Assume a Keynesian small open economy. Let r be the real interest rate, the desired consumption and desired investment can be described by Cd = 200 + 0.6(Y − T) − 200r and Id = 300 − 300r, respectively. Government tax is T = 40 + 0.2Y and government purchase is G = 174. The net exports function is NX = 150 − 0.08Y − 500r. The real money demand function is L = 0.5Y − 250r. Assume the nominal money supply is fixed at 920 and the full employment level of output is Y = 1000.
(a) Calculate the general equilibrium value of output, the real interest rate, consumption, investment, net export and the price level.
(b) Suppose the government cuts the government spending to G = 112. Calculate the short-run equilibrium output and real interest rate after this fiscal policy change.
(c) Calculate the price level in the long run. Briefly explain the intuition of the movement of the price level.
(d) Illustrate the short-run and long-run economic response using the ISLM-FE model in a graph