ECS2602
ASSIGNMENT 2
DUE DATE: 14 SEPTEMBER 2026
,ECS2602 ASSIGNMENT 2 2026
DUE 14 SEPTEMBER 2026
Learning Unit 7: The IS-LM model in an open economy
The left-hand diagram shows a downward shift of the LM curve from LM to LM₁ (interest
rate falls from iˉ\bar{i}iˉ to iˉ1\bar{i}_1iˉ1). Equilibrium moves from point a to a₁. Output
rises from Y to Y₁. The right-hand diagram shows the interest parity relation (IPR).
Equilibrium moves from a to a₁; the nominal exchange rate falls from E to E₁.
Question 1
What will happen to investment spending (I)? Give two reasons for this change.
Investment spending (I) increases.
The interest rate falls from iˉ\bar{i}iˉ to iˉ1\bar{i}_1iˉ1 expansionary monetary policy /
downward shift of LM. There is a negative relationship between the interest rate and
investment, so lower i raises I movement down along the IS curve)
Output/income rises from Y to Y₁. Higher Y raises induced investment (accelerator
effect).
(IS-LM notes; Blanchard open-economy IS-LM analysis)
, Question 2
What happens with the nominal exchange rate? Give the reason for this change.
The nominal exchange rate decreases (E falls to E₁; domestic currency depreciates).
The domestic interest rate falls relative to the foreign interest rate. The interest parity
condition, investors require a depreciation of the domestic currency (expected
appreciation later) to restore equilibrium. The IPR curve shows the movement from a to
a₁.
Question 3
What happens to exports? Give the reason for this change.
Exports increase.
The domestic currency depreciates (E falls). Domestic goods become relatively cheaper
for foreigners, so foreign demand for exports rises (Marshall-Lerner condition).
ASSIGNMENT 2
DUE DATE: 14 SEPTEMBER 2026
,ECS2602 ASSIGNMENT 2 2026
DUE 14 SEPTEMBER 2026
Learning Unit 7: The IS-LM model in an open economy
The left-hand diagram shows a downward shift of the LM curve from LM to LM₁ (interest
rate falls from iˉ\bar{i}iˉ to iˉ1\bar{i}_1iˉ1). Equilibrium moves from point a to a₁. Output
rises from Y to Y₁. The right-hand diagram shows the interest parity relation (IPR).
Equilibrium moves from a to a₁; the nominal exchange rate falls from E to E₁.
Question 1
What will happen to investment spending (I)? Give two reasons for this change.
Investment spending (I) increases.
The interest rate falls from iˉ\bar{i}iˉ to iˉ1\bar{i}_1iˉ1 expansionary monetary policy /
downward shift of LM. There is a negative relationship between the interest rate and
investment, so lower i raises I movement down along the IS curve)
Output/income rises from Y to Y₁. Higher Y raises induced investment (accelerator
effect).
(IS-LM notes; Blanchard open-economy IS-LM analysis)
, Question 2
What happens with the nominal exchange rate? Give the reason for this change.
The nominal exchange rate decreases (E falls to E₁; domestic currency depreciates).
The domestic interest rate falls relative to the foreign interest rate. The interest parity
condition, investors require a depreciation of the domestic currency (expected
appreciation later) to restore equilibrium. The IPR curve shows the movement from a to
a₁.
Question 3
What happens to exports? Give the reason for this change.
Exports increase.
The domestic currency depreciates (E falls). Domestic goods become relatively cheaper
for foreigners, so foreign demand for exports rises (Marshall-Lerner condition).
