Question: Suppose the country of Nepal, a small open economy can be described by the following equations:

Y = C + I + G + NX

Y = 5000

G = 1000

T = 1000

C = 250 + 0.75(Y - T)

I = 1000 - 50r

NX = 500 - 500e

r = r* = 5

(a) For this economy calculate (i) national savings (ii) level of investment (iii) net exports (iv) equilibrium exchange rate

(b) Suppose that Nepal increases its government spending. Illustrate graphically the effects of this fiscal policy using the model of the small open economy. In your graph clearly label your axis and curves. Based on your graph what happens to the national savings, investment, the trade balance and the equilibrium exchange rate for Nepal?

(c) Suppose we know the magnitude of the increase in government spending by Nepal. Government spending (G) rises to 1250. Solve numerically for national savings, investment, the trade balance, and the equilibrium exchange rate. Confirm the variables shifted in the direction your graph predicted from Part (b).