In the Mundell-Fleming model on a Y - e graph, the curves labeled IS^* and LM^* are labeled that way as a reminder that: A) the price level is held constant at the world price level p*. B) the interest rate is held constant at the world interest rate r*. C) the exchange rate is held constant at the world exchange rate e*. D) output is held constant at the full employment level.

Question

Quizplus · Accepted Answer

The curves labeled ISS1U1P1*S1S1P0 and LMS1U1P1*S1S1P0 are the IS and LM curves respectively, under fixed exchange rates in the Mundell-Fleming model. The label "U1" indicates that output is at its full employment level, so option D is incorrect. The label "*S1S1P0" indicates that the price level is fixed at the world price level, so option A is also incorrect. The label "L" in the LM curve stands for liquidity preference, which depends on the interest rate. Hence, the curve LMS1U1P1*S1S1P0 is labeled that way as a reminder that the interest rate is held constant at the world interest rate r*. Thus, option B is the correct answer.

In the Mundell-Fleming Model on a Y - E Graph