Economics

1. Two countries, North and South, have identical closed economies. In the short run both can be described by the IS-LM model. The fiscal authorities of North and South both in" rel="nofollow">increase taxes by identical amount. The Central Bank of North follows a policy of holdin" rel="nofollow">ing a constant money supply. The Central Bank of South follows a policy of holdin" rel="nofollow">ing a constant in" rel="nofollow">interest rate. Compare the impact of the tax in" rel="nofollow">increase on in" rel="nofollow">income and in" rel="nofollow">interest rates in" rel="nofollow">in the two countries. Explain" rel="nofollow">in briefly. Be sure to label: i. the axes; ii. the curves; iii. the in" rel="nofollow">initial equilibrium values; iv. the direction the curves shift; and v. the termin" rel="nofollow">inal equilibrium values. 2. The economic in" rel="nofollow">indicators in" rel="nofollow">in the country of Brin" rel="nofollow">inkland, a closed economy, signal that the country is in" rel="nofollow">in equilibrium, both in" rel="nofollow">in the good and services market and in" rel="nofollow">in the market for money. You are hired as an advisor to the Central Bank of Brin" rel="nofollow">inkland. a. The Congress of Brin" rel="nofollow">inkland embarks on a policy to balance the budget and, hence, in" rel="nofollow">increases lump-sum taxes. Use the IS-LM model to illustrate the effects of this policy graphically and explain" rel="nofollow">in briefly to the central bankers. Be sure to label: i. the axes; ii. the curves; iii. the in" rel="nofollow">initial equilibrium values; iv. the direction the curves shift; and v. the termin" rel="nofollow">inal equilibrium values. b. Given the policy above, what should the central bank of Brin" rel="nofollow">inkland do if they want to avoid a recession? Illustrate the effects of this policy graphically and explain" rel="nofollow">in briefly. Be sure to label: i. the axes; ii. the curves; iii. the in" rel="nofollow">initial equilibrium values; iv. the direction the curves shift; and v. the termin" rel="nofollow">inal equilibrium values. 3. Assume that your advice to the central bankers of Brin" rel="nofollow">inkland is so effective that its short-run equilibrium real GDP is now at a level above its natural rate. Take this as your startin" rel="nofollow">ing poin" rel="nofollow">int and use the IS–LM model to illustrate graphically how the levels of in" rel="nofollow">income and in" rel="nofollow">interest rates change as the economy of Brin" rel="nofollow">inkland returns to the natural rate of output in" rel="nofollow">in the long run. Explain" rel="nofollow">in briefly. Be sure to label: i. the axes; ii. the curves; iii. the in" rel="nofollow">initial equilibrium values; iv. the direction the curves shift; and v. the termin" rel="nofollow">inal equilibrium values. Page 2 4. Brin" rel="nofollow">inkland’s authorities now decide to open their economy to trade and let the exchange rate float freely, although they know their economy is too small to affect in" rel="nofollow">international markets. The Congress of Brin" rel="nofollow">inkland main" rel="nofollow">intain" rel="nofollow">ins its policy to balance the budget and, hence, in" rel="nofollow">increases lump sum taxes. Illustrate graphically the short-run impact of this policy on the exchange rate (no. of foreign currency per unit of Brin" rel="nofollow">inkland’s currency) and output of Brin" rel="nofollow">inkland. Explain" rel="nofollow">in briefly. Be sure to label: i. the axes; ii. the curves; iii. the in" rel="nofollow">initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium. 5. Assume that the LM curve for a small open economy with a floatin" rel="nofollow">ing 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 NX is NX = 200 – 100e, where e is the exchange rate. The price level (P) is fixed at 1.0. The in" rel="nofollow">international in" rel="nofollow">interest rate is r * = 2.5 percent. a. Usin" rel="nofollow">ing the LM curve, fin" rel="nofollow">ind the equilibrium level of Y in" rel="nofollow">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? 6. Two small open economies, Fixus and Flexus are otherwise identical except that Fixus main" rel="nofollow">intain" rel="nofollow">ins a fixed exchange rate, while Flexus main" rel="nofollow">intain" rel="nofollow">ins a flexible exchange-rate regime. The governments of both countries decrease spendin" rel="nofollow">ing by the same amount. Compare what happens in" rel="nofollow">in the two countries to: a. the exchange rate b. equilibrium output c. net exports.