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 – 20r, where r is the real interest rate measured in percentage, and the world real interest rate is 10 percent.

a.

Compute the investment, trade balance, and net capital outflow. (Note: be careful in doing the calculation especially regarding the real interest rate measurement. Recall that real interest rate has already measured in percentage).

b.

Does the investment 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 increase in G?

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