If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the IS* curve:
A)slopes downward and to the right because the higher the exchange rate, the lower the level of net exports and, therefore, of short-run equilibrium income in the goods market.
B)is vertical because there is only one investment level that is consistent with the world interest rate.
C)is vertical because the exchange rate does not enter into the IS* equation.
D)slopes downward and to the right because the higher the exchange rate, the higher the level of net exports and, therefore, of short-run equilibrium income in the goods market.

Question

Quizplus · Accepted Answer

In the Mundell-Fleming model, the IS* curve represents the combinations of output and the exchange rate that satisfy the goods market equilibrium condition. Higher exchange rates lead to lower net exports, which reduces the level of short-run equilibrium income in the goods market. Hence, the IS* curve slopes downward and to the right.

If Short-Run Equilibrium in the Mundell-Fleming Model Is Represented by a Graph