ECON 456-GUW-Ch4-probs.pdf - Problem-1 Consider a...

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Econ 456 Page 1 of 2 Problem-1 . Consider a two-period model of a small open economy with a single good each period. Let preferences of the representative household be described by the utility function ln(C 1 ) + ln(C 2 ), where C 1 and C 2 denote consumption in periods 1 and 2, respectively, and ln denotes the natural logarithm. In period 1, the household receives an endowment of Q 1 = 10. In period 2, the household receives profits, denoted by π 2 , from the firms it owns. Households and firms have access to financial markets where they can borrow or lend at the interest rate r 1 . (r 1 is the interest rate on assets held between periods 1 and 2.). Firms invest in period 1 to be able to produce goods in period 2. The production technology in period 2 is given by Q 2 = √(I 1 where Q 2 and I 1 denote, respectively, output in period 2 and investment in period 1. Assume that there exists free international capital mobility and that the world interest rate, r*, is 10% per period (i.e., r* = 0.1). Finally, assume ),

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