Question

in a small open economy with full employment, consumption depends only on disposable income. National saving is 300, investment is given by I = 400 – 20r, where r is the real interest rate measured in percentage, and the world real interest rate is 10 percent.

Compute the investment, trade balance, and net capital outflow.

Answer 1

Given :

1. Small open economy with full employment

2. Consumption depends only on disposable income. i.e. C = f(Y^d)

3. National saving is 300 i.e. S

4. Investment is given by I = 400 – 20r, where r is the real interest rate measured in percentage

5. The world real interest rate is 10 percent.

Compute the investment, trade balance, and net capital outflow.

In an open economy,

S = NX - I

300 = NX - (400 - 20r)

Now as the economy given is a small open economy hence it will take the world interest rate as given i.e. r = 10

300 = NX - (400 - 20*10)

300 = NX - 200

NX = 500 implies Net capital outlow of -500 because Balance of payment account has to been zero

Investment will be 200

Trade balance will be 500

Net capital outflow will be -500