Question

Question 3 Consider a small open economy. Assume that the following variables are exogenously set: G=1,000; T=800; L=2,500; K=3,000; A=1 and a=0.3. In addition, the consumption function is given by: C=50+0.65(Y-T). Investment is given by: 1=1,000-20r Finally, the world real interest rate is 6% and net exports are given by: NX=500-100€ (e=real exchange rate) Using the long-run model developed in chapter 5, compute the equilibrium values of the following variables. National saving equals Investment equals Trade balance equals The real exchange rate equals

Answer 1

Cobb Douglas production function;

Y=A*K^a*L^(1-a)

Y=1*3000^0.3*2500^0.7=100*30^0.3*25^0.7=2640.55

C=50+0.65(2640.55-800)=50+0.65*1840.55=1246.3575

National saving=Y-C-G=2640.55-1246.3575-1000=394.1925

Investment=1000-20*6=1000-120=880

National saving=Investment+ trade balance

Trade balance=national saving- investment=394.1925-880=-485.8075

NX=500-100e

-485.8075=500-100e

985.8075=100e

e=985.8075/100=9.858075