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PS 7 Fall 08 Ans - Problem Set 7 FE312 Fall 2008 Rahman...

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Problem Set 7 FE312 Fall 2008 Rahman Some Answers 1) Consider an economy described by the following equations: 5 * 500 500 50 1000 ) ( 75 . 0 250 1000 1000 5000 = = - = - = - + = = = = + + = r r NX r I T Y C T G Y G I C Y ε a. In this economy, solve for national saving, investment, the trade balance, and the equilibrium exchange rate. S = I = 750. NX = 0. ε = 1 b. Suppose now that G rises to 1250. Solve for national saving, investment, the trade balance, and the equilibrium exchange rate. ` S = 500. I = 750. NX = -250. ε = 1.5 c. Now suppose the world interest rate rises from 5 to 10 percent (G is again 1000). Solve for national saving, investment, the trade balance, and the equilibrium exchange rate. S = 750. I = 500. NX = 250. ε = 0.5 2) The country of Leverett is a small open economy. Suddenly, a change in world fashions makes the exports of Leverett unpopular. a. What happens in Leverett to saving, investment, net exports, the interest rate, and the exchange rate? Page 1 of 6
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Problem Set 7 FE312 Fall 2008 Rahman When Leverett’s exports become less popular, its domestic saving Y – C – G does not change. This is because we assume that Y is determined by the amount of capital and labor, consumption depends only on disposable income, and government spending is a fixed exogenous variable. Investment also does not change, since investment depends on the interest rate, and Leverett is a small open economy that takes the world interest rate as given. Because neither saving nor investment changes, net exports, which equal S – I, do not change either. This is shown below as the unmoving S – I curve.
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