PS-7 - Spring 2016-Intt 212 Problem Set 7 Please try to...

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Spring 2016-Intt 212 - Problem Set 7 Please try to solve the problems on your own and check your answers with the following ones: End of Chapter 19 problems: 1, 2, 4, 5, 7, 9, 10, 12, 1. a. Because it takes considerable investment to develop uranium mines, you would want a larger current-account deficit to allow your country to finance some of the investment with foreign savings. b. A permanent increase in the world price of copper would cause a short-term current account deficit if the price rise leads you to invest more in copper mining. If there are no investment effects, you would not change your external balance target because it would be optimal simply to spend your additional income. c. A temporary increase in the world price of copper would cause a current account surplus. You would want to smooth out your country’s consumption by saving some of its temporarily higher income. d. A temporary rise in the world price of oil would cause a current account deficit if you were an importer of oil, but a surplus if you were an exporter of oil. 2. Because the marginal propensity to consume out of income is less than 1, a transfer of income from B to A increases savings in A and decreases savings in B . Therefore, A has a current account surplus and B has a corresponding deficit. This corresponds to a balance of payments disequilibrium in Hume’s world, which must be financed by gold flows from B to A . These gold flows increase A ’s money supply and decrease B ’s money supply, pushing up prices in A and depressing prices in B . These price changes cease once the balance of payments equilibrium has
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