Question 1

If investors in a large open economy become more willing to substitute foreign and domestic assets, then this will make the net capital outflow function:

Accepted Answer

When investors are more willing to substitute between foreign and domestic assets, the net capital outflow function becomes flatter, indicating that capital flows are more responsive to changes in the interest rate. This increased responsiveness also makes the IS curve flatter, as changes in the interest rate have a larger effect on net exports and thus on aggregate demand.

Question 2

The introduction of a stylish new line of Toyotas, which makes some consumers prefer foreign cars over domestic cars, will, according to the Mundell-Fleming model with fixed exchange rates, lead to:

Accepted Answer

Under the Mundell-Fleming model with fixed exchange rates, an increase in demand for foreign goods (in this case, Toyotas) leads to an outflow of currency to purchase these goods. This results in a decrease in the domestic money supply (assuming the central bank does not intervene), which can lead to higher interest rates and a decrease in investment and consumption, ultimately causing a fall in income. Additionally, since more foreign goods are being imported, net exports will decrease.

Question 3

The goods produced in U.S. industries may be made more competitive in world markets by:

Accepted Answer

Depreciating the U.S. currency would make American goods relatively cheaper in comparison to foreign goods, making them more competitive in world markets. This is because a weaker currency lowers the cost of exports and makes imported goods more expensive. Conversely, appreciating the U.S. currency would make American goods relatively more expensive, hurting their competitiveness in global markets. Keeping the exchange rate fixed or expanding the money supply may have little effect on the competitiveness of U.S. industries in the short run.

Question 4

The government of a small open economy with perfect capital mobility wants to establish a "stronger" currency by moving its exchange rate higher. Suggest both an appropriate monetary policy adjustment and an appropriate fiscal policy adjustment that would allow the economy to move to a higher exchange rate. What are the consequences of these adjustments on domestic output and net exports?

Accepted Answer

The answer of The government of a small open economy...

Question 5

Suppose Congress cuts government spending in order to balance the budget. Use the Mundell-Fleming model with floating exchange rates to illustrate graphically the short-run impact of the cuts in government spending on the dollar exchange rate and output in the United States. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Accepted Answer

The answer of Suppose Congress cuts government spending in order...

Question 6

Explain how net capital outflows change in a large open economy when there is a: 
a. monetary contraction
b. fiscal contraction.

Accepted Answer

The answer of Explain how net capital outflows change in...

Question 7

Macroland is a small open economy with perfect capital mobility and a flexible-exchange-rate system. Macroland is initially in equilibrium at the natural level of output with balanced trade. Compare the impact of a tax cut in the short run (when prices are fixed) and in the long run (when prices are flexible) on: (a) output, b) consumption, (c) investment, (d) net exports, and (e) the exchange rate.

Accepted Answer

The answer of Macroland is a small open economy with...

Question 8

In early 1994, Mexico was adhering to a fixed-exchange-rate system. Use the Mundell-Fleming model to illustrate graphically the short-run impact on the exchange rate and level of output of increased country risk caused by the Chiapas uprising and the assassination of presidential candidate Colosio. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Accepted Answer

The answer of In early 1994, Mexico was adhering to...

Question 9

Assume that the LM curve for a small open economy with a fixed exchange rate is given by Y = 200r - 200 + 2(M/P). This IS curve is given by Y = 400 + 3G - 2T + 3NX - 200r. The function for the net exports is NX = 200 - 100e, where e is the exchange rate. The price level is fixed at 1.0, the world interest rate is r^* = 2.0 percent, and the exchange rate is initially 1.0. a. If $M = 100 , G = 100$, and $T = 100$, solve for the equilibrium short-tun values of $Y$ and $N X$. Is the initially given exchange rate equal to the equilibrium exchange rate? b. If the Fed buys bonds in order to raise the money supply, will equilibrium $Y$ increase?

Accepted Answer

The answer of Assume that the LM curve for a...

Question 10

In the Mundell-Fleming model with a fixed exchange rate, a rise in the world interest rate will lead income:

Accepted Answer

In the Mundell-Fleming model with a fixed exchange rate, a rise in the world interest rate leads to capital outflows, which reduces domestic income. However, net exports remain unchanged because the exchange rate is fixed, preventing any change in the trade balance.

Question 11

A U.S. Congressman wants to reduce the U.S. trade deficit by imposing tariffs on imports. Use a model of a large open economy with a flexible exchange rate to predict the impact of tariffs on U.S. imports, exports, net exports, the exchange rate, and the interest rate.

Accepted Answer

The answer of A U.S. Congressman wants to reduce the...

Question 12

Assume that the LM curve for a small open economy with a floating 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 international interest rate is r^* = 2.5 percent. a. Using the $L M$ curve, find the equilibrium level of $Y$ 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 $N X$ ? c. If this value of $N X$ is to be achieved, what must be the equilibrium exchange rate, $e$ ?

Accepted Answer

The answer of Assume that the LM curve for a...

Question 13

Two small open economies, Fixed and Flex, can be described by the Mundell-Fleming model. The countries are otherwise identical except that Fixed maintains a fixed exchange rate, while Flex maintains a flexible exchange-rate regime. The governments of both countries increase spending by the same amount. Compare what happens in the two countries to: 
a. the exchange rate
b. equilibrium output
c. net exports.

Accepted Answer

The answer of Two small open economies, Fixed and Flex,...

Question 14

The introduction of automatic teller machines, which reduces the demand for money, will, according to the Mundell-Fleming model with fixed exchange rates, lead to:

Accepted Answer

The answer of The introduction of automatic teller machines, which...

Question 15

a. You are the chief economic adviser in a small open economy with a floating-exchange-rate system. Your boss, the president of the country, wishes to increase the level of output in the short run in order to win reclection. Do you recommend using expansionary or contractionary monetary or fiscal policy?

b. Use the Mundell-Fleming model to illustrate graphically your proposed policy. Be sure to Label: 
i, the azes; 
ii. the curves, 
iii. the initial equilibrium levels
iv. the direction the curves shift
v. the new short-run equilibrium

Accepted Answer

The answer of a. You are the chief economic adviser...

Question 16

Economic expansion throughout the rest of the world raises the world interest rate. Use the Mundell-Fleming model to illustrate graphically the impact of an increase in the world interest rate on the exchange rate and level of output in a small open economy with a floating-exchange-rate system. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Accepted Answer

The answer of Economic expansion throughout the rest of the...

Question 17

Suppose the government of a small open economy with a floating exchange rate imposes 50 percent tariffs on all imports. Use the Mundell-Fleming model to illustrate graphically the short-run impact of the tariffs of the exchange rate and output in the country. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium levels; iv. the direction the curves shift; and v. the new short-run equilibrium.

Accepted Answer

The answer of Suppose the government of a small open...

Question 18

Assume that a large open economy with a floating exchange rate is described in the short run by the equations:
C = 0.5(Y - T)
T = 1,000
I = 1,500 - 250r
G = 1,500
NX = 1,000 - 250e
C + I + G + NX = Y
M/P = 0.5Y - 500r
M = 1,000
CF = 500 - 250r
NX = CF
The last two equations specify that CF, net capital outflow, decreases with r, the interest rate, and that NX, the net exports, is equal to net capital outflow. NX is also related to the exchange rate, e, and falls when e appreciates. The price level (P) is fixed at 1.0.

Calculate short-run equilibrium values of Y, r, C, I, CF, NX, e, private saving, public saving, and foreign saving. Foreign saving is defined here as minus NX. Check your work by ensuring that C + I + G = Y and private saving plus public saving plus foreign saving equals domestic investment. (Hint: As in the appendix to textbook Chapter 13, form the IS curve from C + I + G + NX = Y, and then substitute CF for NX to get C + I + G + CF = Y. Combine with the LM curve and solve for Y, r, and CF and then use NX = CF to get NX and the equation relating NX to e to get e.)

Accepted Answer

The answer of Assume that a large open economy with...

Question 19

In the Mundell-Fleming model with a floating exchange rate, a rise in the world interest rate will lead income:

Accepted Answer

The answer of In the Mundell-Fleming model with a floating...

Question 20

The introduction of automatic teller machines, which reduces the demand for money, will, according to the Mundell-Fleming model with floating exchange rates, lead to:

Accepted Answer