Suppose the economy is given by the following:

Consumption function: C= 26 + 0.6(Yd)

Investment function: I= 23-50r

Government spending: G = 10

Tax collections: T = 10

Exports schedule: X= 6-

Imports schedule: (IM) = 2 + 3

Money supply: M = 492

Nominal Money demand L(Y)= 5Y-50r

Price level=1

Labor supply=50

Production function=2N

IS curve: Y = 142.5 - 125r - 10

LM curve: r = 0.1Y - 9.84

AD curve: Y = 1372.5 - 12.5Y - 10

e) Plot the IS and the LM equations in terms of

f) Find the equilibrium output and interest rate for this economy assuming a free floating exchange rate regime and a world interest rate r* of 0.16.

g) Suppose the government decides to increase G to 12. Compute the new short-run equilibriu m levels of output, and exchange rates.

h) Graph and explain the adjustment of the economy to this shock

i) Suppose now that the Fed decides to decrease M to 400 (assume G is 10). Compute the new equilibrium levels of output, and exchange rates.

j) Graph and explain the adjustment of the economy to this money supply shock in the longer run once prices and wages start adjusting.

k) Suppose now that the country follows a fixed exchange rate regime. Explain what this means and why some countries may want to follow such a regime.

l) Calculate now the effects of the fiscal shock mentioned in (g). What is the reaction of the Fed to this shock? Graph your results

m) Calculate the effects of the monetary shock mentioned in (i). Graph your results.

n) Based on your results, explain the differences in the effectiveness of economic policies in each of the two exchange rate regimes.