Re: sample questions of ISI ME 2 , 2010

Posted by Dheeraj on Mar 01, 2014; 12:10pm
URL: http://discussion-forum.276.s1.nabble.com/sample-questions-of-ISI-ME-2-2010-tp4990586p7584972.html

Ans-5 Someone pls let me know if this is correct

  trade balance is given by  TB = T`+ bP*/P - mY, so trade balance equilibrium will be when TB=0, i.e.
  mY = T` + bP*/P

  Commodity market equilibrium:
   Y = C + I + G + X - M
   Y = C`+ c(1-t)Y + I`-br + G`+ X`- mY    ; here (`) represents (bar) to represent exogenous..Here we assume export as exogenous.

   Y = A`+ c(1-t)Y - br - (T`+ bP*/P)  ; where A`= C`+I`+G`+X` and from TB equilibrium mY = T` + bP*/P

   [ 1-c(1-t) ] Y = A`- br - (T`+ bP*/P)

 (a) this curve will be same as IS curve for closed economy because both represent the negative relation between r and Y. LM curve can be drawn as usual upward sloping on (Y,r) plane.

 (b) Now if government spending is increased this curve would shift rightwards causing an increase in interest rate and income. Now when income increases, imports will increase and trade balance will get worsen. To maintain the trade balance equilibrium, the home currency should depreciate i.e. exchange rate 'e' should increase.
 
 (c) when P* increases, income should decrease from the above equation. and then to maintain the trade balance 'e' should also decrease.

  Let me know if there is something wrong in  this..