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Consider the Open Economy IS-LM Model discussed in the course. You are given the following information:
C = 200 + 0.8(Y - T)
I = 200 - 10r
G = 300
T = 0.2Y
NX = 100 - 10e
L(Y,r) = Y - 50r
rstar = 10 (The World Real Interest Rate)
a) Derive the open economy version of the IS curve and plot it on a graph with Y on the horizontal axis and e on the vertical axis.
b) Derive the open economy version of the LM curve and plot it on your graph in part a). What is the equilibrium nominal exchange rate if P=1 and M=1000?
c) Discuss the effects of a decrease in taxes under a floating exchange rate regime. Specifically, what are the short run effects on Y, NX, C and I? Would you recommend fiscal stimulus in a recession if a country has a floating exchange rate? Show graphically, you don't need to solve for the specific numbers.
d) How does your result from part c) change under a fixed exchange rate regime? Name one advantage each for flexible and fixed exchange rate regimes.
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