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homework4summer2006 - Economics 302 4 Week Summer Session...

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Economics 302 4 Week Summer Session 2006 Homework #4 Due Monday, June 19, 2006 6/13/06 Homework will be graded for content as well as neatness. Sloppy or illegible work will not receive full credit. 1. Use the Mundell-Fleming Model of a small open economy under a floating exchange rate regime to answer this question. Suppose the initial equilibrium for this economy in shown in the graph below: a. (1 point) Suppose there is an increase in taxes in this economy. Redraw the above graph showing the effects of this policy change on the IS* curve, the LM* curve, the level of output and the exchange rate. b. (1 point) Given your answer in part (a), what happens to the trade balance? Explain your answer. c. Suppose instead of a change in fiscal policy the central bank of this economy increases the money supply. i. (1 point) What is the effect of this change in the money supply on real balances? ii. (1 point) What is the effect of this change in the money supply on the LM* curve, the exchange rate, and the level of aggregate output?
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