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METU
Department of Economics
Econ 202 Macroeconomic Theory
Instructor: Şirin Saraçoğlu – Ebru Voyvoda
20102011 Spring Semester
Problem Set 5
Question 1:
Casinolandia (C) and Marcolandia (M) are two close countries that trade with each other but not with
the rest of the world. We can extend our multiplier model to a two country model where variables with
the subscript C refer to Casinolandia and variables with the subscript M to Marcolandia.
Each country is characterized by the following equations,
C
i
=bY
i
IM
i
=m
i
Y
I
i
G
i
T
i
=0
where IM are imports and m is the marginal propensity to import and the subscript i is either C or M
depending on whether we refer to Casinolandia or Marcolandia. Also note that investment and
government spending are exogenous and that taxes are zero in both countries.
The usual equilibrium condition applies here,
Y
i
=Z
i
=C
i
+I
i
+G
i
+X
i
IM
i
Note that in a two country model, by definition, X
c
=IM
m
and X
m
=IM
c
.
a)
Derive the reduced form equation of the equilibrium level of output of Casinolandia, Y
c
. That is,
derive the equation for Y
c
as a function of I
c
, G
c
and Y
m
(note that from C’s perspective, Y
m
is
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View Full Documentexogenous) and parameters. Similarly, derive the equation for Y
m
as a function of C
m
, G
m
, I
m
and Y
c
and parameters.
b) Let,
I
c
=G
c
=60
I
m
=G
m
=30
b
c
=b
m
=0,9
m
c
=0,1
m
m
=0,4
What are the equilibrium levels of output in the two countries? (Note that when solving this you
should get two (easy to solve) equations and two unknowns, Y
c
and Y
m
) What are the two countries
current accounts respectively?
c) Show that, in equilibrium, investment equals savings in both countries.
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