2.
Assume that in a small open economy with full employment, consumption depends only on
disposable income. National saving is 300, investment is given by
I
= 400 – 20
r
, where
r
is the
real interest rate in percent, and the world interest rate is 10 percent.
a.
If government spending rises by 100, does investment change? What is
the level of investment after the change?
b.
Does the trade balance change if
G
rises by 100? If it changes, does it
increase or decrease, and by how much?
c.
Does net capital outflow change if
G
rises by 100? If it changes, does it
increase or decrease, and by how much?
d.
Will the real exchange rate rise, fall, or remain constant as a result of
the change in
G
?
Ans:
a. No. 200.
b. Yes. It decreases by 100.
c. Yes. It decreases by 100.
d. It will rise.
Topic:
Numerical Problems
3.
Assume that the following equations characterize a large open economy:
(1)
Y
= 5,000
(2)
Y
=
C
+
I
+
G
+
NX
(3)
C
= 1/2(
Y
–
T
)
(4)
I
= 2,000 – 100
r
(5)
NX
= 500 – 500
ε
(6)
CF
= –100
r
(7)
CF
=
NX
(8)
G
= 1,500
(9)
T
= 1,000
where
NX
is net exports,
CF
is net capital outflow, and
ε
is the real exchange rate.
Solve these equations for the equilibrium values of
C
,
I
,
NX
,
CF
,
r
, and
ε
. (
Hint:
Substitute
equations (9) and (1) into (3), then substitute (1), (3), (4), (8), and (5) into (2). Then substitute (5)
and (6) into (7). Now you have two equations in
r
and
ε
. Check your work by seeing that all of
these equations balance given your answers.)
Ans:
C
= 2,000;
I
= 1,750;
NX
= –250;
CF
= –250;
r
= 2.5 percent;
ε
= 1.5
Topic:
Numerical Problems