The IS-LM curve of the economy.

Question

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Answer 1

Question

Chapter 13, Problem 2PA

(a)

To determine

The IS-LM curve of the economy.

(a)

Expert Solution

Explanation of Solution

The IS-LM curves of the economy can be calculated from the given details. It is given that the value of C=50+0.75(Y−T), I=200−20r, NX=200−50∈, MP=Y−40r, G=200, T=200, M=3,000, P=3 and r*=5. In order to obtain the IS curve of the economy, the goods market equilibrium should be obtained through clearing the goods market of the economy as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+200−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=400−50∈Y=400−50∈0.25=1,600−200∈

Similarly, the LM curve of the economy can be obtained by equating the money market as follows:

MP=L(r*,Y)3,0003=Y−40r*1,000=Y−(40×5)Y=1,000+200=1,200

Economics Concept Introduction

Mundell - Fleming model: The Mundell Fleming model is the extended version of the IS-LM model of the economy that incorporates the BOP into the equilibrium. Thus, it is the model that portrays the short run relationship between the nominal exchange rate of the economy, interest rate and the output.

(b)

To determine

The equilibrium exchange rate, income, and net exports.

(b)

Expert Solution

Explanation of Solution

The equilibrium exchange rate of the economy can be calculated by equating the output (Y) from both the IS curve and the LM curve as follows:

Y(IS)=Y(LM)1,600−200∈=1,200200∈=400∈=400200=2

Thus, the equilibrium exchange rate in the economy is 2. The equilibrium income in the economy can be calculated by substituting the value of net exports in the equation above as follows:

Y(IS)=Y(LM)1,600−(200×2)=1,2001,600−400=1,2001,200=1,200

Thus, the equilibrium income in the economy is equal to 1,200. The net exports in the economy can be calculated by substituting the value of the exchange rate in the net exports as follows:

NX=200−50∈=200−(50×2)=200−100=100

Thus, the net exports in the economy is equal to 100.

(c)

To determine

The IS and LM curves when the government spending increases by 50.

(c)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS curve can be derived as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+250−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=450−50∈Y=450−50∈0.25=1,800−200∈

Since the economy has the floating exchange rate, the LM curve of the economy remains unchanged. As a result, there will be no change in the income and output of the economy. Thus, the income remains at 1,200. Therefore, the new exchange rate can be calculated as follows:

Y(IS)=Y(LM)1,800−200∈=1,200200∈=600∈=600200=3

Thus, the exchange rate is 3. A higher exchange rate decreases the exports as the domestic currency appreciates and becomes costly to the foreign countries. Thus, the increased government spending will be matched by a lower net exports. This can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 1

Thus, the IS curve shifts toward the right graphically, whereas the exchange rate increases.

(d)

To determine

The IS and LM curves when the government spending increases by 50 under fixed exchange rate.

(d)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS equation becomes 1,800−200∈. When the exchange rate is fixed unlike the floating one in above part, the new income can be calculated as follows:

Y(IS)=1,800−200∈1,800−(200×2)1,800−4001,400

Thus, when the exchange rate is fixed at 2, the equilibrium income should increase to 1,400. As a result, the money supply must be increased by the monetary authority to keep the exchange rate fixed at 2. Therefore, M would increase to 3,600 due to the rightward shift in the LM curve and it can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 2

Thus, the IS curve shifts toward the right increases the exchange rate, whereas the increase in the money supply leads to the rightward shift in the LM curve which brings the exchange rate back to the original position with increased output and income.

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Students have asked these similar questions

The following information is provided about an open economy with a government. Use the information to answer the questions that follow: C = 450 + 0.4Y I = 350G = 150X = 70 Z = 35 + 0.1Y T = 0.15YYf = 1550 Calculate the level of autonomous spending in this economy.

Write the Total Spend equivalence in an open and governmental economy. (Variables will be written with their names, not abbreviations)

Exercise 2 Consider a small open economy. Assume that GDP (Y) is 5000. Consumption (C) is given by the equation C = 1000 + 0.25(Y-T). Investment (1) is given by the equation I = 1500 – 50r, where r is the real interest rate in percentage points. The world interest rate is actually 5% (r*-5). Taxes (T) are 1000 and government spending (G) is 1500. Net exports are given by the equation NX=500-250E. 1. Compute the equilibrium real exchange rate. Is the Purchasing Power Parity assumption respected? Suppose that prices in the home currency are ten times smaller than prices in the dominant foreing currency. Which is the nominal exchange rate? 2. Is the government budget in surplus or deficit? For each of the possible policy tools to achieve a balanced budget, compute the equilibrium exchange rate and represent it graphically. Interpret your results. 3. Suppose T and G at their initial values (1000 and 1500). Suppose there is a shift in the global supply of funds, so that the new world…

Answer 2

Question

Chapter 13, Problem 2PA

(a)

To determine

The IS-LM curve of the economy.

(a)

Expert Solution

Explanation of Solution

The IS-LM curves of the economy can be calculated from the given details. It is given that the value of C=50+0.75(Y−T), I=200−20r, NX=200−50∈, MP=Y−40r, G=200, T=200, M=3,000, P=3 and r*=5. In order to obtain the IS curve of the economy, the goods market equilibrium should be obtained through clearing the goods market of the economy as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+200−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=400−50∈Y=400−50∈0.25=1,600−200∈

Similarly, the LM curve of the economy can be obtained by equating the money market as follows:

MP=L(r*,Y)3,0003=Y−40r*1,000=Y−(40×5)Y=1,000+200=1,200

Economics Concept Introduction

Mundell - Fleming model: The Mundell Fleming model is the extended version of the IS-LM model of the economy that incorporates the BOP into the equilibrium. Thus, it is the model that portrays the short run relationship between the nominal exchange rate of the economy, interest rate and the output.

(b)

To determine

The equilibrium exchange rate, income, and net exports.

(b)

Expert Solution

Explanation of Solution

The equilibrium exchange rate of the economy can be calculated by equating the output (Y) from both the IS curve and the LM curve as follows:

Y(IS)=Y(LM)1,600−200∈=1,200200∈=400∈=400200=2

Thus, the equilibrium exchange rate in the economy is 2. The equilibrium income in the economy can be calculated by substituting the value of net exports in the equation above as follows:

Y(IS)=Y(LM)1,600−(200×2)=1,2001,600−400=1,2001,200=1,200

Thus, the equilibrium income in the economy is equal to 1,200. The net exports in the economy can be calculated by substituting the value of the exchange rate in the net exports as follows:

NX=200−50∈=200−(50×2)=200−100=100

Thus, the net exports in the economy is equal to 100.

(c)

To determine

The IS and LM curves when the government spending increases by 50.

(c)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS curve can be derived as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+250−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=450−50∈Y=450−50∈0.25=1,800−200∈

Since the economy has the floating exchange rate, the LM curve of the economy remains unchanged. As a result, there will be no change in the income and output of the economy. Thus, the income remains at 1,200. Therefore, the new exchange rate can be calculated as follows:

Y(IS)=Y(LM)1,800−200∈=1,200200∈=600∈=600200=3

Thus, the exchange rate is 3. A higher exchange rate decreases the exports as the domestic currency appreciates and becomes costly to the foreign countries. Thus, the increased government spending will be matched by a lower net exports. This can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 1

Thus, the IS curve shifts toward the right graphically, whereas the exchange rate increases.

(d)

To determine

The IS and LM curves when the government spending increases by 50 under fixed exchange rate.

(d)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS equation becomes 1,800−200∈. When the exchange rate is fixed unlike the floating one in above part, the new income can be calculated as follows:

Y(IS)=1,800−200∈1,800−(200×2)1,800−4001,400

Thus, when the exchange rate is fixed at 2, the equilibrium income should increase to 1,400. As a result, the money supply must be increased by the monetary authority to keep the exchange rate fixed at 2. Therefore, M would increase to 3,600 due to the rightward shift in the LM curve and it can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 2

Thus, the IS curve shifts toward the right increases the exchange rate, whereas the increase in the money supply leads to the rightward shift in the LM curve which brings the exchange rate back to the original position with increased output and income.

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Answer 3

Question

Chapter 13, Problem 2PA

(a)

To determine

The IS-LM curve of the economy.

(a)

Expert Solution

Explanation of Solution

The IS-LM curves of the economy can be calculated from the given details. It is given that the value of C=50+0.75(Y−T), I=200−20r, NX=200−50∈, MP=Y−40r, G=200, T=200, M=3,000, P=3 and r*=5. In order to obtain the IS curve of the economy, the goods market equilibrium should be obtained through clearing the goods market of the economy as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+200−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=400−50∈Y=400−50∈0.25=1,600−200∈

Similarly, the LM curve of the economy can be obtained by equating the money market as follows:

MP=L(r*,Y)3,0003=Y−40r*1,000=Y−(40×5)Y=1,000+200=1,200

Economics Concept Introduction

Mundell - Fleming model: The Mundell Fleming model is the extended version of the IS-LM model of the economy that incorporates the BOP into the equilibrium. Thus, it is the model that portrays the short run relationship between the nominal exchange rate of the economy, interest rate and the output.

(b)

To determine

The equilibrium exchange rate, income, and net exports.

(b)

Expert Solution

Explanation of Solution

The equilibrium exchange rate of the economy can be calculated by equating the output (Y) from both the IS curve and the LM curve as follows:

Y(IS)=Y(LM)1,600−200∈=1,200200∈=400∈=400200=2

Thus, the equilibrium exchange rate in the economy is 2. The equilibrium income in the economy can be calculated by substituting the value of net exports in the equation above as follows:

Y(IS)=Y(LM)1,600−(200×2)=1,2001,600−400=1,2001,200=1,200

Thus, the equilibrium income in the economy is equal to 1,200. The net exports in the economy can be calculated by substituting the value of the exchange rate in the net exports as follows:

NX=200−50∈=200−(50×2)=200−100=100

Thus, the net exports in the economy is equal to 100.

(c)

To determine

The IS and LM curves when the government spending increases by 50.

(c)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS curve can be derived as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+250−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=450−50∈Y=450−50∈0.25=1,800−200∈

Since the economy has the floating exchange rate, the LM curve of the economy remains unchanged. As a result, there will be no change in the income and output of the economy. Thus, the income remains at 1,200. Therefore, the new exchange rate can be calculated as follows:

Y(IS)=Y(LM)1,800−200∈=1,200200∈=600∈=600200=3

Thus, the exchange rate is 3. A higher exchange rate decreases the exports as the domestic currency appreciates and becomes costly to the foreign countries. Thus, the increased government spending will be matched by a lower net exports. This can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 1

Thus, the IS curve shifts toward the right graphically, whereas the exchange rate increases.

(d)

To determine

The IS and LM curves when the government spending increases by 50 under fixed exchange rate.

(d)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS equation becomes 1,800−200∈. When the exchange rate is fixed unlike the floating one in above part, the new income can be calculated as follows:

Y(IS)=1,800−200∈1,800−(200×2)1,800−4001,400

Thus, when the exchange rate is fixed at 2, the equilibrium income should increase to 1,400. As a result, the money supply must be increased by the monetary authority to keep the exchange rate fixed at 2. Therefore, M would increase to 3,600 due to the rightward shift in the LM curve and it can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 2

Thus, the IS curve shifts toward the right increases the exchange rate, whereas the increase in the money supply leads to the rightward shift in the LM curve which brings the exchange rate back to the original position with increased output and income.

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Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 4

Question

Chapter 13, Problem 2PA

(a)

To determine

The IS-LM curve of the economy.

(a)

Expert Solution

Explanation of Solution

The IS-LM curves of the economy can be calculated from the given details. It is given that the value of C=50+0.75(Y−T), I=200−20r, NX=200−50∈, MP=Y−40r, G=200, T=200, M=3,000, P=3 and r*=5. In order to obtain the IS curve of the economy, the goods market equilibrium should be obtained through clearing the goods market of the economy as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+200−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=400−50∈Y=400−50∈0.25=1,600−200∈

Similarly, the LM curve of the economy can be obtained by equating the money market as follows:

MP=L(r*,Y)3,0003=Y−40r*1,000=Y−(40×5)Y=1,000+200=1,200

Economics Concept Introduction

Mundell - Fleming model: The Mundell Fleming model is the extended version of the IS-LM model of the economy that incorporates the BOP into the equilibrium. Thus, it is the model that portrays the short run relationship between the nominal exchange rate of the economy, interest rate and the output.

(b)

To determine

The equilibrium exchange rate, income, and net exports.

(b)

Expert Solution

Explanation of Solution

The equilibrium exchange rate of the economy can be calculated by equating the output (Y) from both the IS curve and the LM curve as follows:

Y(IS)=Y(LM)1,600−200∈=1,200200∈=400∈=400200=2

Thus, the equilibrium exchange rate in the economy is 2. The equilibrium income in the economy can be calculated by substituting the value of net exports in the equation above as follows:

Y(IS)=Y(LM)1,600−(200×2)=1,2001,600−400=1,2001,200=1,200

Thus, the equilibrium income in the economy is equal to 1,200. The net exports in the economy can be calculated by substituting the value of the exchange rate in the net exports as follows:

NX=200−50∈=200−(50×2)=200−100=100

Thus, the net exports in the economy is equal to 100.

(c)

To determine

The IS and LM curves when the government spending increases by 50.

(c)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS curve can be derived as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+250−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=450−50∈Y=450−50∈0.25=1,800−200∈

Since the economy has the floating exchange rate, the LM curve of the economy remains unchanged. As a result, there will be no change in the income and output of the economy. Thus, the income remains at 1,200. Therefore, the new exchange rate can be calculated as follows:

Y(IS)=Y(LM)1,800−200∈=1,200200∈=600∈=600200=3

Thus, the exchange rate is 3. A higher exchange rate decreases the exports as the domestic currency appreciates and becomes costly to the foreign countries. Thus, the increased government spending will be matched by a lower net exports. This can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 1

Thus, the IS curve shifts toward the right graphically, whereas the exchange rate increases.

(d)

To determine

The IS and LM curves when the government spending increases by 50 under fixed exchange rate.

(d)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS equation becomes 1,800−200∈. When the exchange rate is fixed unlike the floating one in above part, the new income can be calculated as follows:

Y(IS)=1,800−200∈1,800−(200×2)1,800−4001,400

Thus, when the exchange rate is fixed at 2, the equilibrium income should increase to 1,400. As a result, the money supply must be increased by the monetary authority to keep the exchange rate fixed at 2. Therefore, M would increase to 3,600 due to the rightward shift in the LM curve and it can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 2

Thus, the IS curve shifts toward the right increases the exchange rate, whereas the increase in the money supply leads to the rightward shift in the LM curve which brings the exchange rate back to the original position with increased output and income.

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Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 5

Chapter 13, Problem 2PA

(a)

To determine

The IS-LM curve of the economy.

(a)

Expert Solution

Explanation of Solution

The IS-LM curves of the economy can be calculated from the given details. It is given that the value of C=50+0.75(Y−T), I=200−20r, NX=200−50∈, MP=Y−40r, G=200, T=200, M=3,000, P=3 and r*=5. In order to obtain the IS curve of the economy, the goods market equilibrium should be obtained through clearing the goods market of the economy as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+200−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=400−50∈Y=400−50∈0.25=1,600−200∈

Similarly, the LM curve of the economy can be obtained by equating the money market as follows:

MP=L(r*,Y)3,0003=Y−40r*1,000=Y−(40×5)Y=1,000+200=1,200

Economics Concept Introduction

Mundell - Fleming model: The Mundell Fleming model is the extended version of the IS-LM model of the economy that incorporates the BOP into the equilibrium. Thus, it is the model that portrays the short run relationship between the nominal exchange rate of the economy, interest rate and the output.

(b)

To determine

The equilibrium exchange rate, income, and net exports.

(b)

Expert Solution

Explanation of Solution

The equilibrium exchange rate of the economy can be calculated by equating the output (Y) from both the IS curve and the LM curve as follows:

Y(IS)=Y(LM)1,600−200∈=1,200200∈=400∈=400200=2

Thus, the equilibrium exchange rate in the economy is 2. The equilibrium income in the economy can be calculated by substituting the value of net exports in the equation above as follows:

Y(IS)=Y(LM)1,600−(200×2)=1,2001,600−400=1,2001,200=1,200

Thus, the equilibrium income in the economy is equal to 1,200. The net exports in the economy can be calculated by substituting the value of the exchange rate in the net exports as follows:

NX=200−50∈=200−(50×2)=200−100=100

Thus, the net exports in the economy is equal to 100.

(c)

To determine

The IS and LM curves when the government spending increases by 50.

(c)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS curve can be derived as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+250−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=450−50∈Y=450−50∈0.25=1,800−200∈

Since the economy has the floating exchange rate, the LM curve of the economy remains unchanged. As a result, there will be no change in the income and output of the economy. Thus, the income remains at 1,200. Therefore, the new exchange rate can be calculated as follows:

Y(IS)=Y(LM)1,800−200∈=1,200200∈=600∈=600200=3

Thus, the exchange rate is 3. A higher exchange rate decreases the exports as the domestic currency appreciates and becomes costly to the foreign countries. Thus, the increased government spending will be matched by a lower net exports. This can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 1

Thus, the IS curve shifts toward the right graphically, whereas the exchange rate increases.

(d)

To determine

The IS and LM curves when the government spending increases by 50 under fixed exchange rate.

(d)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS equation becomes 1,800−200∈. When the exchange rate is fixed unlike the floating one in above part, the new income can be calculated as follows:

Y(IS)=1,800−200∈1,800−(200×2)1,800−4001,400

Thus, when the exchange rate is fixed at 2, the equilibrium income should increase to 1,400. As a result, the money supply must be increased by the monetary authority to keep the exchange rate fixed at 2. Therefore, M would increase to 3,600 due to the rightward shift in the LM curve and it can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 2

Thus, the IS curve shifts toward the right increases the exchange rate, whereas the increase in the money supply leads to the rightward shift in the LM curve which brings the exchange rate back to the original position with increased output and income.

Answer 6

Chapter 13, Problem 2PA

(a)

To determine

The IS-LM curve of the economy.

(a)

Expert Solution

Explanation of Solution

The IS-LM curves of the economy can be calculated from the given details. It is given that the value of C=50+0.75(Y−T), I=200−20r, NX=200−50∈, MP=Y−40r, G=200, T=200, M=3,000, P=3 and r*=5. In order to obtain the IS curve of the economy, the goods market equilibrium should be obtained through clearing the goods market of the economy as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+200−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=400−50∈Y=400−50∈0.25=1,600−200∈

Similarly, the LM curve of the economy can be obtained by equating the money market as follows:

MP=L(r*,Y)3,0003=Y−40r*1,000=Y−(40×5)Y=1,000+200=1,200

Economics Concept Introduction

Mundell - Fleming model: The Mundell Fleming model is the extended version of the IS-LM model of the economy that incorporates the BOP into the equilibrium. Thus, it is the model that portrays the short run relationship between the nominal exchange rate of the economy, interest rate and the output.

Answer 7

Chapter 13, Problem 2PA

(a)

To determine

The IS-LM curve of the economy.

Answer 8

(a)

Expert Solution

Explanation of Solution

The IS-LM curves of the economy can be calculated from the given details. It is given that the value of C=50+0.75(Y−T), I=200−20r, NX=200−50∈, MP=Y−40r, G=200, T=200, M=3,000, P=3 and r*=5. In order to obtain the IS curve of the economy, the goods market equilibrium should be obtained through clearing the goods market of the economy as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+200−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=400−50∈Y=400−50∈0.25=1,600−200∈

Similarly, the LM curve of the economy can be obtained by equating the money market as follows:

MP=L(r*,Y)3,0003=Y−40r*1,000=Y−(40×5)Y=1,000+200=1,200

Answer 9

(a)

Expert Solution

Answer 10

(a)

Expert Solution

Answer 11

Expert Solution

Answer 12

Economics Concept Introduction

Mundell - Fleming model: The Mundell Fleming model is the extended version of the IS-LM model of the economy that incorporates the BOP into the equilibrium. Thus, it is the model that portrays the short run relationship between the nominal exchange rate of the economy, interest rate and the output.

Answer 13

(b)

To determine

The equilibrium exchange rate, income, and net exports.

(b)

Expert Solution

Explanation of Solution

The equilibrium exchange rate of the economy can be calculated by equating the output (Y) from both the IS curve and the LM curve as follows:

Y(IS)=Y(LM)1,600−200∈=1,200200∈=400∈=400200=2

Thus, the equilibrium exchange rate in the economy is 2. The equilibrium income in the economy can be calculated by substituting the value of net exports in the equation above as follows:

Y(IS)=Y(LM)1,600−(200×2)=1,2001,600−400=1,2001,200=1,200

Thus, the equilibrium income in the economy is equal to 1,200. The net exports in the economy can be calculated by substituting the value of the exchange rate in the net exports as follows:

NX=200−50∈=200−(50×2)=200−100=100

Thus, the net exports in the economy is equal to 100.

Answer 14

(b)

To determine

The equilibrium exchange rate, income, and net exports.

Answer 15

(b)

Expert Solution

Explanation of Solution

The equilibrium exchange rate of the economy can be calculated by equating the output (Y) from both the IS curve and the LM curve as follows:

Y(IS)=Y(LM)1,600−200∈=1,200200∈=400∈=400200=2

Thus, the equilibrium exchange rate in the economy is 2. The equilibrium income in the economy can be calculated by substituting the value of net exports in the equation above as follows:

Y(IS)=Y(LM)1,600−(200×2)=1,2001,600−400=1,2001,200=1,200

Thus, the equilibrium income in the economy is equal to 1,200. The net exports in the economy can be calculated by substituting the value of the exchange rate in the net exports as follows:

NX=200−50∈=200−(50×2)=200−100=100

Thus, the net exports in the economy is equal to 100.

Answer 16

(b)

Expert Solution

Answer 17

(b)

Expert Solution

Answer 18

Expert Solution

Answer 19

(c)

To determine

The IS and LM curves when the government spending increases by 50.

(c)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS curve can be derived as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+250−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=450−50∈Y=450−50∈0.25=1,800−200∈

Since the economy has the floating exchange rate, the LM curve of the economy remains unchanged. As a result, there will be no change in the income and output of the economy. Thus, the income remains at 1,200. Therefore, the new exchange rate can be calculated as follows:

Y(IS)=Y(LM)1,800−200∈=1,200200∈=600∈=600200=3

Thus, the exchange rate is 3. A higher exchange rate decreases the exports as the domestic currency appreciates and becomes costly to the foreign countries. Thus, the increased government spending will be matched by a lower net exports. This can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 1

Thus, the IS curve shifts toward the right graphically, whereas the exchange rate increases.

Answer 20

(c)

To determine

The IS and LM curves when the government spending increases by 50.

Answer 21

(c)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS curve can be derived as follows:

Y=C(Y−T)+I(r*)+G+NX(∈)=50+0.75(Y−T)+250−20r+200+200−50∈=50+0.75Y−(0.75×200)+200−(20×5)+200+200−50∈Y−0.75Y=50+150+200−100+200+200−50∈0.25Y=450−50∈Y=450−50∈0.25=1,800−200∈

Since the economy has the floating exchange rate, the LM curve of the economy remains unchanged. As a result, there will be no change in the income and output of the economy. Thus, the income remains at 1,200. Therefore, the new exchange rate can be calculated as follows:

Y(IS)=Y(LM)1,800−200∈=1,200200∈=600∈=600200=3

Thus, the exchange rate is 3. A higher exchange rate decreases the exports as the domestic currency appreciates and becomes costly to the foreign countries. Thus, the increased government spending will be matched by a lower net exports. This can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 1

Thus, the IS curve shifts toward the right graphically, whereas the exchange rate increases.

Answer 22

(c)

Expert Solution

Answer 23

(c)

Expert Solution

Answer 24

Expert Solution

Answer 25

(d)

To determine

The IS and LM curves when the government spending increases by 50 under fixed exchange rate.

(d)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS equation becomes 1,800−200∈. When the exchange rate is fixed unlike the floating one in above part, the new income can be calculated as follows:

Y(IS)=1,800−200∈1,800−(200×2)1,800−4001,400

Thus, when the exchange rate is fixed at 2, the equilibrium income should increase to 1,400. As a result, the money supply must be increased by the monetary authority to keep the exchange rate fixed at 2. Therefore, M would increase to 3,600 due to the rightward shift in the LM curve and it can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 2

Thus, the IS curve shifts toward the right increases the exchange rate, whereas the increase in the money supply leads to the rightward shift in the LM curve which brings the exchange rate back to the original position with increased output and income.

Answer 26

(d)

To determine

The IS and LM curves when the government spending increases by 50 under fixed exchange rate.

Answer 27

(d)

Expert Solution

Explanation of Solution

When there is an increase in the government spending by 50, the new IS equation becomes 1,800−200∈. When the exchange rate is fixed unlike the floating one in above part, the new income can be calculated as follows:

Y(IS)=1,800−200∈1,800−(200×2)1,800−4001,400

Thus, when the exchange rate is fixed at 2, the equilibrium income should increase to 1,400. As a result, the money supply must be increased by the monetary authority to keep the exchange rate fixed at 2. Therefore, M would increase to 3,600 due to the rightward shift in the LM curve and it can be illustrated as follows:

Macroeconomics, Chapter 13, Problem 2PA , additional homework tip 2

Thus, the IS curve shifts toward the right increases the exchange rate, whereas the increase in the money supply leads to the rightward shift in the LM curve which brings the exchange rate back to the original position with increased output and income.