Consider an economy where
C=200+0.25(Y-T)
I=150+0.25Y-1000i
G=250, T=200
(M/P)d=2Y-8000i
(M/P)s =1600
X = 0.3Y*, IM =0.2Y,
ε (real exchange rate) = 2, Y* is foreign output (Y*=900)
i) If government follows an expansionary fiscal policy and G changes by 60, calculate the change in Y for both the closed economy (?Yclosed) the open economy (?Yopen). Assume no change in the foreign output (Y*), Calculate the new trade balance.
ii) If this economy has flexible exchange rate regime, how would the exchange rate respond to a fiscal expansion policy? Appreciation or Depreciation? Explain why.