ECON 202, SPRING 2006
Malhar Nabar
April 14, 2006
MID TERM II: ANSWER KEY
Instructions.
The maximum score is 100. Please answer all THREE questions. Show all your
work. Simply writing down an answer (even if it happens to be the correct one) without adequate
demonstration of how you arrived at your answer will not get you full credit. You may use a
1. (
)
Open economy ISLM model (MundellFleming)
A small open economy with ±oating exchange rates is described by the following equations:
Interest rate:
r
=
r
= 0
:
05
(where
r
is the world interest rate)
Consumption:
C
= 100 + 0
:
8(
Y
T
)
6000
r
Investment:
I
= 150
1000
r
Net Exports:
NX
= 1000
&
0
:
5
Y
250
(where
is the real exchange rate)
Government expenditure:
G
= 250
Tax revenue:
T
= 250
Demand for Real Money Balances:
L
(
r;Y
) = 0
:
5
Y
2000
r
Supply of Real Money Balances:
M
P
= 400
Potential output:
Y
= 1200
(i.e. the output level associated with the natural rate of unemploy
ment)
a. (Five points)
Why would consumption be negatively related to the interest rate?
on credit. This will reduce consumption expenditure. It is also possible that when the interest rate
goes up, some consumers±preferences may be such that they are induced to save to take advantage
of the higher interest rate.
Suppose that the goods and money market are in equilibrium. Calculate
the values of the following FIVE variables: output, the real exchange rate, net exports,
investment and consumption.
Money Market equilibrium:
M
P
=
L
(
r;Y
)
400
=
0
:
5
Y
2000
r
= 0
:
5
Y
2000(0
:
05)
)
Y
= 1000
1
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View Full DocumentGoods market equilibrium:
Y
=
C
+
I
+
G
+
NX
= [100 + 0
:
8(
Y
T
)
6000
r
]
+ [150
1000
r
] + 250
+ [1000
&
0
:
5
Y
250
]
Substitute for
r; T
and simplify to get
0
:
7
Y
= 950
250
Substitute for
Y
and simplify to get
= 1
Substitute for
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 Spring '08
 Nabar
 Macroeconomics, Inflation, Phillips Curve, Small open economy, in‡ ation

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