Suggested Solutions to Assignment 2 - Department of Economics

In the short run, the price level remains fixed at 2. M has increased to 1024. Substituting
r = 0.19, M = 1024, and P=2 into the LM curve (Eq. (6)), we get
1024 5
0.19 = − + Y
200* 2 2000
1
⇒ 0.19 = −2.56
+ Y
400
1
⇒ Y = 2.75
400
⇒ Y = 1100.
So, the short-run equilibrium value of the output is 1100 (output has increased in the
short run).
Substituting r = 0.19 and Y = 1100, and P=2 into the IS curve (Eq. (4)), we get
810 5 6
0.19 = − e − 1100
500 5000 5000
⇒ 0.19 = 1.62 − 0.001e
−1.32
⇒ 0.001e
= 0.11
⇒ e = 110.
So, the short-run equilibrium value of real exchange rate, e = 110 (the real exchange rate
has depreciated in the short run).
The short-run equilibrium value of net exports,
NX = 170 - 0.08*1100 - 0.5*110 = 27 (net exports have increased in the short run).
The short-run equilibrium value of consumption,
C= 200 + 0.6(1100 – 20-0.2*1100) – 200*0.19 = 200 + 0.6(860)-38 = 678 (consumption
has increased in the short run).
The short-run equilibrium value of investment, / = 300 – 300*0.19 = 243 (investment has
remained unchanged in the short run).
Figure 4(d) illustrates the short-run equilibrium values of output and the real interest rate
in the IS-LM-FE diagram.
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