Question

11. Assume that the world works according to the Classical model. In a small open economy, output is produced according to a Cobb-Douglas production function, consumption is equal to C=40+0.6(Y-T) and the investment function is I=280-10r. You know that the output produced is Y=900, government spending is G=150, taxes are T=90 and that the world real interest rate is 4% (r*=4).
In all the questions below, make sure to explain your answers and show all your work.

a. Compute: i. Private saving, Public saving, and National saving; ii. the amount of net capital outflows for this country; iii. the trade balance of this country. Show your work.

Answer 1

Consumption = 40 + 0.6*(900 – 90) = 526

i) Private saving = Y – T – C = 900 – 90 – 526 = 284

Public saving = T – G = 90 – 150 = -60

National Saving = Private saving + Public saving = 224

Investment = 280 – 10*4 = 240

ii) Net capital outflows = S – I = 224 – 240 = -16

iii) Trade balance = Y – C – I – G = 900 – 526 – 150 – 240 = -16