Question

1. In the two-period small open (endowment) economy model reviewed in Chapter 3 of the textbook, when a consumer chooses to allocate all of its lifetime wealth to consumption in period 2 and if Bo=0 then her C2 must be equal to: (a) Q2 + (b) Q2 + 14, (c) Q:(1+r)+22 (d) Q2(1 + r) + Q1 (e) 9+02 2. When the world interest rate rises then the income effect leads to a(n): (a) decrease in consumption in period 1 if the country is a creditor (b) decrease in consumption in period 1 if the country is a debtor (c) increase in consumption in period 1 if the country is a debtor (d) decrease in consumption in period 2 if the country is a debtor 3. In the two-period model of chapters 3 and 4, a decrease in the world interest rate makes (a) consumption in period 1 more expensive relative to consumption in period 2 (b) consumption in period 1 less expensive relative to consumption in period 2 (c) the IBC rotate clockwise around the endowment point, becoming steeper (d) the IBC rotate counter clockwise around the endowment point, becoming less steep. (e) b and d (f) a and c 4. All else equal, an increase in the terms of trade of period 2 (temporary shock) (a) raises consumption in period 1 and improves the trade balance in period 1. (b) raises consumption in period 1 and worsens the trade balance in period 1. (c) does not affect the level of consumption in period 1 (d) does not affect the current account and the trade balance in period 1. 5. In chapter 4 we say that under imperfect information what matters for the determination of the current account (a) the actual path of income (b) the expected path of income (c) both the actual path of income and the expected path of income (d) none of the above

Answer 1

1. (c) Q1(1+r1) + Q2

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2. (b) decrease in consumption in period 1 if the country is a debtor.

Reason: Higher interest rates lower consumption through the substitution effect, because current consumption becomes expensive relative to saving--households reduce their spending today in favor of spending tomorrow.

3. (f) a and c

Reason: Higher interest rates lower consumption through the substitution effect, because current consumption becomes expensive relative to saving--households reduce their spending today in favor of spending tomorrow and IBC slope is−(1+r1), because if you sacrifice one unit of consumption and put it in the bank for one period, you get 1+r1units next period.

4. (b) raise consumption in period 1 and worsens the trade balance in period 1

5. (b) the expected path of income

Reason: the determination of the current account is not the actual path of income,but the expected path of income