Consider an economy which is characterized by the following: Consumption: C 2000+0.75 (Y-T) T=0.2Y Tax Investment...

   

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Consider an economy which is characterized by the following: Consumption: C 2000+0.75 (Y-T) T=0.2Y Tax Investment Government Spending Net Exports Real Money Supply Real Money Demand I=1000-40r G = 800 NX-0 M/P-4000 M/P=0.4Y-40 r +1000 a) Derive the IS curve. b) Derive the LM curve. c) Compute the equilibrium levels of interest rate and the income. d) Assume that the "increase in expected future prices" causes the demand for money increase by 500. Calculate the new equilibrium, and show the impact on a new diagram. e) Suppose that the equilibrium, computed in part c, is the natural (potential) level of GDP. What type of fiscal policy the government can use to restore the GDP back to its potential level, and by how much? Note: Ignore tax policies. f) Suppose the government and the central bank take no action to return the economy back to its potential GDP. Explain what kind of changes will take place in the long-run. g) Assume that this economy experiences frequent "expected future prices" shocks, as described in part d. Also assume that the central bank of this economy has two options on its monetary policy: (A) fixing the money supply or (B) fixing the interest-rate. Which option is better, A or B, if the central bank's main concern is to stabilize the output? Explain by using diagrams. Question Show with graph, if government purchases increase in a small open economy, such as during a war; a) What will happen to the trade balance, net capital inflow and the real exchange rate? b) Does your answer depend on whether this is a local war or a world war? c) how the change in real exchange rate can affect the relative prices of domestic goods to foreign goods? Consider an economy which is characterized by the following: Consumption: C 2000+0.75 (Y-T) T=0.2Y Tax Investment Government Spending Net Exports Real Money Supply Real Money Demand I=1000-40r G = 800 NX-0 M/P-4000 M/P=0.4Y-40 r +1000 a) Derive the IS curve. b) Derive the LM curve. c) Compute the equilibrium levels of interest rate and the income. d) Assume that the "increase in expected future prices" causes the demand for money increase by 500. Calculate the new equilibrium, and show the impact on a new diagram. e) Suppose that the equilibrium, computed in part c, is the natural (potential) level of GDP. What type of fiscal policy the government can use to restore the GDP back to its potential level, and by how much? Note: Ignore tax policies. f) Suppose the government and the central bank take no action to return the economy back to its potential GDP. Explain what kind of changes will take place in the long-run. g) Assume that this economy experiences frequent "expected future prices" shocks, as described in part d. Also assume that the central bank of this economy has two options on its monetary policy: (A) fixing the money supply or (B) fixing the interest-rate. Which option is better, A or B, if the central bank's main concern is to stabilize the output? Explain by using diagrams. Question Show with graph, if government purchases increase in a small open economy, such as during a war; a) What will happen to the trade balance, net capital inflow and the real exchange rate? b) Does your answer depend on whether this is a local war or a world war? c) how the change in real exchange rate can affect the relative prices of domestic goods to foreign goods?

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Here are the steps to solve this problem a To derive the IS curve set Investment Savings 1 1000 40Y ... View the full answer