Question

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.

b. Assume that the public authorities of this country decide to decrease government spending G from $150 to $100. Assume that all other countries around the world leave their policies unchanged.
i. Compute the change in Private saving, Public saving, and National saving after G is decreased to $100.
ii. What will happen in the domestic loanable funds market of this country after the decrease in G? Will the domestic supply of loanable funds change? Will the domestic demand of loanable funds change?
iii. Compute the change in the trade balance of this country after G is decreased to $100.

c. Assume again that in this country government spending G is decreased from $150 to $100. However, assume now that most countries in the rest of the world decide to follow the same policy and decrease government spending. As a consequence, the world real interest rate decreases to 3% (r*=3).
i. Compute the change in Private saving, Public saving, and National saving after G is decreased to $100 and the world real interest rate decreases to 3%.
ii. What will happen in the domestic loanable funds market of this country after the decrease in G and the decrease in r*? Will the domestic supply of loanable funds change? Will the domestic demand of loanable funds change?
iii. Compute the change in the trade balance of this country after G is decreased to $100 and the world real interest rate decreases to 3%.

Answer 1

hi. Please post parts and subparts in lot of four. Thank you!