1. This question uses a numerical example to understand the connections between the goods,

money, and foreign exchange (FX) markets. Use the information below to answer the following

questions.

Goods Market

C

= 300 + 0

.

8(

Y

T

)

, T

= 400

(Consumption)

I

= 400

2

,

000

i,

e

= 0

(Investment)

G

= 500

(Government Spending)

TB

= 400(1

2

E

)

0

.

2(

Y

100)

(Trade Balance)

Money Market

M

= 1050

(Money supply)

MD

= 0

.

5

Y

5

,

000

i

(Money demand)

P

= 2

(Price)

FX Market

i

= 0

.

08

(Foreign interest rate)

E

e

= 2

(Expected Exchange rate)

A. Write out an expression for the IS and LM curves, and UIP conditions.

B. Find the equilibrium (home) interest rate, i, and the equilibrium (home) output, Y. Calcu-

late consumption, investment, trade balance, and the exchange rate at the economy's equilib-

rium.

C. Suppose the government wants to achieve a balanced budget (G=T) through adjusting

taxes. What level of taxes would balance the budget? Repeat (B) using this new level of taxes.

D. Now, suppose that monetary policy is implemented to stabilize output. Find the new level

of the money supply that will allow the economy to maintain the same level of output (output

before tax policy) with increased taxes. Calculate the new values for

Y,i,E,C,I,

and

TB.

.

Hint: Tax is the level in C, but output is the level in B