answer 3 - Solutions Chapter 6(17) Balance of Payments I:...

Therefore, the country’s initial external wealth, W
0
(1 r
*
) W
1
, is equal to
the present value of the country’s future trade deficits.
d. How would the expressions in (a) and (b) change if the economy had net labor
income (positive or negative) to or from abroad or net unilateral transfers? Ex-
plain briefly.
:
3. In this question, assume all dollar units are real dollars in billions, so $150 means $150 bil-
lion. It is year 0. Argentina thinks it can find $150 of domestic investment projects
with an MPK of 10% (each $1 invested pays off $0.10 in every later year). Argentina
invests $84 in year 0 by borrowing $84 from the rest of the world at a world real in-
terest rate r
*
of 5%. There is no further borrowing or investment after this.
Use the standard assumptions: Assume initial external wealth W ( W in year 1) is 0.
Assume G 0 always; and assume I 0 except in year 0. Also, assume
NUT KA 0 and that there is no net labor income so that NFIA r
*
W
The projects start to pay off in year 1 and continue to pay off all years thereafter. In-
terest is paid in perpetuity, in year 1 and every year thereafter. In addition, assume that
if the projects are not done, then GDP Q C $200 in all years, so that
PV ( Q ) PV ( C ) 200 200/0.05 4,200.
a. Should Argentina fund the $84 worth of projects? Explain your answer.
.
b. Why might Argentina be able to borrow only $84 and not $150?
c. From this point forward, assume the projects totaling $84 are funded and com-
pleted in year 0. If the MPK is 10%, what is the total payoff from the projects in
future years?