Question

6. An open economy is described by the following equations C = 1000 + 0.6(Y-T) I 20, 000 200r G 5000 T = 5000 MD MS = 60.000 CA = NX = 2000-0.1Y-1000e KA = 5500+ 2(r-r") r"--10 (a) Derive the IS curve (Y as a function of r and e), LM curve (Y as a function of r) and the BP curve (r as a function of Y, e, and the capital mobility parameter z) interest rate, income, exchange rate and trade balance income, and trade balance? Draw the change on a graph. (b) Assuming free capital mobility (z → oo) and a flexible exchange rate, solve for the equilibrium (c) If government spending increases by 1800, what happens to the interest rate, exchange rate,

Answer the question (c)

Answer 1

a) For the derivation of IS curve , Y = C+I+G+NX

or, Y=1000+0.6(Y-5000)+20,000-200r+5000+2000-0.1Y-1000 $\varepsilon$

or, Y=1000-3000+20,000+5000+2000+0.6Y-0.1Y-200r-1000 $\varepsilon$

or, 200r = 25,000 - 0.5Y - 1000 $\varepsilon$

or, r = 125 - 0.0025Y - 5 $\varepsilon$

For the derivation of LM curve, Money demand = Money supply

or, 2Y-800r=60,000

or, 800r = 2Y-60,000

or, r = 0.0025Y - 75

For derivation of BP curve, NX+CF=0

or, 2000-0.1Y-1000 $\varepsilon$ +5500+z(r-10) = 0

or, 7500-0.1Y-1000 $\varepsilon$ +zr-10z = 0

or, r = 1/z(0.1Y+1000 $\varepsilon$ +10z-7500)