Assume that in a small open economy where full employment always prevails, national saving is 250....

Assume that in a small open economy where full employment always prevails, national saving is 250.

a. If domestic investment is given by I = 650 – 22 r, where r is the real interest rate, what would the equilibrium "r" be if the economy were closed?

b. If the economy is open and the world interest rate is 11 percent, what will investment be?

c. Using your answer from part b., what is the current account surplus/deficit ?

d. What is the net capital flow?

Solutions

Expert Solution

(a)

Setting S = I,

250 = 650 - 22r

22r = 400

r = 18.18

(b)

When r = 11,

I = 650 - (22 x 11) = 650 - 242 = 408

(c)

Since S < I, X < M and there is current account deficit.

Current account deficit = I - S = 408 - 250 = 158

(d)

Current account deficit of 158 means a Net capital inflow of 158.

Rahul Sunny answered 2 years ago

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