Question: 4. Consider a small open economy with a fixed exchange rate. The following four equations describe the economy: = C(Y,T) +I (,Y) +G+ NX (Y,Y*,

4. Consider a small open economy with a fixed exchange rate.

4. Consider a small open economy with a fixed exchange rate. The following four equations describe the economy: = C(Y,T) +I (,Y) +G+ NX (Y,Y*, ) (Goods market), MS P YL) [Money market), p* E E (Uncovered interest parity) and P = P (1+ m)F(1 - 2) Aggregate supply]. Initially, the economy is in a medium-run equilibirum. Then, the gov- ernment engages in an expansionary fiscal policy and increases its ex- penditure from Gj to G2. (a) Use the IS-LM, AD-AS and IPC diagrams to show the short-run effects of this policy. (6 points) (b) Use the same IS-LM, AD-AS and IPC diagrams that you have drawn for part (a) and show the medium-run effects of this pol- icy. Assume adaptive price expectations: P = P-1. (6 points) In all three diagrams, label the initial equilibrium points as e1, the short run equilibrium points after the increase in G as e, and the new medium run equilibrium points as 3. 4. Consider a small open economy with a fixed exchange rate. The following four equations describe the economy: = C(Y,T) +I (,Y) +G+ NX (Y,Y*, ) (Goods market), MS P YL) [Money market), p* E E (Uncovered interest parity) and P = P (1+ m)F(1 - 2) Aggregate supply]. Initially, the economy is in a medium-run equilibirum. Then, the gov- ernment engages in an expansionary fiscal policy and increases its ex- penditure from Gj to G2. (a) Use the IS-LM, AD-AS and IPC diagrams to show the short-run effects of this policy. (6 points) (b) Use the same IS-LM, AD-AS and IPC diagrams that you have drawn for part (a) and show the medium-run effects of this pol- icy. Assume adaptive price expectations: P = P-1. (6 points) In all three diagrams, label the initial equilibrium points as e1, the short run equilibrium points after the increase in G as e, and the new medium run equilibrium points as 3

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