Question

Part II: Answer any one question from this part. 20 marks. 2. (a) Consider two countries Markin and Cheeni who trade only with each other Markin is a larger economy with a flexible exchange-rate regime. Cheeni also has flexible exchange rate but is a smaller economy. Markin's Gov. ernment is running a budget deficit and want to reduce that. Suppose Markin's Government does reduce its deficit by some combination of taxes and spending. Suggest what has to happen to taxes and spending in order for the Government to achieve that? Explain using appropriate graphs. (5 marks) (b) What will be the consequence of the above policy implementation that you have suggested on Markin? Use the Mundell-Fleming framework to an- swer this question. Explain using appropriate graphs. (10 marks) (c) Will there be any impact on the economy of Cheeni? Explain using appro- priate graphs. (5 marks)

Answer 1

open economy in which done. Answer have Cheeni both Markin and Export) has been external trade (Import and large economy Markin is a and and having budget deficit for reducing this Markin economy government will do deficit finiencing in internal economy. and govt. impose more tax on good which are ex Produced in home town country and increase the farsiff on Imported goods. By doing this people of Markin's economy now decrease importing goods, and consume household production. This reduce import of goods and increase the domestic sector income. First of all we will discuss Markin's internal economy equillibirum, * There are two economy we are taking Markin's & Markins economy devided in two market u Goods market lig Money Market Goods Market Goods Market is in equillibisum where economy. AD = AS &t I = ¢ts I - S investment and of Interest and AD= AS = Aggregate demand Agregate Supply are function of Here Rate saving saving 2020-3-30 18:45

IS of Interest o Income (2 Here is an equillibirum in goods market, Money Market money Money market equilli bioum happens where demand and money supply is equal. Mg = ma Money supply is determined by government. Money is demanded for three motives w Tranction Hotive me = fcy) (1) Precautionary motine mp = f (y) (1) Speculative motive Ms = f (R) This is represented by LM curve. LM curue shows money market equillibirum. At LIM cusu every point show equillibirum in money demand and Supply, In the diagram evere /LM point on LM show" Demand for money in a function of Incom Rate of Interest & Ms=kCyth(8 x 2020-3-30 18:48

Market Equillibitum in Explanation of diagram In the diagram where at boint les both market are in equillibirum. LM Rate of Interest TIS Income economy for In an oben showing equillibirum model. Mundell Fleming we use Mundell - Fleming models shows an equillibisum in the oben economy with help of IS-LM cusue. and for showing external equillibisum he use Balance of payment cuisue. he use Is=LM = BP curve for showing equillibirum in oben economy, Is curve in open economy. Is curve shows such combination of Income and Rate of Interest where It Gtx = SITIM Here Is show goods market equillibirum in an 3 open economy... LH cuore in ofen economy LH Curve Remain same in open economy Derivation of BP curve Balance of payment shows such combination of 2020-3-30 18:53

and country CH) Income and Rate of Interest where Balance of Payment is Zero. and capital Account t current 0 Account = For convenience we use only. (Export - Impost) an left Transfer payment. & Balance of capital Account in it we count copital outflow by home country and capital Inflow by foreign country.. Here we show Net capital outflow by It is invease to Reute of Interest if rate of Interest et ta cobital mutflow t cabital L (viceurs outflow . Net Export is inverse to Income if Income t then Import (vice-versal » B.P curve and Reach in equillibirum in Floating Exchange Rate. 3 at IS. Interest -----BP - Bli Rate of o Income Explaination: At the initial stage Yol Income) Ro (Rate of Interes- Here internal equillibirum but Bro. It represent Deficit on Balance of payment. By this value of 2020-3-30 18:55 ***

Income and Rate of Interest where Balance of Payment is Zero. capital and Account + current 0 Account = For convenience we use only. (Export-Impost) and left Transfer payment. > Balance of capital Account In it we count capital outflow by home country and capital Inflow by foreign country, Here we show Net capital outflow by outflow by CH) It is invexse to Reute of Interest if rate of Interest ts capital outflow & (uice una Net Export is inverse to Income. if Income e then Import t (vice - veosalt - B.P curve and Reach in equillibirum in Floating Exchange Rate. T IS, Interest & BP Vorotu -- ---LM. Rate of ó Income Explaination: At the initial stage Yo Income) Ro (Rate of Interest more internal equillibisum but Bro. It represent Defict on Balance of payment. By this ve pe of payment. By this value of 2020-3-30 18:57