Question

Use the Mundell Fleming model (draw the appropriate graphs and show on the graphs as well) to predict what would happen to aggregate income, the exchange rate, and the trade balance under both floating and fixed exchange rates in response to each of the following shocks in a small open economy.

a. A fall in consumer confidence about the future induces consumers to spend less and save more. b. The introduction of a stylish line of Toyotas makes some consumers prefer foreign cars over

domestic cars.

c. The introduction of automatic teller machines reduces the demand for money.

Answer 1

Answer:

using the Mundell Fleming model ​​​​​​:

(a)  A fall in consumer confidence about the future induces consumers to spend less and save more then  aggregate income, the exchange rate, and the trade balance under both floating and fixed exchange rates are:

An increase in the savings shift the scheduled to the right, increasing the supply of dollars to be invested , the increase supply of dollars increase the real time exchange to fall,as of dollar become less valuable the domestic goods become less expensive to the foreign market .

so the export rises and import falls,thus  nominal exchange rate falls following the movement of the real exchange rate, because prices do not change in response to this shock

(b) The introduction of a stylish line of Toyotas makes some consumers prefer foreign cars over domestic cars then aggregate income, the exchange rate, and the trade balance under both floating and fixed exchange rates are:

The introduction of a stylish line of Toyotas makes some consumers prefer foreign cars over domestic cars has no effect on saving or investment, but it shifts the NX schedule in ward (imports rise).

The trade balance does not change, but the real exchange rate falls.Because prices are not affected,the nominal exchange rate follows the real exchange rate.

(c) The introduction of automatic teller machines reduces the demand for money then aggregate income, the exchange rate, and the trade balance under both floating and fixed exchange rates are:

The introduction of automatic teller machine reduces the demand for money.Money in the classical sense is nominal and there by effects on real variables.

Y is fixed by factors of productions and I is determined by real interest rate, savings S depends on consumption function, output and taxes none of this changes.

Therefore SI does not change there by NX schedule do not change and real exchange rate also does not change.