Question

Consider the following economy (with flexible exchange rate system): • Desired consumption: Cd = 300 + 0.5Y −2000r • Desired investment: Id = 200−3000r • Government purchases: G = 100 • Net export: NX = 350−0.1Y −0.5e • Real exchange rate: e = 20 + 1000r • Full employment: ¯ Y = 900. • Nominal money stock: M = 4354 • Real money demand: L = 0.5Y −200r
(f) Using the IS-LM-FE model, evaluate the effects of a rise in full employment output to ¯ Y = 940 (12 points) • Short run effects on on real interest rate, exchange rate, net export, real money demand (6 points) • Long-run effects on of the above and the price level. (6 points) • Note that you have to who the effects by calculating the values of the respective variables

(g) Show the short-run and long-run effects of a rise government expenditure to 120 (8 points)

(h) Show the short-run and long-run effects of a rise in money supply to 6531. (8 points)

Answer 1

in short run

y = c+ i + g+ nx

Y =  300 + 0.5Y −2000r + 200−3000r + 100 + 350−0.1Y −0.5e

= 300 + 0.5Y −2000r + 200−3000r + 100 + 350−0.1Y −0.5(20 + 1000r)

Y = 940 +0.4Y -5500r

0.6Y = 940 -5500r...1

also md = ms

4354 / p = 0.5Y −200r..2

in short run , prices are constant so let p = 1

0.6Y = 940 -5500r

Y =( 940 - 5500r )/0.6

4354 = 0.5Y −200r

4354 = 0.5 ( (940 - 5500r )/0.6 - 200r

2612 = 470 - 2750r - 120r

2142 = 2870r

r = 0.74

y = 5217

e = 20 +100(0.74) = 94

nx = 350−0.1Y −0.5e = -219

In long run

Y = 940

0.6Y = 940 -5500r.

0.6*940 = 940 - 5500r

5500r = 376

r = 0.06

e = 20 +100(0.06 )= 26

nx = 350−0.1*940 −0.5*26 = 256

4354 / p = 0.5Y −200r.

4354/ p = 0.5*940 - 200*0.06

4354/p = 458

p = 9.5

clearly prices rose , int rate fall , output fall from short run to long run. and nx is poisitive in long run.

g)Y =( 960 - 5500r )/0.6

4354 = 0.5Y −200r

r = 1.34

Y = 10,683

long run

0.6Y = 960 -5500r.

0.6*940 = 960 - 5500r

r = 0.07

R has risen and so output.

h)S.R

6531 = 0.5Y −200r

Y =( 940 - 5500r )/0.6

6531 = 0.5( 940 - 5500r )/0.6 - 200r

3919 =470 - 2750r - 120r

3449 = 2870r

r = 1.20

Y = 9434

L.R

6531 = 0.5*940 −200r

6061 = -200r

r = 30.3