9. Consider an open economy operating with a fixed exchange rate (E0) which is i
ID: 1162518 • Letter: 9
Question
9. Consider an open economy operating with a fixed exchange rate (E0) which is initially in equilibrium at point 1 in the diagram below where DD and AA1 intersect. a) Suppose that the output market of this economy can be described by the following key equations: D- C+I+G+CA C-5+ 0.75(Y-T) 1= 30 G= 45 T-40 CA-15 20E-P*/P 0.25(Y-T) P-P*1.0 E-E-1.25 Given the above information, the initial equilibrium value of domestic output (Y') can be calculated to be balance (CA) equals while the initial equilibrium value of the current account (4 marks) b) Now suppose that this economy suffers an exogenous decrease in exports and thus in its current account balance. Specifically, the value of CA decreases by 5 units at given values of the real exchange rate (E-P*/P) and aggregate disposable income (Y-T. The new current account function is thus: CA = 10 + 20E-P*/P-0.25(Y-T)Explanation / Answer
A)
D=C+I+G+CA
D=5+0.75(Y-T)+30+45+15+20E-P*/P-0.25(Y-T)
D=5+0.75(Y-40)+90+20(1.25/1)-0.25(Y-40)
D=5+0.75Y-30+25-0.25Y+10
D=5-30+25+10+0.50Y
D=10+0.50Y
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