Consider an open economy characterized by the equations below.
The parameters m1 and x1 are the propensities to import and export. Assume that the real exchange rate is fixed at value of 1 and treat foreign income, Y*, as fixed. Aslo assume that taxes are fixed and that government purchaes are exogenous (i.e. decided by the government). We explore the effectiveness of changes in G under alternative assumptions about the propensity to import.
A. Write the equilbrium conditon in the market for domestic good and solve for Y.
B. Suppose government puchases increase by one unit. What is the effect on output? (Assume that 0<m1<c1+d1<1. Explain why.)
C. How do net exports change when government purchases increase by one unit?
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