Small Open Economy Consider a small open economy described by the following equa

Question

Small Open Economy Consider a small open economy described by the following equations. Y = C + I + G + NX Y = 5000 G = 1000 T = 1000 C = 250 + 0.75 (Y - T) I = 1000 - 50r NX = 500 - 500epsiv r = r* = 5 In this economy, solve for national saving, investment, the trade balance, and the equilibrium exchange rate. Suppose now that G rises to 1250. Solve for national saving, investment, the trade balance, and the equilibrium exchange rate. Explain what you find. Now suppose that the world interest rate rises from 5 to 10 percent (with G 1000). Solve for national saving, investment, the trade balance, and the equilibrium exchange rate. Explain what you find.

Explanation / Answer

a) S= Y-C-G = 750; I = 1000-50(5) = 750; NC= S-I= 0; NX=NC, thus 500-500e = 0, e = 1

b) S= Y-C-G = 500; I = 1000-50(5) = 750; NC = S-I = -250; NX = NC, thus 500-500e = -250; e=1.5   

c) S = Y-C-G = 750; I = 1000-50(10) = 500; I = 1000-50(10) = 500; NC = S-I =250; NX = NC, thus 500 -500e = 250,e=0.5.

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