Mundell-Fleming-Model and AD-AS Model (26 points)
A small open economy with perfect capital mobility is currently in its long run equilibrium with ???? and r = r*. Suddenly the world interest rate r* increases.
(a) What might cause the world interest rate to increase?
(b) Analyze the effect of the increase in r* on income and the price level in the short-run and in
the long-run for a country that has a flexible exchange rate regime.
(c) Analyze the effect of the increase in r* on income and the price level in the short-run and in
the long-run for a country that has a fixed exchange rate regime.
The production function of a closed economy is given by
b) Draw the Solow-model graph and mark the steady state level of capital stock per worker and the steady state level of income per worker in your graph.
c) How do you know that the steady state is stable? Explain, using your graph.
d) Calculate the steady state values of capital and income per worker.
g) Assume that the depreciation rate δ falls. Analyze graphically the effect of this decrease in δ on capital, income and consumption per worker. Does the fall in δ have a long-run growth effect or a long-run level effect?
h) Suppose that the country unexpectedly discovers new oil reserves. Assume here that oil forms a major part of the country's capital stock. How will the discovery of new oil reserves affect the economy's capital, income and consumption per worker in the short-run and in the long-run?
Explain in words and support your answer with a graph. What does your result imply for thelong-run benefits of capital injections?