Economics 302
Spring 2008
Homework #3
Homework will be graded on completeness and content as well as neatness. Sloppy or
illegible work will not receive full credit. This homework requires the use of Microsoft
Excel, and round your answers to two decimal places when appropriate.
1.
Small Open Economy
Use the following set of Classical Model equations for a small open economy to
answer the following questions.
Y = F (K, L) = AK
α
L
1α
C = C (Y – T) = 23 + .72 (Y – T)
I = I (r*) = 325 – 15.5 r* (Where r is expressed as a percentage, i.e. if the interest
rate is 5% then r = 5 in the equation.)
Y = C + I + G + NX
Y = C + S
P
+ T
G = 220
T = 155
K = 1000
L = 8000
A = 0.3
Capital’s Share of Income = 1/3
a.
What is aggregate output, Y, for this economy?
b.
What is the level of consumption, C, for this economy?
c.
What is the level of investment, I, for this economy if the world real interest rate
(r*) is 7%?
d.
Given the information you have found in parts ac, find the level of net exports for
this economy.
e.
Is this country borrowing from or lending to foreigners? What is the relationship
between domestic spending and domestic production in this economy, and how do
these two topics relate to one another?
f.
Suppose government spending increases by 25.
What are the effects of the
increased government spending on the level of output, consumption, investment,
and net exports in this economy?
g.
Did the increase in government spending completely crowd out investment
spending as it would have in a closed economy?
Explain your answer.
1
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h.
What happens to the country’s real exchange rate when government spending
increases, holding everything else constant? Explain your answer.
Will foreign or
domestic goods become more attractive with the change in the real exchange rate?
i.
Assume that the Money Supply for this small open economy is 300 and that the
velocity of money is 6.
If the real exchange is 3 US goods for each domestic
good and the price level in the US is 2.25 then what is the nominal exchange rate
between this country and the US?
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 Spring '07
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 Economics, Macroeconomics, Inflation, Unemployment, labor force

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