1. Consider a version of the open economy version of the IS-LM framework. Y = C

Question

1. Consider a version of the open economy version of the IS-LM framework.

Y = Cd + Id + G + X - Q ; let = 1

Cd = c0 + c1 (Y - T)

Id = i0 - i1 * r + i2Y

X = x0 + x1Y*

Q = q0 + q1Y

a) Identify the different marginal propensities for expenditure . Assume that foreign income is fixed.
b) Write out the equilibrium condition in the market for domestic goods and solve for Y.
c) Suppose that government expenditures increase by $1B. What is the impact on Y? Assume that 0 < q1 < c1 + i2 < 1. Why?
d) How do net exports change following the increase in government spending?
e) Suppose that c1 + i2 = 0.6 , but that the q1 is different in two countries. In the first it is 0.1 and in the second it is 0.5. If one country is larger than the other would you expect it to have a larger q1? Explain why or why not.
f) Repeat the answers for parts c) and d) using these parameter estimates.
g) In which country would fiscal policy be more effective? Explain.

Explanation / Answer

c+1=i2 if 1 -e

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