Question: Using an IS-LM-FE diagram as an aid, show the effect on a small open economy of a permanent increase in the full-employment level of output.

Using an IS-LM-FE diagram as an aid, show the effect on a small open economy of a permanent increase in the full-employment level of output. Assume flexible exchange rates and assume that the domestic interest rate does not deviate from the foreign interest rate. Explain what happens to output, the price level, net exports, the nominal exchange rate, and the real exchange rate.

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