In the context of the Mundell-Fleming model of an open economy (where the exchange rate is defined as…
In the Mundell-Fleming open-economy model, the IS curve shifts upward and to the right whenever autonomous aggregate demand (C + I + G + NX) increases: (1) when the exchange…
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In the context of the Mundell-Fleming model of an open economy (where the exchange rate is defined as units of domestic currency per unit of foreign currency), consider the following variables that shift the IS function:
1. a rise in the exchange rate
2. an increase in foreign income
3. a cut in taxes
4. a fall in exchange rate.
Which of the following combinations of these factors shift the IS function upwards towards the right ?
Answer and explanation
Correct answer C
In the Mundell-Fleming open-economy model, the IS curve shifts upward and to the right whenever autonomous aggregate demand (C + I + G + NX) increases: (1) when the exchange rate is defined as units of domestic currency per unit of foreign currency, a rise in the exchange rate represents a depreciation of the domestic currency, which makes exports cheaper and imports dearer, increasing net exports (NX) and shifting the IS curve to the right; (2) an increase in foreign income boosts foreign demand for domestic exports, raising net exports (NX) and shifting the IS curve to the right; and (3) a cut in taxes increases disposable income and consumption (C), also shifting the IS curve to the right. By contrast, a fall in the exchange rate (4) represents a currency appreciation that reduces net exports. Therefore, the correct combination is 1, 2, 3 .
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UGC NET Economics