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Category > Management Posted 22 Feb 2018 My Price 9.00

open economy

7.  Multipliers, openness, and fiscal policy

Consider an open economy characterized by the equations below.

C = c0 + c11Y - T 2 I = d0  + d1Y

IM  = m1Y

X = x1Y *

The parameters m1 and x1 are the propensities to import and export. Assume that the real exchange rate is fixed at a value of 1 and treat foreign income, Y *, as fixed. Also assume that taxes are fixed and that government purchases are exog- enous (i.e., decided by the government). We explore the effec- tiveness of changes in G under alternative assumptions about the propensity to import.

a.    Write the equilibrium condition in the market for domes- tic goods and solve for Y.

b.   Suppose government purchases increaseby one unit. What is the effect on output? (Assume that 0 6 m1  6  c1  + d1 6 1. Explain why.)

c.    How do net exports change when government purchases increase by one unit?

Now consider two economies, one with m1 = 0.5 and the other with m1 = 0.1.  Each  economy  is  characterized  by 1c1  + d12  = 0.6.

d.    Suppose one of the economies is much larger than the other. Which economy do you expect to have the larger value of m1? Explain.

e.    Calculate your answers to parts (b) and (c) for each econ- omy by substituting the appropriate parameter values.

f.   In which economy will fiscal policy have a larger effect on output? In which economy will fiscal policy have a larger effect on net exports?

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Maurice Tutor
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Status NEW Posted 22 Feb 2018 09:02 PM My Price 9.00

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