IS-LM open economy

Question 1

Formula for demand in an open economy?

Answer 1

See iPad

Question 2

What affects imports and exports in the goods market?

Answer 2

Imports (IM): Increase with Y and real exchange rate (e)
Exports (X): Increase with foreign income (Y*) and decrease with real exchange rate (e)

Question 3

Why is the multiplier smaller in an open economy?

Answer 3

Because part of the increased demand spills over into imports, reducing the domestic impact of fiscal policy

Question 4

What is the multiplier?

Answer 4

The factor by which an initial change in spending or tax can lead to larger change in national income

Question 5

Spending multiplier

Answer 5

1/MPS
MPS - Marginal propensity to save

Question 6

Money multiplier

Answer 6

1/ Reserve requirement

Question 7

What happens when government spending (domestic demand) increases (fiscal policy)

Answer 7

Demand is higher
Output increases
Increase in output leads to increase in imports
Increased output does not affect exports
Trade deficit

Question 8

What happens when foreign demand increases?

Answer 8

Increase in demand for domestic goods
Output increases, increasing income and consumption
Trade surplus (multiplier effect)

Question 9

Differences in an open economy

Answer 9

Smaller multiplier
Expansionary fiscal policy deteriorates the trade surplus
No control over foreign demand

Question 10

Direct effects of depreciation

Answer 10

Exports increase
Imports decrease

Question 11

Marshall-learner condition:

Answer 11

Exports increase enough and Imports decrease enough to compensate for the increase in price of imports that a real
depreciation leads to an increase in net exports.

Question 12

To eliminate trade deficit without changing output the government can do what?

Answer 12

Reduce government spending.
Depreciation.

Question 14

What is the J-curve effect?

Answer 14

After a depreciation, net exports initially worsen before improving.