Question

Suppose that North Korea is a closed economy.

A war breaks out abroad and, as a result, North Korean consumers become uncertain about the future and increase their saving rate.

1) Explain what effect this event would have on the North Korean economy. You do not need to draw the graph, but you do need to describe which curves move and in what direction. No points will be given for answers without an explanation.

2) How would the following variables change as a result of this event?

• Saving
• Investment
• The trade balance
• The interest rate

Answer 1

A war breaks out abroad and as a result ,North Korean consumers become uncertain about the future and decided increase their saving rate 1. Decline in consumer confidence due to the outbreak of war decrease the consumption demand in the economy. Thus there will be surplus of good and services in the economy. Because people will increase their saving rate. Hence consumer will purchase less amount of good than they bought before. So firms will reduce their production of good and services due to fall in demand . Thus it will decrease the aggregate supply of good and services. Economic growth based on consumption expenditure and investment expenditure. So higher saving rate make National GDP to decline Suppose AD-AS model is equilibrium at point A where AD curve and AS curve intersects at Y level of output and P level of price . Fall in consumption and rise in saving rate shifts both AD and AS curve leftward and reduce output from Y to Y1 2. a. Saving : Individuals are uncertain about future due to the outbreak of war. It will reduce their consumer confidence and they rise their saving rate . Because they can use this saving for future consumption. Due to the war , they don't know the future conditions b.Investment : Uncertainty about future , they will decline their investment projects. Because firms are expecting ,low investment return. Thus they become pessimistic about the economy c. The trade balance: In closed economy , there is no import and exports. The nation become self sufficient to produce good and services for their own need. Due to the outbreak of war ,there will be shortage of good and services d. Interest rate: During war period , there will be excess demand for good and services and thus it will rise in interest rate.