Assume That the LM Curve for a Small Open Economy

question 29

Essay

Assume that the LM curve for a small open economy with a floating exchange rate is given by Y = 200r - 200 + 2(M/P), while the IS curve is Y = 400 + 3G - 2T + 3NX - 200r. The function for the net exports is NX = 200 - 100e, where e is the exchange rate. The price level (P) is fixed at 1.0. The international interest rate is r* = 2.5 percent.
a.Using the LM curve, find the equilibrium level of Y in the small open economy, if M = 100. b.Given this value of Y, if G = 100 and T = 100, what must be the equilibrium value of NX? c.If this value of NX is to be achieved, what must be the equilibrium exchange rate, e?

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Definitions:

Demand Increase

A situation where the quantity of a product or service that consumers are willing and able to buy at a given price rises.

Price Elasticity

The sensitivity measure of demand for a good relative to its price changes.

Demand Curve

It illustrates the relationship between the price of a good or service and the quantity demanded for a given period, assuming all other factors are constant (ceteris paribus).

Midpoint Method

A technique used in economics to calculate the elasticity of a variable, which averages the starting and ending values to minimize the bias in the elasticities calculated at different points.