Question

A small open economy is characterized by the following set of equations:

S= 10 + 100r*

I = 15 – 100r*

Y = 50; G = 50; r*=0.03

a. Find S, I and NX.

b. If I increases by 2 for each r*, repeat part (a)

Answer 1

Answer a : In a small open economy if

S= 10+100r^*

I = 15-100r^*

Y =50 , G=50 and r^* = 0.03

S = 10+100(0.03) = 13

I = 15-100(0.03) = 12

NX =S-I

NX =13-12 =1

When S> I than there is forgien capital outflow . Therefore it is a situation of trade surplus.

b : If I increases by 2 for each r^* than

I =15-100r^*

Now new I = 14

14=15-100r^*

15-14 =100r^*

0.01 =r^*

Now new saving is S = 10+100r^*

S= 10+100(0.01) = 11

NX = S-I = 11-14 = -3

When S< I than there is forgien capital inflow . Therefore it is a situation of trade deficit.