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# ECON202midterm2_s06_answerkey - ECON 202 SPRING 2006 Malhar...

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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 IS-LM model (Mundell-Fleming) 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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Goods 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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ECON202midterm2_s06_answerkey - ECON 202 SPRING 2006 Malhar...

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