal points if necessary.

a) Derive the net foreign investment function in terms of the exogenous variables. (2 points)

b) Find the long-run equilibrium levels of real exchange rate, net exports and price if the world interest

rate is 6%. (5 points)

The economy is initially in its long-run equilibrium as described in part (b). The outbreak of COIVD-19

leads to economic uncertainty; as a result, the world demand for (loanable) funds drops. In addition,

studies show that this change in the world demand for funds will cause the world interest rate to change

by 3 percentage points.

c) Redo part (b). (6 points)

d) With the aid of a set of diagrams for the long-run classical model of a small open economy, explain

in words your findings in parts (b) and (c). (6 points)

e) Suppose the government wants to balance the trade account via a change in government spending;

and at the same time, the central bank wants to achieve price stability (i.e., keeping the price level

fixed at the initial level) via a change in money supply, find the level of government spending and

money supply that will achieve these goals simultaneously. (6 points)