Assume that a large open economy with a floating exchange rate is described in t

Question

Assume that a large open economy with a floating exchange rate is described in the short run by the equations: C 0.50 -T T-1,000 1,500 250r G 1,500 NY 1,000-250e MP- 0.5 -500r M-1,000 CF 500-250r NY CF The last two equations specify that CF, net capital outflow, decreases with r, the interest rate, and that NX, the net exports, is equal to net capital outflow. N is also related to the exchange rate, e, and falls when e appreciates. The price level (P is fixed at 1.0. Calculate short-run equilibrium values of Y, r, C, CF, NX, e, private saving, public saving, and foreign saving. Foreign saving is defined here as minus NX Check your work by ensuring that C+I+ G Yand private saving plus public saving plus foreign saving equals domestic investment. (Hint: As in the appendix to textbook Chapter 13, form the IS curve from C+I+ G NX- Y, and then substitute CF for NX to get C+ I+ G CF Y. Combine with the LM curve and solve for r, and CF and then use NX- CF to get NXand the equation relating AXto e to get e

Explanation / Answer

C=.5(Y-T)

T=1000

I=1500-250r

G=1500

NX=1000-250e

M/P = .5Y-500r

M=1000

CF=500-250r

NX=CF

P=1

IS curve

Y=C+I+G+NX

Putting all the values

Y=.5(Y-1000)+1500-250r+1500+500-250r

Y= .5Y+3000-500r

Y=6000-1000r

LM curve

M/P=.5Y-500r

1000=.5Y-500r

Y=2000+1000r

Equilibrium where IS curve intersect LM curve

2000+1000r=6000-1000r

R=4, Y=2000,

Putting these value on above equations

C=500, I=500, CF=-500, NX=-500, e=5

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