answerstohomework3spring2007amended - Economics 302 Spring...

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Sheet1 Page 1 Economics 302 Spring 2007 Answer Key: Homework 3 1. a. Y = 2000. C = 1000. S = 2000-1000-500 = 500. Using the condition S=I implies r=10%. The graph is the standard one used in section: national savings is a vertical line, the investment demand function is linear, downward sloping and crosses the y-axis at I 1000 b. In an open economy, the domestic interest rate will equal the world interest rate. The assumption needed to get this is that of perfect capital mobility. Under perfect capital mobility and a world interest rate r*, domestic firms would never pay a domestic investor more than r*, since it could always get a cheaper loan on the international capital market. At the same time, a domestic investor would never lend to a firm at less than r*, since it could always lend its money to a foreign firm and earn return r*. Thus, the equilibrium domestic interest rate with a small open economy must have r=r*. The appropriate graph should demonstrate that it is the interest rate r=5% which is fixed first. Given this, you can find I(r) from the investment demand curve. Compare this with national income, S, to get the trade balance. c. National savings will be S = Y-C-G = 500. (Under the assumptions of our
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answerstohomework3spring2007amended - Economics 302 Spring...

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